What is Credit Scoring or "Insurance Score"?

Insurance Credit Scoring is a relatively new theory in the insurance industry. The theory states that a person's personal credit history is a predictive indicator of two factors relating to insurance: Frequency and Severity.

Frequency refers to the number of claims an insured could be expected to report or turn in within a specified amount of time, or the "policy life" of an insurance customer.

Severity refers to the potential dollar amount of an indiviual claim an insurance company might reasonably expect to pay out during the "policy life" of an insurance customer.

The insurance industry maintains and supports the theory that a person's personal credit history (late payments, slow pays, charge-offs and bankruptcy) are indicative factors of predicting future losses. In short, the theory states that individuals with a "poor" credit history will expose the insurance carrier to far more claim (Frequency) and higher dollar settlements (Severity) in settling these claims.

Statistical studies have been done that show this theory to be true. One of the most famous studies was performed by the University of Texas Bureau of Business Research. You can download this sixteen page study here.

The use of Credit History as an underwriting factor is currently legal in California. However, this is the official stance of the California Department of Insurance:

"The California Department of Insurance is opposed to the use of credit scores, credit reports and other credit information in underwriting homeowners insurance. Concern centers on the use of credit scoring as a potential means of unfairly discriminating against specific populations. Currently, there are several pieces of pending legislation that attempt to address the use of loss history reports and credit scoring. The California Department of Insurance will be following this issue closely and the Commissioner will continue to meet with key legislators on the proposed bills to protect the rights of California consumers."

In response to the use of credit history, the California Department of Insurance has developed this "California Homeowners Insurance Bill of Rights":

Regarding California homeowners insurance rates and policies:

1. The rate must be adequate. This means the rate must generate sufficient premium to meet the expected claims and the expenses of the company.

2. The rate must not be excessive. The rate cannot generate windfall profits, but the company is allowed to earn a fair profit from their business.

3. The rate cannot be unfairly discriminatory. This means the insurance company cannot single someone out for special treatment. The rates must be uniformly applied to all similar insureds.

For more information regarding the use of Credit history and California insurance, visit the California Department of insurance at: http://www.insurance.ca.gov/

For more information regarding the use of credit scoring in general, this is an excellent study done the the Insurance Information Institute here.