6 things to know about insurance credit scores

By Andrew Housser

Most likely, you know that you have a credit score that affects your chances of being approved for credit and the rates you pay for loans. But you might not know that you also have a separate, credit-based "insurance credit score" that affects the rates you pay for auto insurance.

Three major credit reporting agencies -- Equifax, Experian and TransUnion -- each report consumer credit scores, generally based on a formula designed by the Fair Isaac Corporation. Credit scores, which range between 300 and 850, are calculated using mathematical methods that incorporate credit history, amount of credit used and available, number of late and on-time payments, whether any payments due are in default and other variables.

Insurance companies use a variant of credit scoring, developed specifically for their industry, to help predict an individual's likelihood of filing an insurance claim.

In underwriting auto insurance, driving history remains the key factor, but insurance credit scores play an important role as well. Several studies have shown that credit information can indicate how a person manages financial risk. People who manage their finances responsibly also tend to have fewer accidents, which translates into lower costs for insurers. Those people, in turn, can receive lower rates on insurance premiums because they are less likely to incur costs for insurers.

With credit scores figuring heavily into insurance credit scoring, the insurance industry states that insurance scoring benefits a majority of consumers, because most people have good credit scores. The median credit score is 723, according to Fair Isaac. About 45 percent of consumers have a score between 700 and 799, and another 13 percent score above 800.

What does that mean for your insurance rates? Here are a few things to know about insurance scores -- and how you can improve your score.

• Insurance scores take debt, payments into consideration. Insurance scores examine debts, payments, credit history, bankruptcies and new applications for credit. If you have a number of new credit cards or carry high balances, those behaviors might count against you, even if your income is high. Solution: Use credit cards judiciously, make sure to pay off balances in full monthly and think twice before opening new accounts.
  
  
• Insurance credit scores are based on credit information. Insurance credit scores operate under federal laws that prohibit discrimination against consumers for reasons of ethnicity, religion, gender, marital status and birthplace. Therefore, insurance credit scoring is based solely on credit information, not on any personal information.
  
  
• Nearly all states permit insurance scoring. Only Hawaii prohibits insurance scoring to rate auto insurance policies. Several states do have restrictions on the books that limit how insurance scores can be used.
  
  
• 4. Insurance scoring is research-based. The industry has used credit information in making rating decisions since 1970. Several studies have affirmed that there is a connection between credit history and the likelihood of a person filing an insurance claim.
  
  
• 5. Negative issues diminish from the score as time passes. More recent credit activities have a greater impact on the insurance score than older behaviors. Solution: Work to pay bills on time and keep credit usage manageable to improve a less-than-perfect score.
  
  
• 6. You will be notified of score-based rates. If your insurance rates increase because of your insurance score, most companies are required to notify you. The notification -- called an adverse-action letter -- will include information on how to learn more about your score. Solution: Check your credit report regularly. If you see any inaccurate information, take steps immediately to correct the information. Also tell your insurance underwriter about any inaccuracies so that the insurer can choose to evaluate your rates differently.

Overall, the insurance industry maintains that insurance scores help most people pay less for their insurance. The scores also are said to help assign costs of coverage fairly to consumers, based on their risk profiles, and to provide fair tools for insurers to make decisions.

One thing is for sure: Insurance scores are here to stay, and so they create another reason to be smart about managing your money and credit.

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