In the 1970s, insurance companies acquired lawful access to consumer credit histories. Consumer advocates have become increasingly concerned about the potential damage this access may cause to the general public. Advocate concerns refer to an issue regarding an insurance company’s use of credit scores to assess one’s level of insurance risk.

Then, there are those who disagree and remain committed to the belief that a credit score is a worthy statistical underwriting contribution. They claim that studies show that consumers who pay bills on time are likely to file fewer and less costly claims.

By the 1990s, FICO scores had come of age and, a part of the financial terminology. Consumers now understood the purpose of a FICO score. They also realized they needed to manage it proactively.

Soon after, insurance companies began to utilize credit scores to determine policy approvals and rates. Insurance aficionados (i.e., the underwriters, the actuaries, and the insurance attorneys, etc.) began testing theoretical relationships between credit scores, and their ability to predict future insurance losses.

The problem was:

These theoretical hypotheses were tested covertly, without the benefit of transparency. When consumers’ premiums began to rise (based on risk factors revealed in a credit score), they rightfully felt blindsided. By 2006, most insurance companies had adopted a credit score policy to use in underwriting analyses.

You might be wondering…

Do insurance companies now freely publicize that they rely on credit report data? The short answer is not really.

Can Insurers Review My Credit Score without My Authorization?

The Federal Fair Credit Reporting Act (FCRA) specifically drills down on this issue. As the law states,

Insurance companies have access to consumer credit information (without the consumer’s permission) because they possess a “permissible purpose” regarding underwriting.

However, if the purpose of the credit report request is not among the FCRA’s list of ‘permissible purposes’, the credit report request must be accompanied by the consumer’s authorization.

Insurance Rules by State

Each state’s insurance rules differ. According to the National Association Insurance Commissioners (NAIC), each state’s legislature defines and enforces policies regarding insurance regulation. To find the laws in your state, follow this link to your state’s Department of Insurance.

Credit-Based Insurance Scores vs. Credit Scores

A credit score is a snapshot of one’s creditworthiness – at one moment in time. From a lender’s perspective, a credit score is a mathematical construct that determines the likelihood that a borrower will meet their financial obligations. Insurance companies use the information from a credit report differently. They extract portions of the credit report and apply it to their underwriting model.

Once quoted, consumers have the right to ask their insurance company if a credit-based insurance score was used to price their quoted policy premiums. One can even ask to know your personal ‘risk category.’

Here’s the Difference.

First, a Credit Score is an algorithmic, historical representation of the way you manage your credit. An Insurance Score based on a credit profile is used to predict a driver’s loss potential. Additionally, these insurance generated scores incorporate data from other drivers with similar risk factors.

Ironically, insurance companies do NOT report to the credit agencies.

Research Reveals an Existing Credit Score/Insurance Claim Correlation

Through years of research, a discernable correlation between a Credit-Based Insurance Score and insurance losses has emerged. A Federal Trade Commission study confirmed that a statistical relationship exists, and ultimately determined that Insurance Scores based upon a credit profile were reliable risk predictors.

Critics of this policy note that if insurance companies follow this protocol, it is likely that a customer with an excellent driving record, but a reduced credit score, will find their premiums rise.

Monthly Premium Increase for Drivers in 2018, by State and Credit Score

The graph below delineates the 2018 monthly increase, by state, for drivers with poor credit scores. The most substantial increase is in New Jersey; where drivers pay an average 102% more with no credit than drivers with stellar credit.

Source: WalletHub

N.B. Hawaii, Massachusetts, and California have been excluded from analysis because insurers in those states are prohibited from determining premiums based on a credit profile.

A Second Analysis

Quadrant Information Services was commissioned by Insurance.com to statically compare insurance rates for drivers with good, bad and fair credit scores. The comparison-study noted that the average difference between prices for drivers with fair credit and good credit was 18 percent.

These studies reveal that Michigan’s insurance regulations allow for significantly higher premiums (up to 167% more) for drivers with poor credit when compared to their better-credit counterparts. Three states (California, Hawaii & Massachusetts) prohibit the use of credit when determining rates.

How Does Credit Affect Car Insurance Prices?

When calculating one’s insurance rates, an insurance company uses the credit score but does not include factors like ethnicity, income, sex, age, and marital status in the underwriting analysis.

In general, the better one’s credit score is (680+), the more likely they will receive a lower premium.

Examples of favorable credit features include limited use of credit, a clean payment history, or a well–established credit profile. Unfavorable credit issues include the existence of charge-offs or past due obligations, among others.

How to Fight Unfair Pricing?

If your insurance premiums have risen due to a credit score related issue, be proactive. Don’t take it lying down.

Monitor your credit report regularly to ensure the data in your profile is accurate. The Fair and Accurate Credit Transaction Act (FACT Act, 2003) allows consumers to obtain a free credit report annually from each of the three major credit repositories. The link for each credit agency is shown below:

  • Equifax
  • Experian 
  • TransUnion

Should you find errors on your credit profile, contact the credit agency immediately to begin the process of correcting the mistakes. Remember, the data in your credit profile is used to create your credit score. This is critical to improving one’s credit score.

Additional Actions Available

  • Ask that your insurance application be re-underwritten after credit report errors were fixed.
  • Use major credit cards (i.e., MasterCard, and Visa, etc.), which credit scoring algorithms favor.
  • If you receive an adverse action letter (i.e., a denial letter) request the company consider an ‘extraordinary life circumstance exception.’
  • Keep your revolving debt in line; leave lots of room between the balance and the credit limit.
  • Avoid new credit.

The Bottom-Line

The use of credit scores to determine one’s insurance risk level remains a hot debate for the insurance industry, consumers and American legislators. Until the matter is resolved, stay current with the laws in your state. Take advantage if and when, a bill is revised.

In the 2016 legislative session, sixteen state legislators began a long overdue conversation regarding this questionable protocol – permitted in a vast majority of the states.

Critics and advocates stand firm in their opposing beliefs, so for now, the final solution to this predicament remains a mystery.