The truth? credit scores count for car insurance too.
If you've ever applied for a credit card, leased a car, or obtained a loan for a home, you know that credit scores count.
Many U.S. car insurance companies use credit-based insurance scores to help determine risk. (Unless you live in Massachusetts, Hawaii, or California, where the practice has been banned.) And studies have shown that there's good reason to use credit-based scoring in developing rates.
The difference between credit-based insurance scores and credit scores
Credit scores are determined based on information from your credit report and are used by lending institutions to determine how likely it is that you'll repay a loan on time. Credit scores determine interest rates and loan qualifications.
Credit-based insurance scores don't factor in your job, income history, gender, or any other personal information. Car insurance companies use them to help determine the likelihood of an insurance claim in the future.
How credit-based insurance scores work
To establish eligibility for payment plans and to help determine insurance rates, most U.S. insurance companies, including Esurance, use credit-based insurance scores, along with your driving history, claims history, and many other factors (again, except in California, Hawaii, and Massachusetts).
If you have a high credit-based insurance score, an excellent driving history, and zero claims on your record, you'll typically qualify for lower rates. Of course, your score is only one of many factors used to calculate your premium. If you have an excellent insurance score but a less-than-stellar driving history, for example, you might be considered riskier to insure.
Why we use it
It's simple: We want to make sure you're not overpaying for car insurance.
While the reasons why are less than crystal clear, research shows that credit scores can accurately predict accident potential. Statistical analysis shows that those with higher credit scores tend to get into fewer accidents and cost insurance companies less than their lower-scoring counterparts.
In 2003, The University of Texas (PDF) conducted an analysis based on 175,647 policies. They found that those with lower credit scores tended to incur more car insurance losses and higher claims payout, and thus posed greater risk to auto insurers.
The Federal Trade Commission (PDF) also undertook an independent study to understand the relationship between credit history and risk. Like The University of Texas, they found that credit-based insurance scores are effective predictors of risk.
Given these findings, the use of credit-based insurance scores to determine risk and insurance premiums makes a lot of sense.
Factors that influence your score
Esurance uses LexisNexis®, a leading provider of consumer reports, to obtain your credit-based insurance score. LexisNexis looks at the information on your credit history from credit bureaus like Experian to compute your insurance score, meaning that your credit score will impact your credit-based insurance score.
Favorable factors might include:
Long-established credit history
No late payments or past-due accounts
Open accounts in good standing
Unfavorable factors might include:
Accounts in collection
A high amount of debt
A short credit history
A high number of credit inquiries
Your consumer rights
You can obtain your credit-based insurance score report through LexisNexis and dispute any unwarranted entries. Insurance companies aren't permitted to make any adjustments to your score.
The Fair Credit Reporting Act (FCRA) gives you the right to obtain your credit report for free. If you notice inaccurate information, you have the right to contest it and correct your credit history.
The use of credit scores in your state
The use of credit scores is controversial. Opponents of credit-based insurance ratings argue that they unfairly penalize those who have suffered medical or economic crises and negatively impact minorities and low-income consumers.
However, the Federal Trade Commission (FTC) found that the correlation between credit scores and risk remains strong when race, ethnicity, and income are controlled in statistical models. And after several attempts to develop alternative rating models, the FTC was unable to create a rating model that would accurately and effectively predict risk while addressing the disparity between economic and racial groups.
To make sure that insurers use credit scores fairly for all individuals, 48 states have taken legislative action addressing the use of credit information in insurance underwriting and rating.
It's worth noting that since insurance companies started using credit-based insurance scores, rates have become more accurate and safe-driving consumers have benefited.
Control your credit and save
If you're looking to save on car insurance, tracking and proactively responding to problems in your credit report can be an effective technique. Despite the controversy over credit-based insurance scores, they have proven to be an effective means of calculating risk and getting consumers fair and accurate rates.