What’s my credit got to do with it?

A lot, unfortunately (or fortunately if you have good credit).

According to a report by the Federal Trade Commission (whose mission is to protect consumers) credit history is an effective predictor of the claims risk of auto insurance applicant.

And that’s why insurers fight tooth and nail to maintain the right to use credit scores in their underwriting.

But is it fair? Well, that depends. Insurers say they need to be able to accurately gauge how much risk they take on. (Every new policy an insurer sells increases their exposure to risk and uncertainty. This is because they don’t know if they will end up paying out more in claims than they collect in premiums.)

Some consumer and minority advocates say credit scores unfairly target low-income and minority applicants, who are more likely to have bad credit than upper- and middle class whites.

While that is perhaps true, it’s tough to make an argument that the situation is unfair—insurers aren’t to blame for bad credit. Nor can they be blamed for using data that’s effective in predicting someone’s claims risk. If there were no correlation between the two, then insurers would have no reason to use credit in their underwriting formula. In other words, insurers don’t use credit history just to be evil; they use it to be more accurate. It may be cold and calculating but it’s nothing personal.

(If we must put the blame somewhere, maybe we can put it on the credit card companies, who indiscriminately hand out cards to people who shouldn’t have them.)

So maybe fairness isn’t the issue, but that doesn’t mean it’s not an unfortunate state of affairs, namely because people with poor credit and low incomes will have to pay more for car insurance than the average, even though they have fewer resources to do so.

And since car insurance is required drive, and driving is vital in getting to work (where one earns a paycheck), people with bad credit and low incomes often find themselves in a pickle.

But the FTC report did offer a potential benefit to the credit-based underwriting.

Use of scores may result in benefits for consumers. For example, scores permit insurers to evaluate risk with greater accuracy, which may make them more willing to offer insurance to higher-risk consumers for whom they otherwise would not be able to determine an appropriate premium. Scores also may allow insurers to grant and price coverage more efficiently, producing cost savings that could result in lower premiums.

Insurers make a similar argument: let us use every tool at our disposal to help us calculate the claims risk of applicants and as a result, everyone will benefit with lower premiums.


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