By: Annie Norman & Caroline Nagy
While people might assume that insurance companies set their property insurance rates solely or primarily by evaluating the risk profile of individual homes, a homeowner’s credit characteristics are often a bigger driver of the price of homeowner’s insurance. As Federal Reserve researchers put it in a new report, insurers often price rates for “who is living in the house rather than the risk of the house.”
In all but three states, insurance companies are permitted to underwrite a home insurance policy and price those policies based on the homeowner’s credit characteristics. Lower credit score borrowers pay 30 percent more for homeowner’s insurance than households with similarly risky properties but better credit.
Credit scores have no connection to property-level risk. Using them to charge an insurance premium penalty perpetuates racial discrimination and extracts wealth from households least able to afford it. In today’s insurance marketplace, households with lower credit scores are likely to pay more for their homeowner’s insurance. There is a well-documented history of households of color having more limited access to homeowner’s insurance or paying more for coverage which deepens the disproportionate financial burden families of color are forced to bear as premiums rise and insurance becomes less available.
Home insurance is the most important buffer families can have in place to prevent financial hardship after a climate disaster. However, rising insurance costs are becoming a shock of their own to household financial stability: between 2020 and 2023, home insurance prices rose by an average of 33 percent. Insurance companies have increased their rates due to a mix of factors including higher risks due to climate change, the rising cost to rebuild, inflation, and more. Virtually every corner of the country has been touched by rising insurance costs—a recent report by CFA found that 95 percent of zip codes experienced increases in insurance premiums since 2021.
Maryland, Massachusetts, and California have already banned the use of credit scores to set insurance premiums through regulation or legislation. Pennsylvania recently introduced legislation to ban this discriminatory practice as well. Other states should follow their lead for the following reasons:
- Insurance is not a credit product
Credit scores are typically used by consumer financial companies to predict repayment. However, insurance companies do not need to project repayment, since they have nothing at stake if consumers do not pay their insurance premiums: they can simply cancel the coverage. Some insurance companies have claimed that a homeowner’s credit score is correlated with how frequently they file a property insurance claim or how well a homeowner may care for their home. However, the data supporting these claims have not been independently reviewed, and national insurance companies charge drastically different penalty amounts in different states for having a low credit score, ranging from small single-digit percentages to a 181 percent penalty—the highest in the country—in Pennsylvania.
- Credit-score-based pricing is especially unfair to lower-income households
Insurance companies’ use of credit scores to determine home insurance premiums disproportionately exposes lower-credit-score households to unaffordable insurance premiums without clearly demonstrating risk mitigation benefits for insurers. In some states, low credit score borrowers are paying insurance premiums equal to half or more of their mortgage payments. This uneven distribution puts households with fewer resources at greater risk of financial distress. Indeed, liquidity-constrained borrowers, those with less cash on hand, are significantly more likely to miss mortgage payments after an insurance premium increase. With climate change increasing the physical risk to housing, extraction of additional wealth from lower wealth households makes it that much more difficult for them to afford to adapt and manage their risks and insurance costs.
- Using credit scores perpetuates racial discrimination
Homeowners of color may also be at greater risk of experiencing insurance premium increases, regardless of their income. In an analysis conducted last year of 47 million observations of household property insurance expenditures, researchers found that homeowners living in zip codes with larger populations of color paid more for insurance relative to white homeowners with similar disaster risk profiles. While the researchers do not examine potential drivers of these price differences, these data sit within a robust historical context of reported racial disparities with regard to the pricing and availability of property insurance.
While insurers are prohibited from underwriting borrowers based on race, there are proxy factors insurers may use when underwriting a policyholder that can disproportionately affect borrowers of color such as credit score or the age of their home. For example, the median credit score of a Black or Latine homeowner is lower than that of a white homeowner due largely to systemic racism and less engagement with larger financial institutions that would be more likely to report their positive payment history to credit reporting bureaus. It follows that the practice of using credit scores to underwrite insurance policies, a major determinant of a policyholder’s insurance premium, could adversely affect Black and Latine homeowners in some communities. Indeed, several successful lawsuits have been filed by fair housing organizations against insurance companies for this practice and other underwriting practices that adversely affect consumers of color.
- Using credit scores is arbitrary and leads to unfair outcomes
Neighborhood to neighborhood, the penalty someone pays for having a lower credit score can vary wildly, but it can too for neighbors in the same area living 200 feet apart. People expect some differentiation in an insurance rate based on the property details, like age of a home, construction materials, and location. But often, the key factor is the credit score penalty for each state. Take Camden, New Jersey and Philadelphia, Pennsylvania for example—two cities, right next to each other.
A homeowner in Philadelphia with a low credit score could pay as much as $3,245 more to insure their home than someone across the river in Camden with the same low credit score who pays only a $961 penalty. Meanwhile, someone just one hundred miles away in Baltimore, Maryland with a lower credit score pays zero penalty because Maryland has banned the discriminatory practice of using credit scores to price home insurance.
Every state should ban the use of credit scores to set premiums. This outdated practice has no connection to property-level risk and it perpetuates racial discrimination.
When state insurance regulators allow insurance companies to penalize low credit score policyholders in ways that do not reflect risk, they expose low income and communities of color to discriminatory and extractive business practices that make it impossible for these communities to afford to insure their homes, much less to adapt to climate change.