Credit-Based Car Insurance Rates

Credit-Based Car Insurance RatesMost individuals believe that car insurance rates are based primarily on the driving record and the potential risk of the driver. While hitting another car or getting a speeding ticket will undoubtedly increase an individual’s car insurance premium, many drivers do not realize that there is another factor insurance companies take into account, one that is unrelated to driving ability. Even with a spotless driving record, a driver’s premium may go up with the declining status of his or her credit health. Credit-based car insurance scores are computed using bill-paying and loan data collected by the major credit bureaus. Almost all insurers now use insurance scores derived from credit report data to set premiums and accept or reject customers. These insurers insist that there is a correlation between credit scores and the number of claims filed by an individual. Unfortunately, this means that drivers may be paying significantly higher car insurance premiums than they would have in the past.

Although these scoring guidelines have been in practice for decades, many consumers still fail to realize that their car insurance premium hinges on their credit history. Because insurers rarely disclose consumer scores or what role the scores play in setting insurance premiums, consumers are not given adequate opportunity to understand the calculation or how they can improve it. Moreover, not all car insurance companies follow the same scoring model. Lacking agreed upon standards, insurers set premium rates that vary widely for the same driver.  Because of this, accurate and reliable data concerning an actual correlation between driving risk and credit status cannot be collected. With no reliable way to predict whether certain credit behavior will negatively affect your insurance premium, consumers are unable to educate themselves on how to improve their scores and lower their insurance payment. Additionally, the credit data from which the scores are calculated has a reputation for being inaccurate and out of date. Many studies have shown that credit-based insurance scoring discriminates against blacks, Hispanics, and low-income consumers. Despite these pervasive problems, most states allow credit-based insurance scoring, and efforts to limit the practice have been met with aggressive opposition.

The Facts about Insurance Scoring

Insurers have always used statistical data to determine insurance premiums. The standard variables for setting premiums, including the driver’s age, sex, marital status, Zip code, driving record, and three-year history of at-fault accidents, are determined using statistics to find the riskiest drivers to insure. Insurers look at each factor to see how much each one affects the frequency and size of payouts in insurance claims. Insurance representatives then create a formula that calculates a premium based on a driver’s specific characteristics. This formula, the scoring model, begins with a standard dollar amount for each type of coverage and then multiplies, adds, or subtracts amounts based on each of the rating factors. Insurance companies have now begun looking to the credit history and score of the driver to help determine their likelihood for filing an insurance claim.

  • In 1990, Fair Isaac worked with several insurers to test the theory that credit scores might predict homeowners and auto insurance claim losses.
  • Statistical analysis of archived credit files found that 30 of the 100 items in the credit files correlated with insurance payouts, leading to the creation of homeowner and auto insurance scores.
  • In 2000, James Monaghan found that individuals whose oldest account on their credit report dated back 25 to 29 years filed only $60 worth of claims for every $100 of premiums paid over the next three years.
  • The American Academy of Actuaries explains that “aggressiveness” and “willingness to take risks” go along with a poor driving record.
  • Steven Parton, the general counsel for the Florida Office of Insurance Regulation, explains that insurance companies use scores in order to identify who is most likely to file a claim rather than who is most likely to get into an accident.

While there is a correlation between a driver’s credit score and the amount of claims they file, this statistic is not one that insurance companies should necessarily base their insurance rates on. Rather than basing rates on factors that signify which consumers are more likely to file an insurance claim (costing the insurance company more money), insurers should determine rates based on an individual’s driving history and potential risk for an accident. By basing insurance rates on credit scores and economic status, insurers suggest that individuals with better credit scores are less likely to file claims because they have enough money to avoid using their insurance, thus, raising their premiums. On the other hand, individuals with poor credit scores are not allowed this luxury. These individuals need the insurer to assist them with payment and therefore are more likely to file an insurance claim in the case of an accident.

Unstable Insurance Premiums

One of the problems with credit-based insurance scoring is that there are no agreed upon standards for the scoring model among the different insurers nationwide. Because of this, premium rates differ widely from one insurer to another. With varying models and criteria for scoring, insurers make it nearly impossible for customers to understand how their rates are determined or how to improve them. Furthermore, when credit-based criteria are added to the scoring model, premiums become even more unstable and unreliable. As insurers have altered their scoring models, researchers have been able to track the consequences of these changes on customer’s insurance premiums.

  • Lamont Boyd, the insurance market manager at Fair Isaac says that “two thirds to three quarters of customers are getting better premiums because of credit-based insurance scores.”
  • In 2004, the Texas Department of Insurance found that half of the customers paid more and half paid less than they would have without credit-based scoring.
  • Farmers Insurance Group disclosed that there was an $80 annual reduction on average for the 58% of customers who saved because of credit scoring and a $109 increase for the rest.
  • In a study performed by Consumer Reports, the same individual’s insurance premium changed drastically and erratically when calculated based on different insurance company’s standards, using both a neutral and credit-based scoring model.

