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Why do insurers need to know your credit score?

There's no proven link between credit histories and insurance claims, and insurance scoring often can be random and unfair. It's time to limit the practice.

By Money Staff Nov 3, 2010 7:57PM

This post comes from MSN Money's Liz Pulliam Weston.


Liz Pulliam WestonThe fact that credit scores correlate with insurance claims is pretty well-established. People with bad credit cost insurers more, and people with good credit cost insurers less.

But anyone who pretends to know why that's true is blowing air up your skirt.

Because nobody knows why. There are plenty of theories, such as:

  • People with good credit are more careful drivers or homeowners.
  • People with bad credit are less likely to have money to pay claims out of pocket.
  • People with bad credit are more likely to be impulsive/aggressive/bad at judging risk.

The truth is, nobody can prove a causal link between credit history and insurance claims. That's not surprising, since proving causal relationships with most insurance underwriting factors is tough. The fact that you had an at-fault accident doesn't cause you to have another one.


Still, most of us accept, however grudgingly, that there's a relationship between our driving history and our likelihood of filing future claims -- just as we accept there's a link between how we've handled credit in the recent past and how we're likely to handle it in the near future (which is the whole point behind credit scores).

The link between credit and insurance is a harder sell, yet insurers have successfully beaten efforts in many states to ban or heavily restrict the use of credit-related insurance scores in setting premiums. Forty-six states currently allow insurance scoring; only Maryland, Hawaii, California and Massachusetts prohibit insurers from using credit information for homeowners or auto or both. (Michigan's ban on insurance scores was overturned by the state's Supreme Court this summer.)


If so many states approve it, why fight the trend? For a number of reasons:


It isn't the people talking, most of the time. It's lobbying money. True, four years ago Oregon voters rejected a ballot proposition that would have banned insurance scores. But most of the time the decisions about scoring are made in state legislatures, where lawmakers are "advised" by insurance lobbyists and the impressive campaign contributions insurers can make. Two-thirds of the public still doesn't know credit history can affect their premiums, so the debate hasn't really even begun.


Insurers' use of credit information can be, shall we say, capricious. Depending on the scoring formula they use, you can be penalized for opening a credit card within the past two years or taking out your first installment loan after age 26, according to research by Consumer Reports.


The penalties are ridiculous. A bad credit score can more than double your premium at some companies, Consumer Reports found. The bad-credit surcharges found at the eight insurers Consumer Reports surveyed ranged from 29% to 143%.


There's that pesky discrimination thing. A big study in Texas, along with smaller studies in Washington and Missouri, found that insurance scores tend to disproportionately penalize African-Americans, Hispanics and low-income families, who are more likely to have bad scores.


And those studies were conducted during better economic times. Millions of families of all races and economic brackets have been sideswiped by the recession and are paying the price in higher premiums, but the groups already penalized by insurance scoring have been hit even worse than the rest of the population.


Still, as the Federal Trade Commission pointed out in 2007, there may be some benefits from insurance scoring if insurers use it as a way to price insurance for higher-risk customers they might otherwise reject. Also, if you happen to have good scores and land with an insurer that likes the particular way you've handled credit in the past, you may benefit from lower premiums.


The Consumer Federation of America has called for an outright ban on insurance scores, something I think the industry would fight tooth and nail. What might work is a limit on the surcharge, to 20% or so. That would at least limit the potential fallout for people who have already suffered enough economically -- and don't need to pay shockingly higher premiums on top of it all.


Liz Pulliam Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy." Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. She also helps middle-class families cope at Building a Brighter Future.


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Nov 5, 2010 10:42AM

Unfortunately Liz doesn't know what she is talking about.  Doesn't it make sense that if all insurance companies are using credit scoring as an underwriting criteria for rating premium, there is a specific correlation between credit score and claims history?  Just because Liz, the consumer financial advisor, hasn't been privy to this information doesn't mean it doesn't exist.  Liz's article fails to point out why, if there is no correlation, would insurance companies waste their time and go through the expense of collecting this information.  Liz fails to opine on this fact.  Liz also wants us to think she is wiser than the entire collective of insurance company knowledge.  If she is this smart why isn't she president of a multinational insurance company?  I'm sure she would be far wealthier than she is now.

     Dismiss this article, the author is clearly in over her head and should not be advising you on subjects where she clearly lacks factual knowledge. 

