The question of whether a poor credit score can impact insurance premiums is one that does not occur to most people. Why should it? The two things have nothing to do with each other.
After all, a bad credit history sheds no light on whether you will make many claims, does it?
Unfortunately, there is a reason this question is asked. We all know that some seemingly arbitrary factors impact insurance premiums. These could be your socioeconomic class, neighborhood, or even your age. In addition, your credit score can impact your insurance premiums too.
This may seem strange and even unfair. Your credit score paints a picture of how good you are at paying debts, which is irrelevant when getting insurance. If you don’t pay your premium, your insurance claims can be denied. The insurer is not risking anything by taking on people who struggle to repay loans.
However, there are actual reasons credit score is taken into consideration. Let’s take a look at these reasons and whether they are at all fair.
1. Credit score and high claims rates: the correlation
The decision to take your credit score into account is based on a negative correlation. People with lower credit scores historically make higher amounts of claims. The two things don’t necessarily have anything to do with each other, but a poor credit score nonetheless does shine a light on how many claims you might make.
There could be a number of reasons for this. Some people with poor credit scores have made bad financial decisions in the past. These individuals may make claims even on minor scratches or bumps, unaware that this will negatively impact their premiums. Insurers, therefore, expect them to make more claims.
Poor credit scores, however, are often circumstantial. A person with a bad credit score may have defaulted on loans simply because they lost their job, had no generational wealth, and had no one to help when times get tough. These people may have fewer resources to protect their vehicles or other possessions. They may have to leave a car or their home vulnerable, leading to a higher likelihood of theft or break-ins.
As we can see, there is a correlation that does say something about your likelihood of making claims. However, is this at all fair?
2. Correlation does not imply causation
One of the basic principles of statistics is that correlation doesn’t imply causation. For example, fewer people eat ice cream in winter and more people get the flu during the same season. This isn’t because ice cream prevents the flu. Rather, they are both consequences of cold weather.
In the same vein, a poor credit score probably has little to do with your likelihood of making claims. As such, using it in determining premiums is at least somewhat disingenuous. The other metrics used to calculate premiums are more directly connected to insurance claims. While credit score might be a slightly effective indicator in the absence of other data, it is redundant in the context of better indicators.
This is the reason some states actually prohibit the use of credit scores to calculate insurance premiums.
Which States Restrict the use of Credit Scores in Calculating Premiums?
The states which restrict insurers on the use of credit scores to calculate premiums are as follows:
Your credit score can impact your homeowner’s insurance in Hawaii but not your other premiums
Maryland insurers can use your credit score in calculating premiums. However, they cannot deny you coverage or cancel your coverage because of your credit, nor can they use it as a reason to increase your premiums upon renewal of your policy
Your credit score can impact your homeowner’s insurance rates but cannot be used to deny you insurance. It cannot be used in calculating your car insurance rates
Oregon insurers can use your credit score in calculating rates to a restricted degree. They cannot use your credit score to deny coverage
Utah insurers can use credit scores as a reason to provide discounts on auto insurance but not to charge more. If your credit score gets worse, they cannot then increase your premium. In terms of homeowners insurance, the use of credit scores is allowed in determining rates
Since March 2020, Washington has prohibited insurance companies from making any premium decisions based on your credit score, as a safeguard for people who lost income during the pandemic. This law has initially been implemented to last for 3 years
Your credit score is unlikely to be the biggest factor in the cost of your premium but, depending on where you live, it can have an impact. Check out your credit score to get a better idea of whether it will make a difference for better or worse.