Can Your Credit Score Affect Your Auto Insurance Premium?

Have you missed any bill payments this month?  Skip a mortgage payment or a car loan installment lately?  You may think one or two payments won’t make a difference and that no one is paying attention.  Think again.  Your auto insurance company may be keeping track.  Your credit history is often one of the main factors used when an insurer either accepts or rejects your application for auto insurance, and can be one of the determining factors in how high or low your insurance premium is.  It sounds a little like “big brother”, but it’s true and, at least so far, the federal government and most states say it is legal.

Insurers call it “insurance scoring”, and it creates an insurance score or numerical ranking based on a person’s credit history. Actuarial studies show that how a person manages his or her financial affairs, which is what an insurance score indicates, is a good predictor of insurance claims. Insurance scores are used to help insurers differentiate between lower and higher insurance risks and thus provide them with fodder to either outright reject a potential insured, or charge a premium equal to the risk they are assuming. Statistically, people who have a poor insurance score are more likely to file more claims.

Discrimination?
Critics say that minorities are over-represented among consumers with the lowest credit scores and thus pay more for their insurance coverage, so this is a discriminatory practice. Insurers argue that credit scores are not the sole determinant of underwriting or rating decisions. Almost all states have rules on the use of credit-related information, which require credit-based data to be used in conjunction with other relevant facts, such as driving record, miles driven per month, location of residence, previous accidents, age, gender, etc. 

Insurers must be able to assess the risk of loss—the possibility that a driver will have an accident and file a claim—in order to determine whether or not 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.  Note that 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--the ones who are least likely to cost the companies the most money.  It’s all about the bottom line, as it is for any business.  Insurance scores help insurers accomplish this objective.

Tillinghast, an actuarial consulting firm, opines that 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, are more likely to obey the rules of the road, and may also more effectively manage the most important financial assets most Americans own—their car and 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.  But, overall, insurance companies have had success with their insurance scoring system and are not about to change it any time soon unless forced to by law.

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 solely 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 the most weight.

State Restrictions on the Use of Credit History
Many states require insurers to notify their policyholders if credit histories were used or played a role in adverse decisions, such as raising rates or placing a policyholder in a higher rating tier. Many also bar insurers from using insurance scores as the sole determining factor in underwriting or pricing/rating decisions. Most states with restrictions base their law on a model law passed in December 2002 by the National Conference of Insurance Legislators (NCOIL). Among other things, the model legislation requires insurers to disclose to consumers that a credit report may be used and to notify the policyholder in compliance with the federal Fair Credit Reporting Act when credit is the basis for an adverse decision. The model law prohibits the use of credit information as the sole basis for refusal to insure or to non-renew or cancel. It also bars the use of disputed information or information identified as medical collection accounts in the credit report. And it encourages insurers to take into account extraordinary life events, such as catastrophic illness or the death of a spouse.

Some states have limited the use of insurance scores for rating and underwriting. Montana and New Mexico have recently enacted legislation that restricts the use of insurance scores in rating and underwriting consumers. Kansas has similar laws. Texas law prohibits the absence of credit information to be used in underwriting decisions, and insurers must account for extraordinary circumstances, such as hospitalization or identity theft, that could cause declines in one's insurance score if the insured request special consideration in writing. Michigan requires insurance companies to recalculate the score annually, and also when consumers successfully correct information in their credit records.

There are a few states that have very restrictive rules on the use of credit history by insurance companies.  In Washington State, for example, legislation was passed in 2002 that prohibits cancellations after 60 days and non-renewals based in whole or in part on credit history.  Washington state law also forbids companies to deny insurance or base rates on the lack of credit history, credit available, number of credit inquiries and collection accounts for unpaid medical bills.  Maryland bans the use of credit in auto insurance underwriting decisions on existing policies—only allowing credit scores to be used for new business.  Even on new policies, the law places a cap on any discounts and surcharges that are credit-related.

Proposition 103 prohibits California insurers from using credit for auto insurance policies. (The state's insurance commissioner has effectively extended the ban to homeowners’ insurance as well.)  In Massachusetts, although it is not banned, regulators will not approve rate filings for auto (or homeowners’) insurance that include the use of credit scoring.  Hawaii has a law on the books that completely bans the use of credit reports for auto insurance underwriting and rating.

What to do
Other changes in state law may be coming down the pike.  Check your state’s rules on the use of credit ratings by insurance companies by going to the website for your state’s insurance regulatory body, usually the Department of Insurance or a similar title.  The best advice I can give you is that if your state allows the use of your credit history to make their rating decisions, that just adds one more reason why you need to keep your credit rating as high as possible.  To the extent that you are able, pay the vast majority of your bills in full and on time, and you will have a better chance of keeping your rates down.  Unless, of course, you have a lousy driving record--there, I can’t help you.