In the early 1990s I was scratching out a living as an underwriting manager when my phone rang with one of the most asked questions in our industry: “What does my credit score have to do with my car insurance rates?” Not having a better answer at the time, I said something like, “It's really hard to explain, but it just does.”

Today, not much has changed. Credit or credit-based insurance scoring is still easily misunderstood by consumers, making it low-hanging fruit for aspiring politicians. In 2009, almost 50 bills limiting or prohibiting the use of credit in insurance underwriting or pricing were introduced across the country. Fortunately for consumers, none made it into law.

In a business where the only way to predict and price future losses is to look at the past, credit is one of the best, most accurate tools available. A recent study commissioned by the insurance consumer advocate's office in the Iowa insurance commissioner's office confirms credit-based insurance scoring as a fair and accurate predictor of loss.

Most consumers can probably make the connection between common underwriting/pricing variables like driving record, driver age, or wood versus brick construction. It is easy and logical to say if you had a DUI you will pay more for car insurance. However, surcharging drivers with bad driving records or charging higher premiums for homes on the beach is done only after there is evidence that proves those surcharges are warranted. The industry's use of credit meets that same standard.

Insurance agents have been trying to explain all of this to their clients for years.

So why does credit scoring work? Maybe the answer I gave almost 20 years ago still has merit after all–it just does. Study after study (EPIC actuaries, Tillinghast, the University of Texas, and even the Federal Trade Commission) has proven a clear and direct relationship between credit-based insurance scores and losses. Further, those studies validate that credit scoring is not unfairly discriminatory. Because it works, insurers can more accurately predict future risks and price their products accordingly. The result for most consumers is lower premiums.

Remove credit from the underwriting/pricing mix and the predictability of future losses becomes less certain and policies become more expensive. And if you think trying to explain the use of credit is tough, see what happens if the use of credit in the ratemaking process goes away and insurance premiums go up for most of your clients.

Special Reports /

Credit Scoring: Tough To Explain, Hard To Beat

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