The study looked at how much annual premiums changed based on a little-known number: The credit-based insurance score. Researchers found that drivers with a poor score pay 91 percent more for insurance than those with an excellent score. Those with a median score pay 24 percent more.
The credit-based insurance score
If you haven't heard of this number or were not aware that your credit history could affect the amount you pay for car insurance, you aren't alone. According to the study, a 2005 report by the Government Accountability Office found that 66 percent of people interviewed had no idea this score existed, even though 97 percent of insurance companies employ the practice -- and have been doing so since the 1990s.
The credit-based insurance score is different from a regular credit score. It's calculated by the insurance company after taking 20 to 30 different aspects of your financial history into account, such as any outstanding debt you may have, the length of your credit history, bankruptcies and late payments. But its actual calculation is a closely-guarded secret and it can vary wildly from company to company.
Insurance companies don't want their methodology known and, unlike a conventional credit report, don't allow customers to see their score. The companies defend this practice by claiming that revealing their methodology would put them at a competitive disadvantage, Lamont Boyd, an insurance underwriting expert at FICO told insuranceQuotes.com. The best you can hope for is that your insurance agent provides some guidance by telling you which aspects of your financial history the company weighs more heavily than others.
As it stands, a major determining factor of your insurance rates is a number completely unknown to you, that was calculated in complete confidentiality. Not surprisingly, this practice has garnered some serious debate.
Credit score controversy
I know what you're thinking: What the heck does your financial history have to do with car insurance rates? After all, aren't your rates based on your likelihood of getting into an accident? According to Laura Adams, Senior Insurance Analyst at insuranceQuotes.com, there is data that backs up this practice.
"Universities and independent auditors have done the research and found a strong correlation between a low score and the number of claims filed," she said. "Basically, the data shows that you're more likely to file a claim if you have poor credit."
An August 2012 paper from the Insurance Information Institute (III) similarly defended the practice.
"Actuarial studies show that how a person manages his or her financial affairs, which is what an insurance score indicates, is a good predictor of insurance claims," the paper read. "Statistically, people who have a poor insurance score are more likely to file a claim."
That correlation seems pretty cut and dry. But as Robert Hunter, former Texas Insurance Commissioner and current Director of Insurance at the Consumer Federation of America (CFA), points out, correlation does not always equal causation. And that's why he says this is an inherently unfair way of determining insurance rates for drivers.
"It's inappropriate. It violates all the rules of the actuarial community," he said. "What is it about a poor credit score that makes someone bad at driving?"
When determining a driver's likelihood of making a claim, the industry is supposed to use a two-pronged approach, he explained. Generally, a classification is based on a correlation, like we have here with poor financial history and claims, and a thesis, which is an explanation for the correlation. Hunter sees the industry as having, at best, a very weak thesis of causation.
Looking at major nationwide trends, the justification is even feebler.
"During the recession, people's credit got worse. Yet driving improved, with less accidents and fatalities on record," Hunter said. "Charging people more for insurance based on a poor macro economy doesn't make any sense."
Hunter sees the credit-based insurance score as little more than a marketing tool, aimed at attracting more affluent drivers. Although it is illegal for insurance companies to collect data on race or income when determining drivers' rates, Hunter sees this score as a way to circumvent these laws, and thus offer tantalizing lower monthly rates to earn and keep the business of a higher-income demographic.
"Insurance companies love to get rich people," he said.
Non-driving factors and insurance rates
The insuranceQuotes.com study isn't the first to show how non-driving factors can affect what you pay for auto insurance. The CFA performed a study in September 2012 that showed major discrepancies in annual premiums based on personal attributes like marital status, education, employment and past insurance coverage.
The CFA did an experiment, adjusting these non-driving attributes to be "more desirable" to an insurance company. The favorable candidate, who was a college-educated, married professional, was given a quote for an annual premium almost $2,000 less than that of a less favorable one.
In line with his his stance on credit-based insurance scores, Hunter told the New York Times that the difference in rates was "patently unfair" and "actuarially unsound." And in line with their current stance on using the score, spokespeople for the insurance industry said legitimate correlations existed between the factors and number of claims.
The CFA has been urging state insurance commissions to restrict insurers' ability to use these non-driving factors when setting rates. The practice is currently illegal in California, Hawaii and Massachusetts, and, according to Hunter, activity and legislation elsewhere will be seen soon.
The CFA may have a tough slog, though, as insurance companies have a compelling argument for politicians: Restricting the practice would mean constituents who are statistically proven to file less claims would be paying for those that file more.
"You'd have a situation where certain people are subsidizing the risks that others bear," said Michael Barry, vice president of media relations for III.
What you can do
If you live in California, Hawaii or Massachusetts, you have nothing to worry about, as using credit-based insurance scores is not allowed. If you're in any of the other 47 states, however, you'll likely continue to be at the mercy of your financial history.
You can improve your score, and thus lower your rates, by cleaning up your credit score, which involves paying all of your credit obligations on time, not opening new credit accounts unless you absolutely need them and keeping credit card balances as low as possible.
Or, if you're comfortable doing so, you can switch to usage-based insurance, which more accurately analyzes your risk for a claim by monitoring your driving habits with a GPS device. Drivers who have switched to this system saw a drop in their insurance premiums of between 5 and 35 percent.