Auto insurers include your credit score as a factor when determining your premiums, but many motorists have yet to fully appreciate the effect their credit-worthiness has on their car insurance rates.
Here’s how your auto insurance and credit score are linked
On the flip side of this equation is the fact that three in 10 people mistakenly think that their driving record has a bearing on their credit score, according to a recent survey from Wallet Hub. Nonetheless, insurers say credit-based insurance scores actually reward the fiscally responsible among us.
You may be wondering where this idea that how you handle your wallet is related to how you handle your wheels comes from. The most comprehensive public research was done about a decade ago by the Federal Trade Commission in a report on the issue.
The agency found that several states bar insurance companies from basing their underwriting decisions solely on people’s credit scores and credit histories. It has a lot to do with the period of time — the “exposure period” — insurance companies can incur losses.
“[Credit] score developers start with the credit information available about customers at the beginning of the exposure period and the known losses for them during the period,” the FTC report says. “Score developers then use various statistical and other techniques to develop a model that predicts losses based on the credit information that was available at the start of the exposure period. If the relationship between the credit information and loss is sufficiently stable over time, the model can be applied to the credit histories of other consumers to predict the risk of loss they pose. ”
A report by the Insurance Information Institute (III) said that aside from credit scores, other factors, such as where a person lives, previous crashes, age and gender, help insurers determine who is more and less likely to file a claim.
How insurance companies handle those with no credit history
Of course, every person is different: An 18-year-old who may not have much of a credit history can’t possibly be judged the same standards as, say, a 40-year-old with a job and family, right?
When it comes to teenagers and other people without credit histories, many states mandate that insurers adhere to the National Conference of Insurance Legislators’ (NCOIL) “Model Act Regarding Use of Credit Information in Personal Insurance,” which was released in 2002.
The NCOIL rules, which many states have adopted verbatim, say that “no-hits” and “thin files” (people with no or scarce credit histories) should be considered to have “neutral,” or average, credit. The insurer also has the option of using another scoring model, which must be disclosed.
As a conclusion to its report, the FTC says, “A consistent finding of prior research and the FTC’s analysis is that credit information, specifically credit-based insurance scores, is predictive of the claims made under automobile policies. However, it is not clear what causes scores to be effective predictors of risk.”
By Craig Johnson
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