CREDIT-BASED INSURANCE SCORING
- Frequently Asked Questions
Use of credit information affects consumers in many ways in today's society. In addition to securing a loan, it may be checked by employers, landlords and even utility services. Today a vast majority of insurance companies are using credit-based insurance scoring for underwriting and rating personal auto insurance. The use of credit information in the underwriting and rating of insurance is expressly permitted under the Fair Credit Reporting Act (FCRA).
Why are insurance companies using credit-based insurance scores?
Several different studies have established that certain characteristics of an individual's credit history are correlated with future loss activity. Use of credit-based insurance scores are objective, accurate and consistent. Consider a June 2002 Insurance Research Council (IRC) study, which found several shortcomings in the reliability of state MVR data. In one of the states studied, the IRC determined that up to one in five convictions were missing from MVR records. Contrast those results with a study conducted by The Consumer Data Industry Association which found that less than 1% of all credit report challenges result in a change once the inquiry has been fully investigated.
The following studies established irrefutable evidence that insurance scores are correlated with future loss activity:
◊ A March 2003 study prepared by Bureau of Business Research, McCombs School of Business, at the University of Texas at Austin studied over 150,000 policies in the Texas automobile market and concluded that incurred losses on individual policies are statistically related to the credit-based insurance score of the insured. It was also determined that credit-based insurance scores do yield new information that is not contained in other traditional underwriting variables (i.e. age, sex, marital status, geographical area, vehicle usage). The results of this study also revealed that policies found within the lowest 10% of credit-based insurance scores had an average loss of 1.65 times the average loss found within the highest 10% of credit-based insurance scores.
◊ A June 2003 study prepared by EPIC Actuaries, LLC, using nearly 2.7 million earned car years of data (one earned car year = equivalent of one car insured for a one-year period) similarly concluded that the propensity of loss shows a clear pattern of decreasing loss propensity as insurance score increases. It also concluded that insurance score significantly explains risk that is otherwise not being explained by any other risk factor (i.e. age, sex, marital status, geographical area, vehicle usage).
How is credit information used in the rating process?
Credit information assists insurance companies in accurately assessing and pricing a risk. Insurance scores, along with information obtained from the application, MVR and loss history, create an equitable and fair pricing system. Individuals who file more expensive and/or frequent claims pay more while individuals who file fewer and/or less expensive claims pay less.
A high insurance score indicates the insured is a member of a group that is less likely to have future losses. A low insurance score indicates the insured is a member of a group that is more likely to have future losses. There are individual exceptions to the insurance score correlation to loss just as there are exceptions to any other auto rating variable correlation to loss (i.e. not all teenage drivers will file a claim, but as a group they are much more likely to file a claim). The ultimate goal for an insurance company is to correlate rates for an insurance policy as closely as possible to the actual cost of claims.
What is the difference between a credit score and an insurance score?
A credit score is a credit-based statistical analysis of a consumer's likelihood of paying off an installment loan or revolving debt when due. An insurance score is a credit-based statistical analysis of a consumer's likelihood of filing an insurance claim. An insurance score is not a measure of financial assets or wealth, but rather how well people manage their financial affairs.
What is the basis of the relationship between a credit-based insurance score and future loss activity?
Many who have studied this issue in-depth conclude that the relationship is explained by the reasonable assumption that the responsibility required to prudently manage one's finances is associated with other types of responsible and prudent behavior, such as the proper maintenance and the safe operation of automobiles.
What factors are considered in the development of a credit-based insurance score?
Information used in the development of an insurance score includes outstanding debt, length of credit history, late payments, new applications for credit, payment patterns, public records and past due amounts. Insurance inquiry information and non-consumer initiated inquiries are not used as a component of the insurance scoring calculation. Race, color, national origin, age, marital status, income level and address are not considered in the development of an insurance score.
How can a consumer improve their credit-based insurance score?
An insurance score is a snapshot of insurance risk at a particular point in time. Insurance scores are based on patterns of credit management over time with single incidents generally having very little impact. The score improves through a pattern of responsible credit use. Credit-related activities within the last 12 months are given the most significance. Specifically, in order to improve their insurance score, a consumer should pay bills consistently on time, keep balances low on credit cards and other revolving debt, and apply for and open new credit accounts only as needed.
What protections do insurance consumers have under the Fair Credit Reporting Act (FCRA)?
Insurance consumers are protected by the FCRA in the following ways:
◊ They have the right to obtain a free copy of their credit report if they are adversely affected based on information contained in their credit report.
◊ They have the right to contest inaccuracies in their credit report and to have inaccurate information corrected or deleted from their report.
For more information regarding the Choicepoint insurance scoring and reason codes, please visit Choicepoint's website (www.consumerdisclosure.com).