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The Truth About Credit and Insurance Rates

Money Girl explains the relationship between your credit and what you pay for insurance. Find out which states allow credit to be used in setting rates, which types of policies are affected, and exactly how much having fair or poor credit can cost.

By
Laura Adams, MBA,
Episode #415

 

Why Insurance Companies Use Credit to Set Rates

Studies by insurance industry regulators, universities, insurance companies, and independent auditors have shown that consumers with good credit file fewer insurance claims, and therefore are less risky customers.

On the surface, it may seem strange that an insurance company would evaluate your credit when insuring something like your vehicle or home. Let me explain why they care and the types of polices that are affected.

In order for an insurance company to be profitable enough to pay out all the potential future claims it will receive, it has to take in more than enough money in premiums from customers. If they miss the mark and can’t afford to pay out your claims, they go out of business.

So insurers are interested in how often you’re likely to file claims and how expensive those claims could be. They use complicated predictive modeling based on claims they received in the past. Additionally, insurance is regulated at the state level, so companies have to set rates based on what’s legally allowed in each state where they want to do business.  

Studies by insurance industry regulators, universities, insurance companies, and independent auditors have shown that consumers with good credit file fewer insurance claims, and therefore are less risky customers. That's why insurers have been evaluating your credit for more than a decade—it's just one more tool to help determine risk.

Insurance companies can use credit to set rates for auto and home insurance in most states. I'll tell you which states prohibit the use of credit in just a moment. Some states also allow life insurers to evaluate your credit for policies that exceed a certain amount.

But credit is not a factor when it comes to your health insurance. According to the Affordable Care Act, known as Obamacare, insurers can only use 5 factors when setting health rates:

  • where you live 
  • your age 
  • the size of your household 
  • whether you use tobacco (in most states) 
  • the type of plan you choose

The rating factors for health insurance are much more restrictive than other types of insurance. Health insurers can’t use your credit, gender, or even the state of your health when setting rates, no matter if you get coverage through an employer or on your own.

Free Resource: Credit Score Survival Kita free video tutorial to with smart strategies to build credit.

What Are Credit-Based Insurance Scores?

When it comes to auto and home insurance, about 90% to 95% of carriers use a credit-based insurance score to evaluate you. This is different than a regular credit score, such as FICO or Vantage Score, which mortgage lenders or credit card companies may use.

Both types of scores use information in your credit report; however, they’re trying to forecast different things. Insurance scores help predict how likely you’ll be to have a future insurance loss and file a claim. And a regular credit score helps predict how likely you are to repay a debt.

Unlike a regular credit score, you don’t have access to an insurance score because there’s no standard model used by all insurers or credit agencies. Insurance companies don’t let the public know precisely how they use your credit to set rates because underwriting methods are highly guarded in the industry.

See also: Best Tips to Improve Your Credit Score

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