Defining Credit

A number of insurance companies in Canada use credit scores as a rating factor to determine home insurance premiums. While most companies have used this predictive tool for many years, the debate around credit scoring only started to heat up over the last year.

Carriers that use credit scoring argue that it is an accurate predictor for future home insurance claims as a credit score reflects a client’s level of responsibility and behaviour when it comes to managing their finances. Analysis shows a direct link between a person’s credit score and the frequency and severity of claims. The pro credit score argument is that clients with good credit scores will benefit by receiving the most competitive premium.

How Does a Credit Score Impact a Client’s Premium?
The factors used to determine the premium a client pays for their home insurance are specific to individual coverage needs. The premium amount is directly related to a number of traditional rating factors, including:

  • the age, size and features of your home;
  • the materials used to build your home;
  • the estimated cost of reconstruction;
  • where your home is located; and
  • your property claims history.

Other rating factors could include:

  • whether your neighbourhood is prone to sewer backup;
  • the crime rate in your neighbourhood;
  • the value of your personal belongings;
  • how close you live to a fire station and fire hydrant;
  • how your home is heated;
  • the type of coverage and deductible you choose;
  • any applicable discounts; and
  • (for some carriers) your credit score.

Which Product Lines are Affected?
Carriers that use credit scores are only allowed to use this rating for home insurance, except in the province of Quebec where it is also permitted for auto insurance.

What Happens if a Client Doesn’t Authorize Access to their Credit Score?
If a client does not want to authorize access to their credit score, a carrier is bound to respect these wishes. However, most carriers state that failure to provide access to a credit score will result in a less competitive premium–a premium that reflects the risk they are insuring. Still, carriers cannot refuse to provide a quote or coverage if a client withholds permission to check their credit score.

How Often will a Carrier Check a Client’s Credit Score for Insurance Purposes?
Most carriers access policyholder credit scores once per year and apply that score to the renewal premium, along with all other rating factors used in the past.

Are Credit Scores Always Accurate?
A Public Interest Advocacy Centre (PIAC) study found that 18% of people surveyed discovered some type of error in their report. The same study found that most errors had only a small impact on a person’s overall credit score.

How Credit Ratings are Determined
Credit ratings are determined by factors that may include:

  • Payment history–A record of delinquent payments, generally being more than 30 days, will lower the credit rating.
  • Control of debt–Lenders want to see that borrowers are not living beyond their means. Experts estimate that non-mortgage credit payments each month should not exceed more than 15% of the borrower’s after-tax income.
  • Signs of responsibility and stability –Lenders perceive things such as longevity in the borrower’s home and job (at least two years) as signs of stability.
  • Utilization–Lenders ascribe increased risk to accounts with balances near their limits.
  • Credit inquiries–An inquiry is noted every time a company requests some information from a consumer’s credit file.
  • Credit cards that are not used Too many credit cards? Closing these lines of credit will not necessarily improve your score. Many risk models consider the difference between the amount of credit a person has and the amount being used: closing one or more accounts will reduce your total available credit, lower the percentage of available credit, and possibly lower your credit score. Risk models also factor in account age: closing an account with several years of history that is in good standing will most likely negatively affect your score.

Useful Definitions
Credit score:
A credit score is a number used by lenders as an indicator of how likely you are to repay your loans. Your credit score is generated with data from your credit report.

Credit report: A person’s credit history is recorded in files maintained by at least one of Canada’s two major credit reporting agencies: Equifax and TransUnion. A credit report is a “snapshot” of your credit history, including available credit and payment history.

Credit inquiry: A credit inquiry is a notation on an individual’s credit report to identify that a company requested to utilize your credit information.

Soft inquiry: A “soft” inquiry may be obtained when the purpose is not to make a lending decision, such as when an insurance quote is requested. “Soft” inquiries are visible only to you, require your permission to be obtained, do not apply when your score is evaluated, and do not affect your credit score.

© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the April 2010 edition of Canadian Insurance Top Broker magazine.

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