How Insurance Companies Can Use Your Credit Information
Nowadays, it seems that so many facets of life hinge on having a good credit score. Few people realize, however, that you credit score can impact more than your ability to secure a loan for that shiny new car. It also can affect what auto insurance premium you will end up paying for that new car.
Thanks to the Fair Credit Reporting Act, it is legal for insurance companies to check into an applicant’s credit when deciding whether to issue a new policy or renew an ongoing policy. This practice is common for all types of insurance, including auto and homeowner’s. It is also legal to use a policy holder’s credit to determine what insurance premiums that individual will need to pay.
What Credit Information is Used
Insurance companies will look at an applicant’s credit score, a three-digit number that theoretically shows the status of one’s credit at one point in time.
Credit scores are determined based on several financial factors:
- Major Negative Events, including bankruptcy, collections, foreclosures and liens.
- Payment History, specifically looking at number and frequency of late payments as well as the time elapsed between due dates and late payment dates.
- Homeownership, referring to weather one owns his or her home or rents.
- Credit Inquiries, noting the number of times someone has recently applied for new accounts, including mortgage loans, utility accounts and credit card accounts.
- Number of Open Credit Lines, which demonstrates the number of major credit cards and department store credit cards an individual has open.
- Type of Credit in Use, indicating whether the individual relies on major or store credit cards or finance companies.
- Outstanding Debt, showing how much an individual current owes versus the total credit available to his or her.
Bad Credit Could Lead to Higher Premiums
Insurance companies that rely on an applicant’s credit information contend that there is a direct statistic relationship between financial stability and losses. In other words, consumers who are more financially responsible tend to have fewer and less costly losses as opposed to those who have demonstrated less financial responsibility.
For this reason, insurance companies typically use one’s credit in two ways:
- Underwriting: When deciding on whether or not to issue a new policy, insurance companies consider a range of factors, such as an applicant’s driving history. And one’s credit score is often part of the analysis. However, some states do prohibit the use of credit alone to determine whether to issue a new policy.
- Rating: The second way in which one’s credit score can be used by an insurance company is in determining a policy holder’s premium. Premiums are assigned based in what “tier” a policy holder is placed and the better your credit score, the better “tier” you might receive. Other factors often are taken into account when assigning a policy holder to a specific tier, such as motor vehicle records and claims history, but where permitted by state law, insurance companies can determine a policy holder’s premium based on credit score alone.