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Got poor credit? You may be paying double for car insurance (Study)

This may or may not come as a shock, but a new study has determined that your credit history can play a significant role in what you pay for car insurance.

The study, commissioned by insuranceQuotes.com, examined the average economic impact your credit-based insurance score has on auto insurance. Using a hypothetical 45-year-old, single female driver with a bachelor’s degree and no prior claims or lapses in coverage, the study looked at how much annual premiums can change based on this unique factor.

credit score and car insuranceYour credit-based insurance score does look at your credit history – but you shouldn’t confuse it with your credit score. Your credit-based insurance score is calculated using information in your credit report but many insurance companies have their own proprietary methods for using your credit information and evaluating it.

The study found that if you have a median cedit-based insurance score, you’ll pay 24 percent more for car insurance than a driver with an excellent score. And if you have a poor credit-based insurance score, your premium nearly doubles – your rate will increase by 91 percent.

“It’s really hard to say exactly how much your credit score is going to affect your premiums, because every insurance company uses this score differently,” says Bob Hunter, former Texas Insurance Commissioner and current director of insurance at the D.C.-based Consumer Federation of America, a consumer advocacy organization. “But there’s every indication that the difference can be very substantial.”

What’s more, many consumers aren’t even aware that their credit history is being used to set insurance rates. According to a 2005 report by the Government Accountability Office, about two-thirds of 1,578 consumers surveyed did not know that their credit could affect what they pay for insurance.

Analysts and experts say it’s critical that consumers know how credit-based insurance scoring works and what they can do to improve their score.

To learn more, click here to download a free consumer resource, Insurance Rates and Your Credit: What Every Consumer Should Know.

What is a credit-based insurance score?

For more than a decade, about 97 percent of U.S. insurance companies have been using credit-based insurance scores to set auto insurance premiums. Only California, Hawaii and Massachusetts ban insurers from using credit to set auto insurance rates.  

insurance rates and your credit In addition to a variety of other factors, such as your driving record, vehicle type and miles you drive each year, your credit-based insurance score affects how much you must pay for auto insurance.

According to Lamont Boyd, insurance underwriting expert at Fair Isaac Corporation (FICO), credit-based insurance scoring dates back to the early 1990s.  At that time, FICO conducted numerous studies with insurers across the country to determine whether there’s a statistical correlation between a person’s credit score and the likelihood that he or she will file an auto insurance claim in the future.

“What we found is that there’s a correlation,” Boyd says. “The data proves … that people who choose to effectively manage their finances are also less likely to have future insurance losses. We don’t really know why, but we can prove statistically and empirically that this is the case.”

Your credit-based insurance score is created using approximately 20 to 30 different aspects of financial data collected by the major credit bureaus. They may include:

  • Outstanding debt
  • Length of credit history
  • Late payments
  • Collections
  • Bankruptcies
  • New applications for credit

“About 40 percent of every consumer’s bottom line score will be driven primarily by whether or not you paid your credit obligations on time,” Boyd says.

The second most impactful factor has to do with how much credit card and loan debt you have compared to how much you are allowed to borrow. This accounts for about 30 percent of the scoring model, and the closer you are to being maxed on your credit cards, the more your score will be more negatively impacted.

How does your credit-based insurance score affect your auto insurance premium?

When it comes to credit-based insurance scores, there’s no uniformity or standardization.

If this sounds a bit abstract it’s because insurance companies don’t like to let the public know precisely how they use credit-based insurance scores to set rates.  It’s a tightly guarded and highly confidential piece of the overall underwriting puzzle.

“(Your insurance) agent may be able to give some guidance on which insurers weigh (your credit-based insurance score) more heavily than others,” Barry says. “But you’re going to have difficulty quantifying this. Insurance companies feel as though they are at a competitive disadvantage if they share with the public the extent to which they use these scores in writing new policies.”

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It’s also important to understand that unlike a traditional credit score (used by lenders), consumers don’t have access to their credit-based insurance score, and that’s because there’s no single scoring model used by all insurers (or credit agencies).

“I wish consumers could see their score, and it’s actually something I’ve been working on for years,” Boyd says. “The problem is that there are several different scoring models currently in use to calculate credit-based insurance scores, including models developed by third-party vendors and individual insurance companies. There are just too many variables and inconsistencies.”

How often do insurers calculate your credit-based insurance score?

Like all things pertaining to credit-based insurance scores, how often an insurer will calculate your insurance score will  vary from carrier to carrier, and state to state.

“Different carriers are going to look at this score at different times,” says Mark McElroy, executive vice president of insurance business for TransUnion, one of the three major U.S. credit bureaus. “What I can tell you is that the majority of insurance companies are going to use your credit-based insurance score only when you apply for a new policy.”

According to McElroy, “very few” insurance companies use credit-based insurance scores every time a policy is up for renewal, which means that changes to your credit score probably aren’t going to affect your premiums very much, if at all, once you are already signed up for a policy.

“If you already have insurance, your premium is most likely going to be affected by factors other than your credit-based insurance score,” McElroy says. “For instance, changes to your vehicle, changes to where the vehicle is kept, and any accidents or moving violations you incur are the things insurance companies are most interested in mid-policy.”

Opponents to the use of credit-based insurance scores

Credit-based insurance scoring has many critics, most of whom claim that using someone’s credit history to determine risk is unfair and irrelevant.

“The problem here is that there may be a correlation, but there’s no thesis,” Hunter says, a long-time vocal opponent of credit-based insurance scoring. “California did research a few years back that found higher accident rates amongst drivers with dark hair. Should we use hair color as a way to determine premiums?”

What’s more, Hunter says that credit-based insurance scoring negatively impacts low-income drivers more than those with high incomes.

“There are large segments of poor people out there who are unable to afford required minimum liability insurance, and a lot of them are just choosing to drive without insurance,” Hunter says. “(Credit-based insurance) scoring is one of the reasons this problem exists.”

Boyd disagrees, claiming multiple studies have shown credit-based insurance scoring “is beneficial to everybody.”

“The insurance companies benefit because they have one more tool to help determine risk. And consumers benefit because they are getting more accurate premium pricing,” Boyd says. “About 70 percent of consumers applying for auto insurance are getting better prices today because credit-based insurance scores are used as one of the factors in underwriting.”

insurance rates and your credit How to improve your credit-based insurance score

According to McElroy, consumers can improve their credit-based insurance scores the same way they can improve their credit scores. A few tips include:

  • Pay all of your credit obligations on time.
  • Don’t open any new credit accounts unless you absolutely need them.
  • Keep credit card balances as low as possible. And if you have credit card balances, make sure they remain  low compared to your available credit limits.

“The steps you can take to help improve your overall financial rating…are going to have a positive impact on your insurance rating as well,” McElroy says. “The good news is if you can improve your credit report, you can improve your credit-based insurance score.”

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