December 17, 2007
Top ten FAQ of All Time
Q: My insurance company wants to check my credit? What’s that got to do with insurance?
A: Apparently everything; Commercial policies have been credit checked for decades, Insurers started credit checking personal lines ( life, homeowners, car insurance) polices in the 1990s and have been doing it long enough to have pretty convincing results (see [Here]) .
With the mounting actuarial evidence, it’s getting difficult for state legislatures to push back and ban credit checking.
The big things an insurance company looks at:
Policy persistence - will a written policy stay on the books? Do policy holders constantly look for better prices OR let policies lapse for non-payment.
Frequency of losses - How often do policyholders file claims.
Severity of losses - When losses are filed are they small or large.
When evaluating people with poor credit scores, they tend to strike out in all three categories.
- Persistency - Poor credit risks tend to come and go from a book of business, preferred insurers spend money up front writing business; agent commission, underwriting expenses, policy issue expenses. A client has to be on the books for several years before they reach a break even point. With poor credit risks, they may never reach a profitable point.
- Frequency - People with poor credit may pick lower deductibles and “use” their insurance companies to pay for expenses that other more stable people would pay out of pocket.
- Severity - Poor credit risks may account for more large claims: it’s not hard to imagine people torching their house instead of foreclosing. If large payouts go from 1 in 10,000 risks to 1 in 5,000 risks then insurers will have to adjust rates accordingly.
Initially I had some heartburn with using credit as an underwriting tool. This position has changed over the years as I’ve come to correlate personal financial responsibility with responsible driving of autos, maintenance of houses and keeping one’s life insurance policies in force. Clients who pay their bills on time have few if any lapses in coverage and give their agents fewer grey hairs.
I remember reading about an experiment you can try with young children: open a bag of M&Ms, take out 5 of them and put them in a pile. Tell the child they can have the 5 candies now or wait 5 minutes and they can have the whole bag. This will show if they settle for immediate gratification or can wait for a longer term reward. When I think of the kids who settle for 5 M&Ms, is this a reflection of their life to come? Will there lives be filled with bad financial decisions, impulse purchases, missed opportunities and poor decision making skills? Maybe I’m being draconian; I hope financial responsibility is a learn-able skill.
Regardless, if a company has one way to determine if a person had poor decision making skills, I’m guessing a credit report would be the best thing to look at. Not the best way to measure a person, but unless you can automate a better way, it’s what the insurers will use.
I’ve read articles where the insurance industry backs up their claims with statistics. I imagine when they started basing premiums on zipcodes people initially questioned that too. What could zipcodes have to do with how I drive? Well, apparently it makes a difference because you pay less or more depending upon where you live.