Why Do Insurance Companies Look at Credit Reports?
Explore the nuanced relationship between your financial behavior and how insurance companies assess risk for coverage and pricing.
Insurance companies access credit reports when determining policy rates. This practice might seem unusual, as credit information is typically associated with lending decisions. However, checking credit information is a standard part of the underwriting process for many insurers. This approach helps insurance providers assess the likelihood of future claims and set appropriate premiums.
The Relationship Between Credit Behavior and Insurance Risk
Insurance companies use credit information based on statistical and actuarial findings. Research indicates a consistent correlation between certain credit behaviors and the likelihood of an individual filing an insurance claim. Insurers observe that consumers who demonstrate greater financial responsibility, as reflected in their credit management, tend to experience fewer and less costly insurance losses.
Financially responsible habits can extend to other areas of an individual’s life, including how they manage their property and personal risks. This means someone who diligently manages their finances might also take better care of their car or home. The use of credit information is a tool for risk assessment from the insurer’s viewpoint, rather than an evaluation of financial solvency for a loan.
This relationship is not about judging an individual’s ability to pay premiums, but about predicting the probability of future claims. Insurers aim to align premiums more closely with the risk each policyholder represents.
How Credit Information is Used to Create an Insurance Score
Insurance companies process credit report data to develop what is known as an “insurance score.” This score is a proprietary numerical evaluation used by insurers to predict the likelihood of an individual filing a future claim. An insurance score differs from a traditional credit score, such as a FICO or VantageScore, which primarily predicts the likelihood of repaying borrowed money.
An insurance score is calculated using specific categories of credit information, with varying weights assigned to each. Payment history, which indicates how consistently bills are paid on time, often carries the most weight. The amount of outstanding debt or credit utilization is also a significant factor.
The length of an individual’s credit history, reflecting how long accounts have been established, contributes to the score. Recent applications for new credit also influence the score. Lastly, the credit mix, referring to the variety of credit accounts an individual manages, makes up a portion. Inquiries made by insurance companies for rating purposes are considered “soft inquiries” and typically do not impact an individual’s traditional credit score.
Application Across Insurance Types and Regulatory Considerations
Credit information is commonly used in underwriting and pricing for several types of personal insurance policies. These often include auto insurance, homeowners insurance, and renters insurance. However, credit information is generally not used or is prohibited for lines such as life insurance or health insurance.
The use of credit information in insurance is subject to state-level regulations. A federal law, the Fair Credit Reporting Act (FCRA), grants insurers a “permissible purpose” to access consumer credit information. Many states have enacted laws that restrict how this information can be used, often prohibiting it from being the sole factor in determining eligibility or rates.
Some states have specific prohibitions against the use of credit information for certain lines of insurance or in particular circumstances. Insurance scoring models are prohibited from including personal information such as race, gender, age, income, or the location of residence.
Consumers have rights regarding the use of their credit information by insurers. They can request information about the factors that influenced their insurance score, and insurers must provide notice if an adverse action is taken based on a credit report. Consumers also have the right to dispute inaccuracies in their credit reports.