Do Insurance Scores Work?

You have probably heard about credit scores, but you may not have heard about insurance credit scores? These are scores built on credit report data for the insurance industry to predict whether or not a policyholder will file a claim on their auto or property insurance.  There are separate scores for each type of the aforementioned insurance.

Some consumers don’t understand how credit behavior can predict whether you will file a claim on your home or car.  One explanation is if you are careless in handling your finances, you may be the same with the way you drive a car or take care of your home.  Regardless of why it’s predictive, it has been proven to be, in fact, predictive.

This is the eternal battle between consumer groups, politicians and the insurance industry.  Just because you can’t understand WHY something is predictive of insurance risk certainly doesn’t mean it isn’t predictive.  I had a recent meeting with an investor group who was working with a company that was modeling musical choices and social media activity into risk scoring systems. In July 2007 the Federal Trade Commission (FTC) conducted a report on credit based auto insurance scores called “Credit-Based Insurance Scores: Impacts on Consumers of Automobile Insurance”.  The result was credit-based insurance scores were effective predictors of risk in automobile policies, are predictive of the number of claims consumers file and of the total cost of those claims.  The FTC also commented that insurance companies’ use of scores could be beneficial to consumers, if the cost savings from using them are passed on to consumers.  Using scores assists the insurance company in making decisions faster and cheaper.  In addition, higher risk consumers could be evaluated with higher accuracy and a premium determined with the score, but there wasn’t hard data to quantify this.

Most state legislatures agree that credit shouldn’t be tied to insurance and have prohibited certain credit information from being used in an insurance score such as existence of a credit card, credit history, number of credit inquiries, total available credit and use of particular type of credit card.  Some states restrict using credit reports as the sole tool to assess risk and in some you can’t be denied insurance just because you don’t have a credit report.

Whether you agree or not, insurance credit scores and credit reports are used to help in the insurance underwriting decision.

John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry.  Follow him on Twitter here.

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