Insurers can care more about a homeowner’s credit score than the actual dangers the home faces.
That’s the conclusion of a new joint report from the Consumer Federation of America and the Climate and Community Institute called "Penalized: The Hidden Cost of Credit Score in Homeowners Insurance Premiums."
Credit scores range from 300 to 850. A typical homeowner with an approximately 630 FICO score pays nearly $2,000 more annually than owners of identical homes in the same area with a credit score of 820. In 23 states, people with low scores pay at least twice as much as those with high scores.
Even someone with a credit score of around 740 resulted in an extra $792 per year compared with their higher-scored peers.
Sharon Cornelissen, director of housing at the Washington, D.C.-based Consumer Federation and a co-author of the report, said her team was surprised by the size of the price gap.
“We were shocked at just how big a role credit scores were playing,” she said. “In many cases, it’s more expensive to have a low credit score than to live in a high-risk area.”
However, Mark Friedlander, senior director of media relations for the Insurance Information Institute, said the practice is based on sound industry research. “Insurance industry actuarial data has validated that credit-based insurance scores are strongly correlated with claim frequency and severity," he wrote in an email to Homes.com. "How one manages their finances is a predictor of risk."
Most people learn about the environmental risk factors, such as flooding, fires or earthquakes, that affect their insurance prices when buying a home. As disasters related to climate change become more prevalent, those factors are ordering migration patterns, said Cornelissen.
“A lot of people are talking about climate risk. But that’s just a small part of it,” she said.
A person with a home in the first percentile of disaster risk (the lowest level of risk) but with a low credit score pays roughly the same as someone in the 71st percentile of risk but with a high score.
Effects vary nationwide
The results are mixed around the country. Pennsylvania, Arizona, Oregon and West Virginia residents pay the highest penalties for their low credit scores.
Residents of Forest County, Pennsylvania, pay 197% more for having a low credit score than people in identical properties with high scores.
Florida, a state that has struggled with rising premiums and companies leaving the state in recent years, had a surprisingly low and even gap of between 21% and 29% throughout the state. Cornelissen guessed this was an effect of Florida’s large state-run carrier, Citizens Property Insurance Corp., which handles much of the business for low-credit-score residents.
Washington state also has a low gap of roughly 8 to 9%. Researcher Michael DeLong of the Consumer Federation said he believes that’s an effect of “an aggressive insurance department that is dedicated to protecting consumers, and a commissioner that wants to actually do things.”
Three states — California, Maryland and Massachusetts — have banned the practice of letting insurance companies use credit scores in actuarial calculations. Insurance premiums in these three states were lower than in 39 other states.
Insurance companies say it lowers risk
Cornelissen argued that using credit scores in insurance calculations makes no sense, given that insurers are not on the hook monetarily to the homeowner.
“If you default [on a loan], it is costly for lenders,” she said. “If you fall behind on insurance, your insurance company will just drop you.”
Friedlander of the insurance institute said that the practice protects prices in the market by making them more targeted. “Without the use of credit data, insurers may need to rely more heavily on broader risk factors like age, location or claims history, which can be less precise,” he wrote. “This can lead to overpricing low-risk customers and underpricing high-risk customers.
“If insurers can't price risk accurately, they may pull back from certain markets or product lines, reducing competition. Meanwhile, across-the-board rate increases could push some price-sensitive consumers out of the market.”
Data in the report showed insurance companies used more than 150 points of information about homeowners, which Cornelissen argued means they still have plenty of indicators to paint an accurate picture of their customers.
Cornelissen said her research didn’t see higher pricing or reduced competition in the states where credit score consideration is banned. The Consumer Federation is calling for the practice to be outlawed nationwide.
She said the practice pushes heavily on the most vulnerable homebuyers, especially young people who tend to have low credit scores because of debt taken on in college.
“It has a disproportionate impact on the very market we’re trying to get more access [to housing],” she said. “It’s counterproductive to what we’re trying to do in the housing market.”