June 2007

From the Insurance Information Institute, New York

Insurance Information Institute 


Insurance scores are confidential rankings based on credit history information. They are a measure of how a person manages his or her financial affairs. People who manage their finances well tend to also manage other important aspects of their lives responsibly, such as driving a car. Combined with factors such as geographical area, previous crashes, age and gender, insurance scores enable auto insurers to price more accurately, so that people less likely to file a claim pay less for their insurance than people who are more likely to file a claim. For homeowners insurance, insurers use other factors combined with credit such as the home’s construction, location and proximity to water supplies for fighting fires.

Insurance scores predict the average claim behavior of a group of people with essentially the same credit history. A good score is typically above 760 and a bad score is below 600. People with low insurance scores tend to file more claims. But there are exceptions. Within that group, there may be individuals who have stellar driving records and have never filed a claim just as there are teenager drivers who have never had a crash although teenagers as a group have more accidents than people in other age groups.

Credit Report Information — Who Wants It?: It is becoming increasingly important to have an acceptable credit record. Whether we like it or not, society equates the ability to manage credit responsibly with responsible behavior, even if individuals have a bad credit record through no fault of their own. Landlords often look at applicants’ credit records before renting apartments to see whether they manage their finances responsibly and are therefore likely to pay their rent on time. Banks and other lenders look at the credit records of loan applicants to find out whether they are likely to have loans repaid. Some employers also look at credit records, especially where employees handle money, and view a good credit record as a measure of maturity and stability.

In some insurance companies, underwriters have long used credit records in cases where additional information was needed. Before the development of automated scoring systems, underwriters would look at the data and make decisions, often erring on the overly cautious side that disadvantaged many more people. Automated insurance scoring and underwriting systems eliminate the weaknesses inherent in someone's personal judgment and have allowed more drivers to be placed in preferred and standard rating classifications, saving them money. With the development of these scoring models, the use of credit-related information in underwriting and rating for many insurers has become routine. Insurers use insurance scores to different extents and in different ways. Most use them to screen new applicants for insurance and price new business.

Why Insurers Need It: Insurers need to be able to assess the risk of loss—the possibility that a driver or a homeowner will have an accident and file a claim—in order to decide whether to insure that individual and what rate to set for the coverage provided. The more accurate the information, the closer the insurance company can come to making appropriate decisions. Where information is insufficient, applicants for insurance may be placed in the wrong risk classification. That means that some good drivers will pay more than they should for coverage and some bad drivers will pay less than they should. The insurance company will probably collect enough premiums between the two groups to pay claims and expenses, but the good drivers will be subsidizing the bad.

By law in every state, insurers are prohibited from setting rates that unfairly discriminate against any individual. But the underwriting and rating processes are geared specifically to differentiate good risks from bad risks. Since insurance is a business, insurers favor those applicants that are least likely to suffer a loss. One of the key competitive aspects of the personal lines insurance business is the ability to segment risks and price policies accurately according to the likely cost of claims generated by those policies. Insurance scores help insurers accomplish these objectives. Actuarial studies by Tillinghast, an actuarial consultant firm, have shown a 99 percent correlation between insurance scores and loss ratio—the cost of claims filed relative to the premium dollars collected. In other words, people who have low insurance scores, as a group, account for a high proportion of the dollars paid out in claims.

Insurance scores developed by the insurance scoring company Fair Isaac involve a set of 15 to 30 credit characteristics, each with an assigned weight, that produce a score ranging from 100 to 999. The lower the score, the greater the risk. According to Fair Isaac, 76 percent of consumers exhibit good or fair credit management behavior. Only four percent of the population are so-called “no hits” with no credit history. This small group would include the very young, who have not yet established a credit history; those who might not use credit for personal or religious grounds; and retirees who have probably paid off their mortgage.

The reasons behind the predictive value of credit scores appear to be behavioral. The character trait that leads to careful money management seems to show up in other daily situations in which people have to make decisions about how to act, such as driving. People who manage money carefully may be more likely to have their car serviced at appropriate times and may also more effectively manage the most important financial asset most Americans own—their house—making routine repairs before they become major insurance losses. But of course, there are always exceptions to the rule. For example, there are people who have filed for bankruptcy that have never filed an insurance claim. Furthermore, a low insurance score doesn't predict that a person will have an accident.

The information used in insurance scoring models does not include personal data such as a person’s ethnic group, religion, gender, family or marital status, handicaps, nationality, age, address or income. The scoring process relies on information in a person's credit record. Particular emphasis is placed on those items associated with credit management patterns proven to correlate most closely with insurance risk, such as outstanding debt, length of credit history, late payments, collections and bankruptcies, and new applications for credit. Credit-related activities within the last 12 months are given most weight.