At-Fault Credit Behavior

Insurers use credit behavior as a criterion in premium scoring based on the contention that consumers with financial difficulties have a stronger tendency toward risk-taking behavior. This line of thinking implies that individuals who take more risks with their finances are more likely to take risks with their driving and safety. Insurers, therefore, justify using credit history and financial status to determine insurance premium rates. However, credit-based insurance scoring also punishes individuals who do not have explicit financial challenges or, along the insurer’s line of thought, risk-taking financial behavior. Along with credit score and credit history, insurance companies also take into consideration credit factors that do not affect an individual’s financial status. Things such as an individual’s age when he or she first opened an account, whether an individual has shopped for loans, and what types of loans an individual already has are factored in to insurance premium rates. This means that an individual with a perfect credit history may be penalized for opening an account at an age that the insurer has deemed risky, even though this is not a measure of financial stability. Interestingly, insurers, such as Choice Point, are unable to explain why they use financial criteria to set insurance premium rates. They are only able to conclude that there is a correlation between financial status and filing an insurance claim, not that one causes the other. Different insurers have developed several different models for calculating a customer’s insurance premium.

  • 40% of Fair Isaac’s Assist insurance score is based on a customer’s payment history and 60% weighs balances and credit limits, the age of an individual’s earliest account, whether an individual has shopped for loans, and the types of loans an individual has already.
  • Under the Assist model, if a customer has shopped for loans, opened three new credit card accounts, and temporarily ran up balances, their insurance score will plunge.
  • Progressive’s A24 credit-scoring model looks at 12 items on credit records, including opening a new credit card in the previous four months or having a credit card balance higher than 40% of your limit.
  • Under the Choice Point Attract scoring model, factors such as having department store charge cards, auto loans from automaker finance companies, not having an oil company credit card, and having finance company credit will all significantly decrease a customer’s insurance score.

Using Imperfect Data

An insurance score is only as reliable as the data that it uses. For this reason, it is essential that the credit information that insurance scores are derived from is accurate and up-to-date. If insurance scoring models are based on inaccurate data, customers may be given premium rates that are unfair for either the insurance company or the consumer. The Consumer Federation of America, the Federal Reserve, U.S. Public Interest Research Group, and Consumer Reports have found several credit reports with delinquencies, out-of-date balances, and incorrect credit limits (all capable of lowering an individuals’ insurance score and increasing their premium). Furthermore, one of the challenges with basing premium rates on credit information lies within the nature of credit reporting itself. Credit reports are a mere snapshot of a moment in time in an individual’s life. Because credit information can fluctuate at a fast pace, it can be nearly impossible for credit reporters and insurers to maintain a current score and rate. With perpetually changing information, credit bureaus may fail to update a consumer’s credit information when an insurer decides to examine that information for their scoring model. For example, if an individual takes a vacation and runs up a large amount of credit, an insurance scoring model may penalize that person before they are able to return from vacation and pay back the balance in full. The model has no way of anticipating changes, such as paying bills or paying off loans, and is therefore defective in many ways. 

The Adverse Effect of Credit Scoring Insurance Models

Many of the primary elements used in credit-based insurance rating appear to target low-income consumers. Because many individuals living in lower income situations may rely on credit cards for many basic finances, their insurance premiums will be elevated due to insurance scoring. Many critics of credit-based insurance scoring models believe that credit scoring is used as a justification for pricing premiums based on race and income. Using credit information for determining insurance premiums allows insurers to discriminate based on unethical and illegal factors without doing so overtly. Though these arguments are made against credit-based insurance rates, many insurers and supporters remain adamant that credit scoring has no disproportionate impact on customers. However, some basic statistics concerning the demographics of credit holders seem to demonstrate how credit-based scoring could discriminate against lower income individuals and minorities.                                                                 

  • According to a study done in 1995 by the Federal Reserve, 18% of lower income families use finance-company credit.
  • 67% of all families have a major credit card, whereas only 45% of lower-income families do.
  • Studies in Missouri, Texas, and Washington show that insurance scores have a disproportionately adverse effect on blacks, Hispanics, and low-income families.
  • In 2004, the Texas Department of Insurance found that members of minority groups have credit scores that are on average lower than those of whites; 10% to 35% for blacks and 5% to 25% for Hispanics.
  • In 2006, in response to a class action lawsuit filed against Allstate Insurance for discriminating against blacks and Hispanics, Allstate agreed to change its credit-scoring model nationwide.
  • In Oregon, insurance companies can only use a credit-scoring model with new customers.
  • In Florida, insurers have to show that their use of credit scores does not disproportionately affect consumers based on race, color, religion, marital status, age, gender, national origin, or place of residence.

States Resisting

Controversy concerning credit-based insurance is prevalent among those who are aware of it. However, because many consumers are unaware of how premiums are determined, they are not aware that their credit score could play a role in their insurance premiums. Moreover, many insurers refuse to disclose how their premium rates are calculated, making it impossible for consumers to remedy their penalized attributes and lower their premium rate. Insurers have no legal obligation to disclose their insurance scores to their customers. Progressive and Farmers Insurance companies will provide details about premium scores if the customer requests. Choice Point gives out insurance scores to their customers for a $13 fee. Several states have fought against credit-based insurance scores, while others (usually endorsed by insurance companies) have supported the scoring models. Many state laws have prohibited scoring models from counting negligent medical accounts as part of credit-based scoring. While restrictions have been made on the criteria admitted in premium scoring, states still vary widely in their scoring models.

  • Maryland, New Mexico, Oregon, and Washington have stronger restrictions on the criteria insurers can use for credit-based insurance scoring.
  • California, Hawaii, and Massachusetts banned all forms of credit-based insurance scoring.