Why do auto insurance companies check your credit?

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In a nutshell...
  • Insurance companies have to level the risk when adding new customers to their policies
  • They do this by checking your credit rating before issuing a policy
  • If you have a negative credit score, you may pay more in premiums
  • Insurance companies check credit primarily to estimate profitability versus loss

When shopping for auto insurance, one of the concerns that some people have is whether insurance companies check credit before issuing an insurance policy.

Some drivers are afraid that they may not qualify, due to past credit history. However, the likelihood of failure to be eligible for auto insurance is little, when compared to other business applications or purchases.

Unlike standard physical merchandise companies, an insurance company does not deal with physical property. This lowers their risk is you are unable to pay your premium.

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Why is my credit history important?

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Like any company, an insurance company also must exercise due diligence and caution and not take on risk where they will not be compensated.

However, unlike companies where you are purchasing goods or services, insurance companies do not have to worry about the loss of physical property such as houses, clothing, or electronics equipment.

Instead, when a customer fails to pay their premium, they are only out the amount of the premium for that month.

However, they are concerned more with your potential to cost the company money in claims or accidents.

How Insurance Companies Handle Unpaid Premiums

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They will send a 30-day notice, telling the insured that they failed to pay their premium. They also inform customers that their insurance policy could be canceled for non-payment if they do not receive payment within that time.

This protects insurance companies from covering people who do not pay and levels the degree of financial risk that insurance companies take when dealing with customers.

Despite this, they do check credit ratings of new applicants for some other reasons:

Mintlife, a blog by the people who created the Mint.com mobile app on managing finances, published this article on one of the reasons that insurance companies check the credit of their applicants before issuing their policies.

The main point of the article is that the real risk of insurance companies is not whether people pay their premiums as much as it is their likelihood to make claims too often, cost the company money, or to turn a profit. Insurance companies, like any company, must make a profit.

Therefore, credit reports are run to determine your level of financial risk to the company from your overall credit behaviors and credit history.

What is a high-risk driver?

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Identifying high-risk drivers is one of the things that auto insurance agencies must do to protect their financial interests and avoid losing more than they profit on the average customer.

Insurance companies know there will be losses due to auto claims, but they have to weigh their risk of loss with the amount of profit they take in. This is sometimes known as “enterprise risk management.”

The Cost of Claims

If you check the statistics of automobile crashes, you can see why insurance companies check credit and weigh the risk involved before taking on new applicants. Some claims can cost them hundreds of thousands of dollars.

Severe accidents, wrongful death settlements, and the expense of legal costs often go far beyond the amounts of coverage with more severe accidents. Minor fender-benders are not as much of a worry to insurers, but these can add up.

Reference.com reports that over 27,000 car accidents occur each day in the U.S. alone. Most of these are minor, but there are enough serious accidents which result in fatalities or serious injuries that it costs the insurance companies greatly over the course of a year.

This is why they must exercise caution when taking on new customers.

By keeping your claims record to a minimum, you may increase your reputation with your insurance provider and gain their trust on a higher level. This will keep your premiums as low as possible while still providing you with the insurance you need.

What You Can Do to Help Your Credit

Even though car insurance companies often check your credit, this does not mean you will not be issued a policy if you have less than perfect credit.

It is possible that your monthly premiums may be higher than someone who has a higher credit rating, but there are some things you can do to help raise your credit score. Once your score has improved, your insurance company may lower the premium.

This is also affected by a good driving record. If you focus on keeping your driving record clean, avoiding all DUI’s, reckless driving, and traffic violations, you can lower your premiums over time and good behavior, so to speak.

Other things you can do to help your rates include:

  • Paying off some previous debt that was delinquent
  • Being issued new credit by a bank or lending institution (proves people trust you)
  • Getting a better (higher-paying) job
  • Improving your financial situation in any way
  • Keeping your driving record clean

These tips will help you to improve your credit score over time. If you pay off old debt that was previously delinquent, your credit score will improve. This can positively affect the impression your insurer has of your ability to help them make a profit.

They will see you as a lower risk also if you can show proof of new credit.

This can sometimes work against you if your income-to-debt ratio is too high, but it also shows that lending institutions trust you with their money.

Getting a higher-paying job and improving your financial status in any way may also influence your insurance company’s view of you as a lower risk.

Finally, keeping your driving record as perfect as possible is the single best thing you can do to lower your premiums, gain more trust from your insurance provider, and improve your reputation as a responsible driver and citizen.

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