by W. Lane Startin

Created on: August 19, 2008

Credit scoring for insurance purposes is a controversial yet often misunderstood part of the policy quoting and underwriting process. Regardless of how one feels about the merits of this practice, I believe it's important to understand exactly why it's done, what's looked at, and perhaps just as importantly what isn't.

One might initially think people with good credit get better rates because of better payment histories, however this would be incorrect. Insurance companies have a pretty effective way of dealing with people who don't pay their bill regardless of what their credit score might be: they issue cancellations and remain entitled to the earned premium. Payment history really isn't a factor at all here.

To understand the real reason why many insurance companies give better rates to people with better credit, one must have a basic understanding of how insurance companies derive their rates in general. All insurance companies employ individuals called actuaries. A main job of an insurance actuary is to analyze the the data collected on the company's policyholders over time and determine which attributes are shared by those who are prone to insurance claims and those who are not. While no reputable company ever loses sight of its primary responsibility to address legitimate claims quickly and fairly, insurance is still a business, and the prime motive in any business is to turn a profit. Thus it follows that policyholders who don't have claims are more profitable to the insurance company than those who do. Consequently, insurance companies are well-motivated to seek out individuals who statistically speaking are considered to not be as likely to have claims. Since the actuarial department is what determines who these individuals are, that department a tremendously important part of any insurance company.

So, the reason why people with bad credit pay more for insurance than those with good credit is essentially the same reason as why drivers with recent traffic tickets pay more for auto insurance than drivers with clean records: they're less likely to file claims or have claims filed against them. Over the years company after company has found that individuals with good credit file fewer claims than those with bad credit. As far as many actuaries are concerned, a person with bad credit is a claim waiting to happen. Thus, people with bad credit get higher rates.

While credit scoring for insurance purposes is a widespread practice - and a practice certain to

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