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How Your Credit Influences Your Car Insurance Rates

By Kade Phillips

Republish: EasyPublish™ Published: 03May2010 Word count: 706 Viewed: 348 time(s) Get Free Content For Your Site

Insurance at the very core is merely a way to pool risk amongst a group of individuals. Each individual within the group agrees to a contract that offers coverage for a defined list of circumstances. This coverage is provided in exchange for premiums paid by the policyholder. Each policyholder pays a different premium based on a formula that considers a variety of personal factors. One of these factors is your credit score and history.

The use of credit to determine car insurance rates has met with criticism and controversy. Auto insurers insist that a person's credit history is a valuable barometer of the likelihood of future claims. Consumer advocacy groups, on the other hand, insist that not only is it a poor gauge of risk, but is also fraught with numerous problems. We'll explore this issue in greater detail below.

A Predictable Indicator Of Future Claims?

Auto insurers, like all insurance companies, calculate and apply a risk score to each of their policyholders. This score is an amalgamation of your driving record, the type of vehicle you drive, average number of miles driven, and a host of other factors. The purpose of calculating this score is to assign a simple value that represents the probability of the policyholder filing a claim. This probability signifies risk for the insurer.

Your credit is used to calculate your risk score because car insurance companies claim there is a positive correlation between poor credit and increased claims. The underlying reasons are varied.

First, insurers assert that a high credit score suggests the policyholder is responsible. This implies that he or she is likely to make better decisions behind the wheel and thus, avoid accidents and other situations that lead to a financial loss. That translates into fewer claims.

Second, auto insurance companies maintain that a low credit score suggests a policyholder is under fiscal pressure. This leads to higher stress levels and a greater likelihood of taking unnecessary risks on the road. Consequently, more claims.

Whether this correlation between credit usage and claims risk is provable is questionable. What is clear is that there are a few glaring limitations to including it within risk score calculations.

Limitations Of Using Credit To Calculate Premiums

The first - and obvious - problem is that credit reports from Equifax and TransUnion contain errors. These errors often push consumers' scores down undeservedly. If a car insurance company pulls your credit report, they will assume the information is valid and calculate your premiums according to their proprietary risk formula.

The second problem involves identify theft. Suppose you're a victim. Unauthorized revolving credit accounts and loans can be opened in your name and allowed to go into default, damaging your record. This too, can affect your auto insurance premiums.

The third problem is that personal circumstances can impact your credit file while having little to do with your fiscal responsibility. For example, a divorce or a prolonged period of unemployment can cause your credit score to plummet.

There is little you can do to convince an auto insurer to overlook your credit if they already use it to calculate risk scores. However, it's worth noting that every insurer uses a different formula. Some consider credit a low priority.

The Advantage Of Conducting Periodic Comparisons

This brings us to one of the most compelling reasons to shop for lower car insurance rates on a regular basis: variability between insurers. Most people simply renew their contracts each year, assuming the premiums they're paying are the lowest they'll find. Or, they assume that every insurance company offers the same level of coverage for the same rates. This is a common misconception.

In reality, every auto insurer relies upon their own data to determine the risk of future claims. Some insurance companies will have discovered a high correlation between their policyholders' credit files and the likelihood of claims. Others will show a much lower correlation.

Invest the time to compare auto insurance rates online at least once each year (if not more often). Ask insurers whether they use an applicant's credit file to determine rates. You may find that better coverage is available to you for lower premiums - there's no way to know for certain unless you shop around.

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