From the American Insurance Association; prepared for distribution to consumers

Credit-based Insurance Scores: What you need to know

Have you ever applied for a car loan, a mortgage, or a credit card? If so, you know that the way you have managed your credit in the past is very important. The information contained in your credit report can have a major influence over many parts your life, including your car and homeowners insurance.

Many insurance companies use a credit-based “insurance score” when evaluating insurance applications or policies. This brochure was designed to give specific answers to questions about insurance scoring, including how and why it is used.

What is a credit-based insurance score? Why do insurance companies use them?

An insurance score uses information from your credit report to predict the likelihood credit says a lot about how responsible you are. Insurance companies want to reward responsible people by offering them better insurance products and by charging them lower rates. That’s why insurance scores are so useful.

It is important to understand that an insurance score is not the same thing as a credit score. Both are derived from the information found in your credit report, but they predict very different things. A credit score predicts how likely you are to repay a loan or other credit obligation. When you are applying for a loan or some other form of credit, the bank will consider your credit history as well as other factors in determining whether you are likely to repay your debt. While banks and other lenders will look at your income when making decisions, insurers do not.

What does my credit history have to do with how I drive my car?

Having a good insurance score does not necessarily mean you are a good driver or a more responsible homeowner. However, research has shown that consumers with better insurance scores generally file fewer claims and have lower insurance losses.

That is not to say that all people with low insurance scores are higher risks. For instance, if you add a 16- or 17-year-old driver to your auto insurance policy, your premiums will very likely increase. This is because as a group, younger drivers have more claims and losses than those with more experience. That does not mean that all 17-year-olds are bad drivers. Research shows, though, that drivers in that age group are more likely to have losses, so they pay more in premiums. It’s the same thing with insurance scores – research shows that people with certain patterns of behavior in their credit history are more likely to result in losses for the insurance company. As a result, they pay higher premiums, or, in extreme cases, they might have trouble getting insurance from some companies.

How is my credit-based insurance score calculated?

When you apply for insurance, the insurance company orders credit information from one or more of the three major U.S. credit bureaus. This information is entered into a computer program that generates an insurance score. Most of these programs, or “models,” look at things like payment history, collections, credit utilization and bankruptcies. For example, if you have never been late paying your mortgage, you will probably have a better score than a person who pays late. If you have “maxed out” credit cards, that will negatively affect your score. When you apply for coverage and your insurance company orders your score, the credit bureau will make a note in your file that the insurance company looked at the record.

What kinds of things affect my insurance score?

Insurance scores are based on information like payment history, bankruptcies, collections, outstanding debt and length of credit history.  For example, regular, on-time credit card and house payments affect a score positively, while late payments affect a score negatively.

Any time someone looks at your credit report, the credit bureaus record this activity – they refer to it as an “inquiry.” The number of inquiries on your record can also affect your insurance score. There are several types of inquiries, but under the models used by most insurance companies, the only inquiries that affect your insurance score are those you initiate. Every time you apply for credit, whether a department store charge card, a new car loan, or “easy financing” on new bedroom furniture, an inquiry is noted on your record. Applying for a lot of credit in a short time shows that you might be taking on more than you can handle.

One way to improve your insurance score is to limit the number of self-initiated inquiries in your credit report. This can be done by only applying for credit when you really need it. For example, an unsolicited “pre-approved” credit card notice in the mail would not affect your score, because you did not initiate the offer. If you fill out the form and send it back, though, you are applying for new credit. An inquiry will then be posted in your credit history, which may have an effect on your score.