Car insurance premiums are calculated for each driver based on several factors, including the age of the driver, number of years driving experience, type of car insured and the insured’s credit history.
Teenagers are considered higher risk and more likely to cause a car accident than more experienced drivers, and people with lower credit scores are higher risk than those with higher credit scores.
What does an individual’s financial history have to do with their car insurance rates?
The Federal Trade Commission discovered a direct correlation between an individual’s credit score and the risk for car accidents: the lower the credit score a person has, the more likely it is that person will be involved in a car accident.
In addition to the FTC's findings, Connecticut-based research firm, Conning & Co., found that 92% of car insurance companies use credit scores in the calculation of new car insurance policies.
Credit Scores and Credit Reports
From the credit report, the insurance company will have a good idea for how you have been making payments toward your debt obligations.
FICO Credit Score Factors and Their Percentages
|FICO credit score factors||Percentage weight on credit score:||What it means:|
|Payment history||35%||Your track record when it comes to making (at least) the minimum payment by the due date.|
|Amounts owed||30%||How much of your borrowing potential is actually being used. Determined by dividing total debt by total credit limits.|
|Length of credit history||15%||The average age of your active credit lines. Longer histories tend to show responsibility with credit.|
|Credit mix||10%||The different types of active credit lines that you handle (e.g., mortgage, credit cards, students loans, etc.)|
|New credit||10%||The new lines of credit that you've requested. New credit applications tend to hurt you score temporarily. Learn more about FICO credit score|
They can also view how frequently you apply for credit within the last two years.
The more often you apply for credit, the lower your credit score will be since you appear financially risky if you are requesting loans and credit frequently.
Public record data, including foreclosures, judgments, collections, bankruptcies, wage garnishments and tax liens, may also appear on your credit report.
The FICO credit score is used to generate an insurance score – which is the score used to predict the driver’s risk for car accidents.
Predicting Risk for Accidents
An insurance score is calculated based on a number of variables found within an individual’s credit report, including the length of credit history, the number of new inquiries for credit and financing, outstanding debt and number of late payments made, and available credit.
The insurance score predicts the likelihood the individual will be involved in a car accident or insurance claim.
The insurance score is non-discriminatory as it does not take into consideration the individual’s race, gender, address, marital status, disability, salary information or employment history.
Benefits of the Credit-Score-to-Insurance-Premium Formula
While some consumers feel that using their credit score to calculate their insurance premium is an unfair approach, there are a number of benefits for using credit scores in the premium formula.
The primary benefit is the increased competition among various car insurance companies – when companies began using credit scores as a factor in the car insurance premiums, the rates also became more competitive.
The better an individual’s credit score, the better their car insurance rates.
Credit Score Ranges and Quality
|Credit Score Ranges||Credit Quality||Effect on Ability to Obtain Loans|
|300-559||Very Bad||Extremely difficult to obtain traditional loans and line of credit. Advised to use secured credit cards and loans to help rebuild credit.|
|560-649||Bad||May be able to qualify for some loans and lines of credit, but the interest rates are likely to be high.|
|650-699||Average/Fair||Eligible for many traditional loans, but the interest rates and terms may not be the best.|
|700-749||Good||Valuable benefits come in the form of loans and lines of credit with comprehensive perks and low interest rates.|
|750-850||Excellent||Qualify easily for most loans and lines of credit with low interest rates and favorable terms.|
If credit information was not used in the calculation of car insurance premiums, even financially responsible individuals and good drivers would pay more for car insurance in order to subsidize people who are more likely to cause car accidents and put in car insurance claims.
Using credit in the calculation of car insurance premiums gives individuals yet another reason to focus on improving their financial situation for long-term benefits in all aspects of their life.
Improve Your Insurance Score
Your insurance score is improved in the same way that you can improve your credit score and most improvements will take time before your score is adjusted.
For example, how long you have had credit plays a role in your score, so as time goes by, your score will increase if you are financially responsible with your debt obligations.
You can improve your credit and insurance scores by making payments on time, reducing the total amount of debt you have and avoiding credit inquiries.
You can obtain a copy of your credit report to make sure there are no mistakes in the data which are erroneously contributing to a lower credit score (and therefore causing you to pay higher car insurance rates than necessary).
Make the effort to achieve better credit and you're more likely to qualify for an auto loan or lease and your insurance rates could be cheaper.