What You Should Know About Credit-Based Insurance Scores
Find out why insurers base rates on your credit score – and the U.S. states where that’s not allowed.
Laura Adams, MBA
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What You Should Know About Credit-Based Insurance Scores
If you’re a regular Money Girl reader or podcast listener, you already know that credit is an important part of your financial life. It affects what you have to pay for interest on a car loan, mortgage, or credit card.
But many people don’t realize that even if you don’t have credit accounts, your credit still determines how much you have to pay for certain types of insurance.
In this episode I’ll tell you what a credit-based insurance score is, why it’s used, how to raise it, and the U.S. states where using your credit to set rates is prohibited.
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What Is a Credit-Based Insurance Score?
A credit-based insurance score is a rating used by most insurance companies to help predict your risk for property policies, such as auto and home coverage.
Studies by federal and state regulators, universities, insurance companies, and independent auditors have shown that consumers with good credit file fewer insurance claims, and therefore are less risky customers.
In order for an insurance company to be profitable, it has to take in more money in premiums than it pays out in claims. So, they’re interested in how often you’re likely to file claims and how expensive those claims will be.
The idea is that the way you handle your finances says a lot about how responsible you are in other areas of your life, like driving a car or maintaining your home. So, instead of raising rates across the board, insurance companies reward those with good credit by charging them less.
Insurance scores aim to predict your likelihood of having an insurance loss while credit scores aim to predict how likely you are to repay a debt.
Insurance Scores Are Different from Credit Scores
It’s important to understand that an insurance score is different from a regular credit score that’s typically used by a lender or credit card company.
Both types of scores use information in your credit report; however, they’re trying to forecast different things. Insurance scores aim to predict your likelihood of having an insurance loss while credit scores aim to predict how likely you are to repay a debt.
When you apply for insurance, the carrier purchases your credit history from one or more of the 3 nationwide credit agencies (Equifax, Experian, and TransUnion). Your information is added to the insurer’s proprietary scoring model or to one created by another company, like TransUnion’s Insurance Risk Score, and generates a score.
See also: 7 Essential Rules to Build Credit Fast
Your credit-based insurance score is never calculated using information such as your age, gender, race, religion, marital status, employment, or any other information that’s not found in your credit report.
How to Increase Your Credit-Based Insurance Score
So what is an insurance score based on? It’s similar to the factors used to calculate a regular credit score, like payment history, credit utilization, amount of debt, length of credit history, credit inquiries, and legal actions (such as filing for bankruptcy).
In other words, you can increase your insurance score when you pay loans and credit card bills on time, don’t max out credit cards, and never apply for more credit than you really need.
But insurance scores hone in on patterns of financial management. For instance, applying for one credit card over a 12-month period isn’t like to have a negative effect, but getting several within a short period of time typically hurts your insurance score.
Additionally, other types of red flags may include having multiple mortgages or auto loans with high average balances. These may be a predictor that you have a home claim or an expensive auto insurance loss in your future.
When you apply for a new credit account or even an insurance policy, a “hard inquiry” is made on your credit report that can temporarily ding your credit score. However, under the credit models used by most insurance companies, the only inquiries that hurt your insurance score are those for new credit accounts, not new insurance applications.
Therefore, due to the differences in insurance scores and credit scores, it’s possible to have good credit, but a poor insurance score. That means you’ll pay more for insurance, or in extreme cases, be denied for a home or auto policy.
What If I’m Denied Insurance Based on My Credit?
If an insurance company denies you coverage due to information in your credit history, you generally have the right to get a free copy of your credit report.
In some cases you may have errors in your credit file that are dragging down both your insurance and credit scores. Always report errors and get them corrected as quickly as possible.
For a video tutorial that shows you step-by-step how to check your credit report and correct errors, download my free Credit Score Survival Kit.
Which States Prohibit the Use of Credit-Based Insurance Scores?
Insurance laws vary depending on where you live because insurance is regulated by states, not the federal government. In recent years, a few states have passed laws that prohibit insurers from using credit to set rates.
For instance, if you live in California, Massachusetts, or Hawaii, insurers can’t use your credit history as a factor when setting rates for auto insurance. And if you live in Maryland, home insurers are prohibited from considering your credit.
However, no state allows credit to be the sole factor in setting insurance rates. There are many other variables that come into play, including your driving record, annual mileage, and vehicle model. Home insurers must consider numerous property features, such as age, construction type, and location.
To sum up, by paying your bills on time and using credit wisely, you can build a good credit history that helps you qualify for lower auto and home premiums, in most states.
More Articles and Resources You Might Like:
5 Ways to Get a Loan with Bad Credit
9 Things That Can’t Hurt Your Credit Scores
Credit Score Survival Kit – a free video tutorial to with smart stategies to build credit!
Money Girl’s Smart Moves to Grow Rich – get the paperback or ebook for yourself or a great gift.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.