2 days ago
Do home insurers really need to check credit?
POP-QUIZ time: Which of the following events do you think would make your home-insurance premiums rise?
You buy a 100-year-old mansion on the beach.
Natural disasters boost insurance claims. Lumber, sheetrock and contractors get more expensive. You're late on some credit-card payments.
The correct answer is, believe it or not, 'all of the above.'
The standard explanation for why insurance costs have soared in the United States is that a heating climate is growing more dangerous, driving up disaster claims and reconstruction prices.
And that's all true. But there's another key factor that gets much less press and has zero to do with climate change: consumer credit ratings.
Using creditworthiness to set home-insurance premiums is a standard practice that insurers contend keeps prices low.
But it's actually making the insurance crisis worse. And unlike climate change, there's an easy, immediate fix: Just stop doing it.
Having a low credit score can double home-insurance premiums in most of the United States, according to a new study by the advocacy group Consumer Federation of America (CFA) and the Climate and Community Institute, a progressive think tank.
A typical homeowner with a low credit score (about 630 on Fair Isaac Corp or FICO) pays US$1,996, or 99%, more a year than someone with a stellar score (about 820 on FICO), the study suggests.
In fact, it's often more expensive for a homeowner to have a low credit score than to live in an area at high risk of climate disaster, according to the study.
A homeowner with a 630 FICO score living in one of the safest places in the country – say a one on a climate-risk scale of one to 100 – might theoretically pay US$3,028 a year in premiums.
A homeowner with an 820 FICO score living in an area that's a 71 on the climate-risk scale would pay the same amount.
'This has big implications for whether insurance prices are really an effective signal about disaster risk for homeowners,' study co-author Nick Graetz, an assistant professor at the University of Minnesota, told me.
In a perfect world, the price of home insurance would mirror the risks of bad things happening to your house.
Rising premiums would discourage people from moving into risky areas or incentivise them to disaster-proof their homes.
In our imperfect world, insurance companies basically subsidise homeowners for living in high-risk areas as long as they have good credit. And that's just the start of the mixed messages. The credit-score effect can vary drastically from state to state, as do insurance premiums in general.
California, Maryland and Massachusetts make it illegal to use credit scores in setting premiums. Arizona, Oregon, Pennsylvania and West Virginia, meanwhile, impose punishing penalties of 150% or more on people with low credit scores.
And rather than encouraging those with bad credit living in high-risk areas to weatherise or move to safer locales, soaring premiums cause them to go without insurance or buy too little. They often lack the financial wherewithal to do anything else.
Meanwhile, in some of the riskiest states, people with every kind of credit score are turning increasingly to state-backed insurers of last resort such as California's FAIR plan.
That plan's total exposure to potential disaster losses has nearly quadrupled in the past four years to US$650bil.
These policies are typically expensive but also offer minimal coverage – the worst of both worlds for homeowners.
All of this contributes to the country's growing problem of under-insurance against climate disasters, which could be hiding US$2.7 trillion in potential property losses, by one estimate.
This is part of what people mean when they talk about a climate-driven 'insurance crisis' in the United States.
But the term refers mainly to the fact that home insurance is rapidly becoming more expensive – rising 74% nationally since the Great Recession by one measure – and crushing housing affordability.
Decidedly not in crisis is the insurance industry itself, which seems to be doing just fine. Property and casualty insurers cleared net income of US$169bil last year, according to credit-rating company AM Best, even as they complained of disaster losses.
At nine of the top 25 US home-insurance providers that are publicly traded, executive pay rose by 30% last year, on average, according to a study by the advocacy groups Revolving Door Project and Public Citizen.
In an email, Bob Passmore of the American Property Casualty Insurance Association, an industry group, rejected the CFA credit-score study as 'flawed' because it used online premium quotes from a data provider called Quadrant Information Services rather than actual homeowner premiums.
He also said insurance companies use special 'credit-based insurance scores,' not regular credit scores, to set premiums.
But those credit-based insurance scores are almost identical to ordinary credit scores, as the CFA showed in a 2023 study.
And the results of the new CFA study gibe with those of a 2024 paper by researchers at the Federal Reserve (Fed) and Philadelphia Fed, which studied the actual credit-rating and insurance data for millions of mortgages and found that buyers with credit scores below 620 paid 30% more for insurance than people with scores above 720.
'Insurance prices often depend more on who lives in a home,' the Fed researchers wrote, 'than on the disaster risk a home is exposed to.'
Insurers say using credit scores to set premiums saves many homeowners money (the richer ones, probably).
In theory, an iffy credit score suggests a policyholder is more likely to need a payout in the event of a disaster. In reality, this makes little sense. Hurricanes and wildfires don't run a credit check before attacking your house.
I have a good credit score, but if my house gets damaged in a storm, you can bet I'll need a payout.
Arguably, low credit scores make it harder for homeowners to obtain financing to bolster homes against disasters, which could raise the risk of insurance payouts.
But doubling their premiums won't solve that problem. And it further punishes the lower-income people and disadvantaged minorities who already suffer the most from climate change.
In fact, this credit-score issue is yet another reason to doubt that our current climate-risk-management system – built on a shaky scaffolding of private home insurance with spotty government reinforcement – is built for an increasingly hostile environment.
'Is this method of trying to price behaviour in the private insurance market the most effective way to reduce the risks of disasters over the long run?' Graetz asked.
Significant reform is needed.
The so-called Insure Act, reintroduced last month by senator Adam Schiff of California, could be a place to start.
It would set up a federal reinsurance programme to backstop losses, make insurers cover all disasters, including floods, and encourage adaptation.
The government's National Flood Insurance Programme should be bolstered and expanded. Those are big lifts in the best of times and probably impossible given the current leadership in Washington.
Barring insurers from using credit scores to set premiums and making them be more transparent about their methods are simpler first steps that might even have bipartisan appeal.
More importantly, that would focus everybody's attention, including insurers, on the big question of how we can all survive and thrive in a changing climate. — Bloomberg
Mark Gongloff is a Bloomberg Opinion editor and columnist covering climate change. The views expressed here are the writer's own.
