Insurance companies often use credit scores as one of the factors in determining insurance premiums for their customers. This practice is particularly common in the fields of auto and homeowners insurance.
Here are 9 ways how insurance companies use your credit score to determine your insurance premiums:
1. Credit-Based Insurance Scores
Insurers use a specific type of credit score, known as a credit-based insurance score, to predict the likelihood of a customer filing a claim. This score is different from the credit scores used for lending purposes (like mortgages or credit cards) but is based on similar information from your credit report, such as payment history, outstanding debts, credit history length, and types of credit used.
2. Risk Assessment
Insurers consider individuals with higher credit scores as lower risks. The reasoning is that individuals who manage their financial obligations responsibly are also more likely to be responsible in other areas of their lives, such as driving and maintaining a home. Therefore, they are less likely to file claims.
3. Premium Determination
A higher credit-based insurance score can lead to lower premiums, while a lower score can result in higher premiums. This is because insurers typically charge higher premiums to higher-risk customers to offset the increased likelihood of paying claims.
4. State Regulations
The use of credit scores in insurance pricing is subject to state regulations. Some states have restrictions or specific guidelines on how insurers can use credit information. For example, California, Massachusetts, and Hawaii have banned the use of credit history in setting auto insurance rates.
5. Non-Discrimination Policies
Insurers are generally prohibited from using certain personal information, such as race, religion, nationality, or gender, in determining credit-based insurance scores. The scores must be based purely on financial information.
6. Consumer Rights
Consumers have certain rights related to their credit information. They are entitled to a free copy of their credit report from each of the three major credit bureaus once a year. If inaccurate information is found on a credit report, the consumer has the right to dispute it.
7. Transparency and Disclosure
Some states require insurers to inform customers if their credit information has adversely affected their insurance premiums or coverage.
8. Improving Credit for Better Rates
Consumers can potentially lower their insurance premiums by improving their credit scores. This involves managing credit responsibly, such as paying bills on time, reducing debt, and not opening numerous new credit accounts.
9. Alternatives to Traditional Insurance
For those adversely affected by their credit scores, there are alternative insurance options. Some companies offer policies that don’t take credit scores into account, although these may come with higher base rates.
Bottom Line
While credit scores are a significant factor in determining insurance premiums in many cases, their use varies by location and is subject to specific regulations and consumer rights protections. Making sure your credit score is in good shape will help you get lower premiums on most insurance.
Would you like to know more about improving your credit score? Read 10 simple ways to improve your credit score ➔.
