Apply for auto or homeowner’s insurance and chances are you’ll find an inquiry on your credit report from the insurance company. Why and how do insurance companies use your credit information? Lamont Boyd, FICO’s director of global scoring solutions for the insurance market, joined me for an interview on Talk Credit Radio to explain how credit information — specifically in FICO’s case, the “credit-based insurance scores” they power — are used by insurers. Following are five “myths” he dispells about how your credit affects the insurance you get.
Myth #1: Your agent will look at your credit report.
In years past, insurance companies may have looked at your credit reports, says Boyd. But “about 18 years ago when FICO created the first credit-based insurance scores, insurance companies from that point forward just began to use credit-based insurance scores. It’s very, very rare that an insurance company is actually looking at anybody’s credit report itself.”
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Myth #2: Your scores are the same for insurance and credit purposes.
While similar types of information go into credit scores and credit-based insurance scores, there are some differences. Boyd explains:
“When (FICO) developed our credit risks scores, we’re trying to find from credit information whether or not the way this person has met their credit responsibilities in the past will more likely lead to default or serious delinquency than somebody else. But that’s not what we’re looking for with credit-based insurance scores. So, the models are really focused on the types of information that come from a credit report that are more indicative of future losses. Is this person — from the way they’ve managed their credit in the past — more or less likely to have an automobile or homeowner’s insurance loss?”
That said, however, Boyd says the same types of factors that impact your credit scores can hurt these scores as well; namely, paying bills late, maxxing out credit cards or credit lines, or having a short credit history.
“Statistically what we’ve found over many years as a result of independent studies is that people who choose to manage their credit responsibilities very effectively also happen to be the same group of people who manage their risk responsibilities well,” he maintains.
While an insurance company will look at your previous claims history, FICO doesn’t include that kind of information when calculating these scores. “Our models are specifically based on credit-based insurance information, more specifically, how does this person manage their credit responsibilities?” says Boyd.
[Related Article: Should Insurance Be Based on Credit Scores?]
Myth #4: Bad credit will get you turned down for insurance.
“In no state in the nation is an insurance company allowed to use credit information as a sole purpose for denying anybody insurance,” Boyd insists. “The use of credit really is to properly segment those risks so they can give them the greatest discount that might be available.”
Myth #5: If you’ve taken a hit financially in the past few years, you’re out of luck.
In addition to the fact that you can’t be turned down for insurance solely because of poor credit, you may also be protected in another way. According to Boyd, the majority of states have implemented provisions of the NCOIL model law (NCOIL stands for National Conference of Insurance Legislators). Under those provisions, somebody who has gone through certain “extraordinary life circumstances” such as a catastrophic event (think hurricanes, tornadoes or flooding); divorce; death of a parent, spouse or child; temporary loss of employment (involuntarily) for three months or more; or identity theft, among others, “has the opportunity to go to their insurance company and offer that information so that the insurance company then can exclude their consideration of credit from their overall underwriting and pricing of that risk.” He says, “That can benefit the consumer who has been negatively impacted by that extraordinary life circumstance.”
Finally, credit-based insurance scores are most heavily weighted toward more recent credit information, says Boyd. So pay down debt, if you can, be sure to make all your payments on time going forward and avoid applying for new credit unless you really need it. “By focusing on those three things, your credit-based insurance score should in fact increase over a period of time,” he says.
FICO offers a website with more information about credit-based insurance scores at InsuranceScores.FICO.com.
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Image: JD Hancock, via Flickr