Nov 5, 2010 3:45PM

The old method of pricing auto insurance based upon an individual's driving record worked just fine.  How else could you do it more fairly?  The use of credit scores is another ridiculous intrusion into our personal lives and should not be allowed whether your score is 500 or 800.


Credit scores can be negatively impacted in a number of ways, not all reflecting frivolous spending or financial neglect on the part of the individual.  Involuntary layoffs, business failures, unforeseen medical bills, etc. all can have a significantly negative impact on one's credit score.  However, it does not mean that the person was negligent or a bad risk.


Credit score checking should not be allowed for insurance purposes.  It's only real purpose is to give insurance companies a legitimate reason to charge higher rates. 

Nov 5, 2010 11:59AM

What most people don't realize is that the actual profit margin for the majority of insurance companies is very small and for many, the consistently are losing money.  There is a thing called loss ratio that comes into play and back in the days when the stock market was going gang busters, companies were actually running loss ratios well over 100% and were relying on their investment income to keep them afloat.  The loss ratio is what is paid out in claims and expenses vs. what is brought in from underwriting (premiums).


If a company has a loss ratio of 100%, what is being paid out is the same as what is being brought in.  Many companies were pricing their products low early in the decade to get business in at any price due to the fact they were doing well with their investments.  Now however, they are not getting anything so they need to bring the dollars in via premium.  The credit scoring is one way of guestimating what a reasonable premium should be for a specific risk.

I know everyone tends to think of insurance companies as "rich".  Unfortunately, most of their employees are overworked and underpaid like the majority of the poor dumb schmucks in the work force.

Nov 5, 2010 11:31AM
insurance companies are smart. even though there is no correlation between poor credit and auto claims, insurance companies know that a lot of people have poor credit. so it was just another way for them to make more money, and screw the consumer. government will eventually step in, but probably not for another decade. Just because you have a good score means nothing.  I don't have the best credit, but in 16 years of driving I have never had a claim.
Nov 5, 2010 10:32AM
complete bull in my opinion. I do not think the credit scoring is fair, and is part of the reason so many lower income people tend to not have any auto insurance. They get stuck with the higher premiums and are already struggling to keep afloat. I was a licensed agent for 4 years and this is part of the reason I decided against renewing my license finally. I got so tired of having to tell people what their premium was going to be and dealing with the shock or outrage that went along with it. Affects me to, my premiums are high, I own a home and have poor credit now thanks to unexpected work changes causing financial issues that are hard to recover from.
Nov 4, 2010 5:27PM
in my view this credit score thing affecting your ins rates is a cash cow for ins. co's. its just another gimick to get more of your dollars. does anyone have any idea what Warren Buffet spends annually advertising his Gieco insurance company ? no other ins. co. comes close. he out spends others to secure your ins. dollars for perhaps a railroad co.? i strongly suggest going to smaller ins. co's. their less likely to snoop into your so-called credit score. 
Nov 5, 2010 3:37PM

I work for a major insurance company, and while I do not work in the actuarial dept, I have much industry experience.  As much as I would have believed the theme of this article before I worked in the industry, I cannot agree with most of what is said now.  This all comes down to one word, statistics...   Yes many of you have less than perfect credit and a fantastic driving history/loss history.  But there is a correlation between the likelihood of paying on a claim and someone's past propensity to pay their obligations.  I am as liberal as you will find, but this really is a fact.  It is called a moral hazard.  What are the chances that an individual will make a decision that could cause damage to themselves or to another party?  Credit history can provide a good statistical correlation for this type of risk...  But it is just insurance, sorry for the long winded post.

Nov 5, 2010 11:53AM

I'm not thrilled about the practice, but ... didn't your parents always tell you to take care of your credit?  It's no secret that good credit (No bad credit) has numerous financial advantages throughout one's life, and speaks to ones credibility and ability to keep afloat (even during bad times, even if it means asking for help from family)


Bad times affect many/most of us at one time or another, but this is just one more incentive to fight your way back out of the situation before it affects you negatively.


I'm sure I this comment will be flamed but tough love is what we all need at some point in our lives.

Nov 5, 2010 10:34AM
Just another way for them to take advantage of us...just like credit card companies & banks.  I don't think it's fair to judge my credit history against my driving record.  I don't even have any points on my license, but I have lousy credit (as much as I hate to admit it).  It's like going to a potential employer & they pull a credit score for a job that doesn't deal with money.  Makes no sense.
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