Credit-based insurance scores play a critical role in the process of insurance and are widely used across the industry for segmentation, but they can be misunderstood. “Credit scores” frequently make headlines, especially during economic downturns or high unemployment. These are “financial credit scores” designed to predict an individual’s creditworthiness or a consumer’s likelihood of paying an installment loan (mortgage, auto loan, etc.) or revolving debt (credit card, etc.) when due.
A “credit-based insurance score” is a predictor of future insurance loss. An individual’s credit report may contain no negative factors from the standpoint of decisions made with respect to the granting of credit, but at the same time could indicate a greater or lesser degree of risk that an insurance loss will occur.
Credit-based insurance scores look at much of the same consumer credit information, but the models are designed to analyze an individual’s propensity to have an auto or homeowner’s loss. For personal lines of insurance, credit-based insurance scoring is essential to the rate order of calculation, enabling better risk segmentation and rate accuracy.
The Insurance Information Institute’s (III) Background on Credit Scoring
points out that credit-based insurance scores are not the sole factor used to underwrite and price insurance. In auto insurance, various other factors (such as previous accidents) can be combined with credit-based insurance scores. In homeowner’s insurance, other factors may include the home’s age and construction, location and proximity to water supplies for firefighting, and proximity to flood risks.
Most scoring systems generate “reason codes” in addition to the numeric score. The reason codes will identify up to four principal factors that influenced the score.