With mortgage rates at record lows, many people are scrambling
to get their finances in order so that they can buy a house or refinance
their current home loan. Now we all know that our credit histories
will affect whether or not we get the loan we need to buy a house
(or car, boat, etc.) or refinance an existing loan, but what most
people don't realize is that credit histories can also affect how
much we pay for auto insurance. Not only can it affect our rates,
but it may even impact whether we can get insurance at all, at least
from some companies.
Increasingly, insurance companies are using credit reports to
develop credit "scoring systems" that classify consumers
based on several factors. As a consumer, how you're classified -
whether you fall into a preferred, average, or high-risk class -
can impact what rate an insurance company charges you.
The use of credit scores in insurance rating became commonplace
over a decade ago with homeowners insurance. It grew out of companies'
attempts to create rating plans that would assess risk levels as
accurately as possible, in order to predict their own expenses as
well as charge appropriate rates. Banks and other financial institutions
had long used credit information in determining risk on business
such as home loans, and the correlation between those financial
records and insurance risks became clear.
The trend moved into the auto insurance industry, and as soon
as the math was done, insurers realized they were onto something.
"After all the variations in rating plans had been accounted
for, there was still something statistically significant that was
explained by credit rating scores," said Wayne Holdredge, a
senior partner with the insurance consulting firm Tillinghast-Towers
Perrin. "Within the last few years, virtually every company
is doing it, because if you don't, you get what's left over - the
people who have low credit."
Holdredge has studied the issue for years, and said the numbers
don't lie - higher credit scores translate statistically into better
insurance risks. The wisdom is that, just as people with good driving
records expect good rates, high credit scorers can therefore pay
rates that reflect that.
The laws that govern insurance companies and regulations are set
at the state level, so where you live determines what information
companies can gather and how they can use it, as well as what your
rights are. Generally, in states where it's allowed, insurance companies
use your credit information like this: They plug basic credit information
(such as bankruptcies, missed payments, the number of cards you
have and how much activity they see) into formulas that also take
into account your accident history, years you have been driving,
geographical factors where you live, your age, gender and assorted
other relevant facts about you.
The formulas assign varying levels of importance to these based
on rather complex data such as the company's loss history and how
statistically important the factors have been shown to be for that
company. (For example, males are more likely than females to get
into accidents. How much more likely depends on still other criteria,
such as what kind of cars they drive.) From a mathematical maze
of interlocking facts and levels of importance comes a risk level
- and a rate plan - for each insurance consumer.
Many states are required to tell consumers what the top several
factors are that affect their rates, but your insurer may not even
understand the exact significance of some of the numbers, since
they often come from outside sources. If you're interested in finding
out if credit was used to determine your rates, contact your insurance
"The best advice for everyone is that periodically you need
to get your credit checked," Holdredge said. That way, if you
spot something, you can take steps to fix it before it hurts you.
So, what if you're insured, and your credit takes a turn for the
worse? You'll probably be all right. For one thing, companies who
know and trust you may be reluctant to (or may not be allowed to)
raise your rates for no other reason than a credit score. And credit
scores generally don't vary dramatically over short periods of time.
Also, insurance companies fall into one of two camps: those that
use credit in rating only new business, and those that favor using
credit scores in periodic updates and adjustments. Consumers may
be relieved to hear that Holdredge estimates 80 percent of companies
fall into the "new business only" category.
Holdrege also sees positive aspects to the use of credit in insurance.
"It allows companies to write risks they otherwise would not
have in the past," he said. "It allows them to go into
areas they were hesitating to appeal to."
For example, in an area that has been deemed geographically undesirable
(such as large cities due to heavy traffic and density, high incidence
of car theft, and vandalism) a resident with a high credit score
may find coverage more easily than would have been the case without
factoring in credit.
Whether or not you support the use of credit in insurance rating
plans, it's wise to regularly review your credit report. And know
your rights - Under the Fair Credit Reporting Act (FCRA), consumers
have the legal right to obtain a free credit report if an "adverse
action" has been taken as a result of a credit report or score.
(The act was passed to hold credit reporting agencies accountable
to standards of confidentiality, accuracy and proper use of credit
information. For more information on your rights under FCRA, go
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