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Credit scores can impact auto insurance rates

Credit scores impact auto insurance rates

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Having an outstanding credit card balance could mean you pay more for car insurance -- at least if your insurance company is among those that use what is known as a credit-based insurance score.

Almost all insurers now use credit-based insurance scores to set premiums and decide whether to accept or reject customers, using details of consumers' credit reports to determine how much risk they represent.  But few insurers regularly disclose scores or what role they play is setting premiums. 

However, insurers do state that consumers who partake in certain credit behaviors, like maintaining high credit card balances, will file more insurance claims.  According to an analysis by Consumer Reports, this method of calculating a driver's risk could end up costing many consumers hundreds of dollars more each year.

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Even individuals with solid credit scores who use credit cards and other forms of credit wisely could get hit in the wallet.  You may always pay your credit card balances in full and on time, but could still end up paying more for car insurance.  That is because insurers' scoring systems can penalize you even for reasonable credit usage. 

An example of this is that under the system, opening three new accounts in the past year, including one credit card in the last four months, and the making two or more loan inquiries could raise your premium.  Frequent loan applications could also hurt your insurance score.

Fair Isaac insurance market manager Lamont Boyd remarked to Consumer Reports that the credit bureau's Assist insurance score is only based 40 percent on payment history, with the remaining 60 percent stemming from credit limits and balances, the age of the consumer's earliest account, if they shopped for loans, and the types of loans they hold.

Meanwhile, the reliability of insurance scores depends on having credit report that reflects reality, which many consumers know is not always the case.  Credit reports often contain mistakes and inaccuracies that could damage a person's credit score. 

Credit report inaccuracies could also hurt a consumer's insurance score.  Also, since a credit report is just a snapshot of an instant in your credit use history, it may not reflect current credit use.  A Federal Reserve report from 2004 showed that with a time lag before lenders update credit bureaus, a balance may appear weeks after it has been paid.

The captured moment in time may be an instance when your credit card balance was much larger than normal but before you had a chance to pay it off -- and you could get penalized for it.  To an observer, it may look like you are using too large a percentage of your credit line, even if you always pay your balances in full.

Perhaps more disturbing than credit-based insurance score methods that end up costing individual consumers are state studies indicating insurance scores may be discriminatory.  That is because some credit scoring models rely on factors that adversely effect low-income and minority consumers, two groups whose use of finance-company credit or lack of a major credit cards are red flags for insurance companies.

Still, according to insurers, there is a statistical link between the data they follow and insurance claims, which in turn shifts costs from drivers who file fewer claims to those who file more claims.  Insurance officials explain that most consumers are paying lower premiums more directly tied to risk, as credit scoring enables companies to sort customers into hundreds of levels.

Although the subject is up for debate, Fair Isaac's Boyd said that two-thirds to three-quarters of consumers are enjoying better premiums due to credit-based insurance scores.  Meanwhile, a 2004 study by the Texas Department of Insurance found that half of customers paid more and half paid less than they would have without scoring.

Consumer Reports found inconsistency among credit scoring techniques.  Hundreds of insurance companies employ scoring models created by ChoicePoint and Fair Isaac, while other insurers have established their own systems.  Each company not only uses different models, but they also weigh different credit-report information.  Certain large companies may only use scoring for new customers as opposed to renewals, while others may use scoring for both. 

Furthermore, Consumer Reports notes that the insurers' scoring models rely on bits of credit data that the average consumer would view as having little to do with a driver's likelihood of making claims.

A driver's use of a credit card does not factor in to the traditional way of coming up with a rating, which instead uses age, driving record, ZIP code, sex, marital status and three-year history of at-fault accidents.  Insurers determine to what degree each factor impacts the frequency and amount of payouts and come up with a formula for calculating a premium based on your characteristics. 

So why are credit-based insurance scores used?  No exact relationship between credit scores and insurance claims is understood by either insurers or the credit-scoring companies that found the connection, but they suggest that consumers with bad credit and a history of irresponsible financial behavior are more likely to be in an accident or to file a claim.

But it may not be simply that bad drivers have bad credit.  Steve Parton, general counsel for the Florida Office of Insurance Regulation, explains that what they are looking for with insurance scores is which consumers are most likely to file a claim, not who is most likely to be in an accident.  He notes that people who have the money are less likely to file a claim, while poorer consumers might rely on their insurance in case of an accident.

Even though insurance scores could end up costing you more, they don't have to.  And, while scores have no consistent effect on premiums (meaning you cannot predict if certain credit behavior will result in a high or low premium), there are steps consumers can take to help avoid paying more for insurance:

  • Shop around for the best quote from several insurers.
  • Get copies of your credit report and make sure they are free of inaccuracies.
  • Avoid the types of credit that can ding your insurance score, such as department store credit cards, credit accounts at a local tire dealer, auto parts store, or service station, as well as retailer credit cards issued by finance companies, not banks.
  • Use oil company credit cards and national bank credit cards (like those from Visa, MasterCard, American Express, and Discover), which are preferred by insurers.
  • Talk to your insurer about your score, using the information to build a case if you wish to complain about incorrect scoring.
  • Avoid running up sizable credit card balances, which could be reported as high relative to your overall credit limit, by paying balances in full every month or even sending smaller credit card payments weekly.
  • Try not to apply for new credit too often, since scoring systems look down on excessive new credit and credit inquiries.
  • Pay your bills on time, perhaps using automatic bill pay from your checking account to avoid late payments or having the check get lost in the mail.
  • Request exceptions for circumstances beyond your control that could have hurt your credit report, such as divorce, job, loss, medical problems, or Hurricanes Katrina or Rita.
  • Ask to have a low score re-scored as often as your state's law permits, which is generally once per year.
See related: Help for bad credit

Published: March 9, 2007


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Updated: 09-30-2016


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