Credit Scores vs. Insurance Scores
A credit risk score is a number, produced by evaluating information in your credit file at a credit reporting agency, which evaluates the likelihood that you'll pay your bills on time. FICO® scores, the scores that most lenders use, are based on mathematical models built by FICO and are available from any of the major credit reporting agencies (Equifax, Experian, and TransUnion). They are used by financial institutions and retail credit grantors for all kinds of decisions: whether or not you get a credit card, or what kind of an interest rate you qualify for on a mortgage loan, for example.
A different kind of a score is used by most insurers to help evaluate the risk of insurance applicants and policyholders. This score, generically called a credit-based insurance score (different credit reporting agencies have different names for the FICO insurance scores they sell), indicates whether you are more or less likely to have claims in the near future that will result in a loss for the insurer.
There are obvious similarities between your credit risk score and your insurance score: they are both based on your current credit report data and are calculated using models built by FICO.
There are, however, important distinctions. The credit risk models are built to predict the likelihood of delinquency or non-payment of a credit obligation. The insurance risk models, by contrast, are built to predict the likely "loss ratio relativity" of any particular individual. Loss ratio is the amount paid out by the insurance company in claims divided by the amount they collected in premiums. Loss ratio relativity measures whether the cost of your insurance claims will be higher or lower than average.
Insurance scores are not used in isolation to set pricing, nor to deny insurance to any consumer.
Insurance risk scores are also used in different ways than a credit grantor would use a credit risk score. For example, an insurance score is most often one factor of many in an insurer's underwriting evaluation. For example, most insurers use an insurance score along with a motor vehicle report, claims history report, home inspection and other kinds of information in their decision-making process. Scores are not used in isolation to set pricing, nor to deny insurance to any consumer.
In fact, for over a decade insurers have used credit-based insurance scores because of the benefits they bring. Among the advantages of insurance scores:
- Consistency. Insurance scores are usually applied in an automated environment, in combination with the insurer's underwriting rules and other criteria. All applicants are therefore treated according to a consistently applied standard.
- Fairer decisions. Insurance scores are completely non-discriminatory and use no data on gender, nationality, ethnicity, address or income. Only credit-related information is included, and its use is governed by the FCRA.
- Better decisions. Insurers can better forecast future performance and thus make sure that each person pays a rate that more closely corresponds to the risk of loss they represent. This means that if you are less likely to have claims that will result in losses for the insurance company, you will pay a lower premium. And because those that will likely have claims or larger claims will end up paying higher premiums, insurance scores help your insurance company make sure that you won’t end up paying more than you should to help cover someone else’s future claims. The bottom line is that because the majority of people have good credit, even during turbulent economic times, most people will pay less for insurance than if insurance scores weren’t used.
- Efficiency. Streamlined operations and better use of key underwriting information and other resources allow insurers to pass savings along to you. Also, because insurance scores are easy to use, you enjoy the added benefit of faster underwriting decisions – meaning you'll get better service, quicker.