Buying Insurance
By now you are starting to see that your credit can affect your life in a variety of ways. Not only does it affect the loans you get, it can make or break an employer's decision about you. The same thing goes for insurers: they may deny you or charge you extremely high rates depending on your credit.
What's Credit Got to Do with It?
You might wonder if your credit has anything to do with your insurance. Is it fair for an insurance company to set your rates (or deny you altogether) because of information in your credit history? That issue has been hotly debated for several years now. Different states have approached regulating and limiting insurance scoring in different ways.
Several studies have shown that there are interesting links between credit information and insurance claims. As you probably know, insurance companies use complex statistical models to predict the likelihood of various events. Recently, they have added statistical analysis of credit information to the mix. When they look at the data, they see that there is in fact a relationship between the customer's profitability and that customer's credit data. In particular, they try to predict the likelihood that a customer will submit a sizable claim within the next two years.
A Variety of Sources
Your insurance company may use a variety of different sources when evaluating you as a customer. For starters, they may dig into your credit history. To do this, they use information housed at the major credit-reporting companies like Equifax, TransUnion, and Experian. Based on the information in your credit history, they can come up with an insurance score. Of course, they could simply look through your credit reports and have a person make subjective judgments about you, but it is much more efficient and effective to use an automated scoring system.
Insurers have a lot of choices when it comes to purchasing insurance scores. The Fair Isaac Corporation has its own insurance-scoring model to supplement the FICO credit score. Their view is that the FICO credit score is irrelevant to insurance-related decisions. While there may be some overlap — for example, making late payments is bad no matter what — there are subtle differences that insurers find useful. The credit-reporting companies also offer insurance-related scores. Finally, some insurance companies have their own internal models that they use.
Some insurance companies use shared databases to track claims history. They keep records of how often you make claims, and they might track a house to see how many claims have been made on it over the years (even with different owners). Like other consumer files, you are entitled to view these reports for free each year.
Scoring models might look at characteristics other than the information at the credit-reporting companies. They might take information that you provide on an application, and they may even dig deeper. Insurers also use specialized services that track your interactions with other insurance companies. These are similar to your credit reports at the credit-reporting companies, except that the subject is insurance instead of credit. You will learn all of the juicy details about these services in Chapter 5.
Figures Lie and Liars Figure
Insurers rely on numbers to help them make decisions. They gather vast amounts of data, and employ armies of mathematical experts to crunch the numbers. These experts can predict how likely an event is given a set of circumstances. For example, they might say that you are more or less likely to be in an auto accident given your credit history. In a large population, they do quite well; their models provide useful information that seems to correspond with reality. However, you are not a large population. You are one individual who will be judged as if you are part of a large population. If your credit is bad and you are an excellent driver, it simply doesn't matter. The fact that you share a characteristic, bad credit, with other bad drivers means that you'll have to pay more for insurance.
The Big Picture
Insurance companies use your credit history for the same reasons that lenders do. They're trying to predict the future, and determine whether or not you will be a profitable customer. If they sense too much risk, they will either deny you coverage or ask for more money in return for that risk. They believe that somebody who has handled his finances responsibly is likely to take good care of his home, drive carefully, and otherwise make less expensive claims.
Your auto insurance, homeowner's insurance, and other types of insurance can be affected by the information in your credit reports. Insurance-scoring experts are not even certain why credit information can successfully be used to predict your costs to an insurance company. Nevertheless, they have found that it works, so you should expect them to continue using credit-based insurance scores.
