How Credit Scores affect Car Insurance Rates

By Lisa Phillips on Dec 9th, 2008 in Credit Scores

Car insurance and your credit scores should be two separate issues. Unfortunately it has become a common practice for big corporations to pull consumers’ credit reports for just about any reason.

This practice has invaded the car insurance industry and bad credit can mean you pay higher insurance rates and may even result in a denial of coverage. In the past insurance companies considered driving record, age, type of automobile and the number of insurance claims to determine who to insure.

The last decade has brought about a change in the insurance industry. Many of them rely heavily upon credit scores as a predictor of risk. Insurance companies believe the better someone’s credit rating the least likely an insurance claim will be made and the more likelihood insurance premiums will be paid.

Decisions based on insurance scores
An insurance company can approve or deny automobile insurance based on your insurance score, even if you have a spotless driving record and never had an at-fault automobile accident.

The insurance company can also raise your insurance premiums based on their credit scoring model. The insurance scores have become more important than your driving record in determining how much you will pay for  insurance premiums.

Why are insurance companies viewing credit histories
When an insurance company pulls your credit they are looking for predictor items associated with credit management patterns. These patterns supposedly correlate insurance risk. The predictors are outstanding debt, how long you have utilized credit, late payments, public records such as bankruptcy, collection items and new credit applications. Emphasis is put on credit activities occurring in the last 12 months.

Their belief is that insurance scores predict the average claim behavior of a group of people with essentially the same credit history. A consumer with a good score, typically 760 and above, is least likely to file an insurance claim. While consumers with a bad score, typically 600 and below, tend to file more claims.

A standard scoring model does not exist
Some insurance companies use a scoring model created by ChoicePoint and Fair Isaac Corporation, the company that invented credit scoring. Other insurance companies have designed their own scoring models. A standard scoring model does not exist. Each insurance company uses different models and weighs different data in a consumer’s credit report.

Credit reports contain errors
According to a study by PIRG (Public Interest Research Group), as many as 79% of credit reports contain errors and 29% of those errors are serious enough to result in a denial of credit. The credit data from which the scores are derived have a reputation for being inaccurate, erroneous and out of date. While the information used in insurance scoring models does not include personal data such as a race, religion, gender, marital status, age, nationality, handicap, address or income; several studies have shown that insurance scoring adversely affects African Americans, Hispanics, and low-income consumers.

Steven Parton, general counsel for the Florida Office of Insurance Regulation, says, “What they’re really looking to see with insurance scores is who is most likely to file a claim, not who will most likely have an accident.

If I have the money, I won’t file a claim, because my rates will go up. People of low economic status don’t have that luxury.” Parton adds, “Insurance companies are looking at whether they’re relying on their insurance in case they have an accident, which is what they’re buying insurance for to begin with.” (ConsumerReports.org)

A consumer must be informed if credit data is used
Insurance companies must disclose to consumers they are using credit information in the underwriting process and to determine rates. If a consumer’s credit score is the determinant in rejecting an application for insurance or another adverse decision, the consumer must be notified. In accordance with the Fair and Accurate Credit Transactions Act of 2003 (FACT), a copy of the consumer’s credit report must be made available to the consumer free of charge.

Studies by ConsumerReports.org (August 2006)
Studies done by ConsumerReports.org found “erratic results” when credit scoring models were used by insurance companies.

“For example, if insurance scores were neutral, our hypothetical customer would pay roughly the same annual premium at Nationwide and GEICO, about $1,150. But if the driver received the worst possible insurance scores, the premium would increase 29 percent to $1,468 at GEICO and 47 percent to $1,706 at Nationwide. At Birmingham Fire, scoring from best to worst increased the premium by $3,166.

Such variations raise questions about whether scoring closely customizes price to each driver’ s loss risk, as insurers contend. How precise can scoring be when our hypothetical customer with the best score gets a 31 percent discount on his annual premium at Progressive but only a 19 percent discount at Birmingham Fire? Or when USAA charges our hypothetical customer with the worst score 32 percent extra, why is State Farm charging him 108 percent more?

Leslie Kolleda, a spokeswoman for Progressive, says that the variation in pricing has “nothing whatsoever to do with credit scores” and is typical of insurer-to-insurer price differences. Progressive’s comparison of 90,000 multicompany premium quotes in 2002 showed a $524 difference, on average, on six-month policies.”

But some state regulators still have doubts. “You can’t say this is the best predictor we have, but at the same time we all do it completely differently,” says Joel Ario, the insurance administrator of Oregon. “Either there’s a core to this or it’s a farce.””