More of us are paying attention to the rules our credit card companies send us or the fine print on our mortgages. Here’s yet another financial ripple to watch for: Your credit score can affect what you pay for homeowners or auto insurance.
The practice by insurance companies of using credit histories to set rates has been around for more than 15 years.
But now that the country is in a historic financial pit, some are asking if the practice is still valid.
As might be expected, the answer depends on whom you ask.
“All the factors in the models deteriorate because of the financial market downturn,” said Birny Birnbaum, executive director of the Council for Economic Justice, a nonprofit advocacy group for minority and low-income consumers. Birnbaum formerly was an associate commissioner for policy and research and chief economist at the Texas Department of Insurance.
The center “called for a moratorium on insurance scoring because consumers shouldn’t be penalized because of reckless spending decisions of lenders,” he said.
Alex Hageli, a policy expert with the Property Casualty Insurers Association of America, said the models work just fine. Both insurance and credit scores have remained steady throughout the recession and in some states have actually improved, he said. He believes consumers began to save and pay down debt, warding off any drops in scores.
“We’ve always maintained they worked,” Hageli said.
He rejects claims from advocates who believe the scoring is unfair and doesn’t work.
Insurance companies say the risk scores they create predict who is more likely to file or inflate claims or commit fraud or arson. Since the early 1990s, there’s been debate about whether credit history and responsibility are linked and whether insurance scoring disproportionately affects minorities and the poor.
“We don’t know, and we’re not required to know, and we don’t care why any of the rating factors work,” Hageli said. “We don’t know, for example, why women are less likely to be involved in an accident. We just know ... the data show that it’s actuarially justified.”
With credit, the thinking is that people who are “responsible with maintaining credit will be more meticulous with other area of their lives,” he said. “But ultimately, who knows.”
Insurance credit scores generally incorporate financial history from credit reports, which can include information such as bankruptcies and other delinquencies, how close a consumer is to reaching a credit limit and how many open accounts a consumer has. The insurance scores also can incorporate information about location, past claims and accidents and tickets.
Insurers generally keep their scoring models secret because of rate competition, although some states require companies to file the models with regulatory agencies. Many companies develop their own scoring systems and others use models created by Atlanta-based ChoicePoint and Fair Isaac Corp., the Minneapolis company that invented credit scoring.
Consumers have become used to hearing about the importance of credit reports and scores, but might not know how often that information affects what they pay – or are paid. Scores can be a factor in credit card and mortgage rates and even in employment.
Still, a 2005 report from the Government Accountability Office said about two-thirds of 1,578 consumers surveyed did not know credit histories can affect insurance premiums.
The Federal Trade Commission is now studying the impact of insurance scoring on homeowners insurance. Last Wednesday, the House Subcommittee on Financial Institutions and Consumer Credit held an informational hearing about use of credit information by insurers.
In addition, Georgia Department of Insurance spokesman Glenn Allen said the state will participate in a survey announced last week by the National Association of Insurance Commissioners.
The NAIC said it will ask state insurance regulators around the country to poll auto insurers about how rates are created, the variables in credit-based scores and the range of premium differences among consumers based on those scores. The group hopes to issue a report this year.
Every year, Hageli said, there are a dozen or so efforts to ban or restrict insurance scoring, but most fail.
“Given all the debate, that’s a pretty good track record of states looking at scoring and agreeing that consumers should be able to enjoy the benefits,” he said. “It helps a vast majority of insurance consumers to get cheaper insurance.”
A few states do have bans. California effectively bans insurance risk scores for both home and auto insurance; Maryland, for home insurance; and Hawaii, for auto. Michigan bans the use of all credit-based insurance scores, but the law is being challenged in court.
Georgia, Illinois, Utah and Washington prohibit insurers from canceling or refusing to renew auto policies based solely on credit information.
Georgia also prohibits insurers from using the absence of a credit card against a consumer or penalizing them for credit blemishes caused by medical bills. Consumers who have “life-changing or unusual events” such as identity theft, serious illness or divorce can appeal credit-related increases in their premiums.
“These insurance companies and the modelers are saying ‘trust us, credit scores haven’t changed’,” Birnbaum said. “Now, why would we trust them? When it comes to banking, the public has independent data ... where we can see where all the delinquencies and foreclosures are happening.”
“Right now, there’s no place to verify these [insurance company] claims,” Birnbaum said.
One unofficial barometer shows scores are going down. Scores dropped two points nationally among users of Credit Karma, a site that allows consumers to view free, estimated credit scores and gives financial advice. In exchange, Credit Karma uses personal information it collects to broadcast advertising messages tailored to its member users, which it says now total one million.
The San Francisco company periodically releases trend reports tracking users’ indebtedness and scores. In its latest report in January, comparing more than 100,500 user scores, the company said consumers paid down credit card debt 2 percent from the month before. Despite that, scores declined.
Credit Karma said trends that previously showed credit scores going up are now reversing because of the recession.
Check our sources
• About credit scoring and how it works, from the Federal Trade Commission
• A credit scoring white paper from the Insurance Information Institute, a nonprofit run by the insurance industry
• A primer on insurance, from the Center for Economic Justice, a nonprofit representing low-income and minority consumers
How to improve your insurance risk score
Here are a few factors that affect your score and some strategies to improve it:
• Payment History: A consistent record of on-time payments going back several years shows responsibility. Late payments and delinquent accounts can lower your score.
• Debts Owed: It's typically best to have few active and open credit accounts with low balances. Use no more than 30 percent of your available credit at any given time. Major bank credit cards with good payment records are better for your score than department store cards, which generally carry low limits.
• Length of Credit History: The longer you have had credit and kept individual accounts open, the better. If you decide to cut up a credit card, do not close the account as this will raise your balance-to-credit-limit ratio and can have a negative impact on your credit score.
• New Accounts: Limit new applications for credit. Resist offers to open new cards for last-minute check-out discounts on store purchases or other one-time benefits. A large number of new inquiries on your report can make it seem like you intend to run up debt.
• Balance of credit and loan accounts: Generally, it's best to have two to six open credit cards and one or two loans.
Sources: Insurance Information Institute and Credit.com