Credit score and insurance score: How they drive your premium

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By: Phil Bradford
on 12th May,2016

Your insurance premium depends a lot on your credit score. Brush up your knowledge here.

A credit score is a metric to assess creditworthiness. It evaluates the likelihood of whether or not a borrower will be able to repay a loan. Many people are unaware that insurance companies rifle through credit scores to foretell a consumer’s probability to file a claim. If a person has a sub-par credit score as per the insurance company’s mandate, then he/she has to cough up more dollars to buy an insurance policy. The same is applicable even if the person hasn’t met with an accident ever in his life.

Insurance companies know that irresponsible credit use is directly related to increased insurance risk. Every insurance company uses a proprietary insurance score developed with about 30 of the 130 elements found in a credit report. This score is quite different than FICO score. As a result, it is difficult to use one to guess the other.

The TransUnion, LexisNexis, and FICO are the leading organizations to provide insurance scores. Almost 85-90 percent homeowners insurance companies and around 90 percent auto insurance providers use this credit-based insurance score. In the case of LexisNexis over 300 insurance companies use their insurance scoring system.

Must read: Major credit card mistakes that can lower credit score

Effects of Insurance Score

An insurance score is a computed rating metric used by the insurance companies. This score determines the likelihood of a consumer to file a claim during his/her coverage term under the concerned insurance company. In other words, it helps to determine the insurance risk of a person and not to find out how consumers will pay off their debts. Insurance score plays a vital role in determining the amount of premium to be paid by a person for a particular insurance policy, regardless whether it is homeowner’s health care or any other insurance policy.

Insurance companies use this score along with other information to arrive at a definite insurance rate. For instance, an auto insurance provider will verify driving record and the state in which a car has been registered before approving a consumer’s insurance policy. In the case of mortgage lenders, these people study the location of the borrowers’ house, besides the construction materials used to built it, amongst other metrics prior to closing the deal.

Hence, the amount of premium to be paid on an insurance policy is inversely proportional to insurance score. In other words, the premium will increase if insurance score is low and vice versa.

Credit Score vs. insurance score

An insurance score isn’t a credit score. It helps the insurance companies to determine the premium amount to be charged on an insurance policy.

Assessing insurance score

A major portion of the insurance score is based on credit rating. Historical data suggest a clear correlation between credit rating and the amount of coverage claimed by consumers. As a result, insurance score is derived based on two factors; first, the credit score of the consumer and second, insurance claim filing history of the person.

Take, for instance, an individual with sub-par credit score has a greater inclination to claim insurance coverage as compared to the person with excellent credit score. Similarly, if a consumer has a perfect insurance score, then he/she is considered to be of least risk as far as filing insurance coverage claim is concerned.

Credit scoring system and its social effects

Some states have already put a ban on the use of insurance score by the insurance companies. This is why consumers must check with their respective state of residence’s Department of Insurance, before buying any insurance policy.

Federal Trade Commission (FTC) in 2007 has declared the use of credit score to determine insurance rates as discriminatory and has since put a ban on the same. According to FTC, it discriminates against the low-income group and the minorities based on their race and economic condition.

Regardless of one’s opinion, this kind of scoring system does have a negative effect. Therefore, it’d be wise to keep one’s credit score in the best category possible, if not worse. For that, one has to keep a track on his/her credit report, pay off debts on time and in full, avoid skipping monthly debt payments and weed out credit report errors as soon as possible for optimum result.

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