Insurance Basics You Should Know to Protect Your Credit Score

Like having the right credit score, choosing the appropriate insurance policies has a big impact on your financial health. Without the right insurance policies, it is easy to get caught in a financial pinch.

But the world of insurance and its impact on your finances is often murky. Although you likely know that you need insurance, understanding what kinds you need and what your coverage options are isn’t always cut and dried.

Let’s take a closer look at some of the insurance basics that you should know. Plus, we’ll clarify the difference between a credit score and a credit-based insurance score.

How Insurance Policies Can Impact Your Credit Score

Before we jump into the nitty gritty details, it’s important to understand how your insurance policies can impact your credit score. Although the impacts are indirect, making the connection between your insurance policies and credit health is helpful when assessing your overall financial picture.

As with most things, the insurance policies you carry might have a positive or negative impact on your credit score.

Positive Impact

If you have an insurance policy with the right coverage level and deductible, you are less likely to resort to credit. When you are not relying heavily on credit to get through sticky situations, that tends to have a positive impact on your credit score.

For example, let’s say that you are carrying an auto insurance policy with $100,000 in liability coverage, $50,000 in collision coverage, and a $100 deductible. After an at-fault accident, you file a claim with your insurance company. The insurer pays out the claim, leaving you with just a $100 deductible to cover on your own. Since you probably don’t have to turn to a high-interest credit card to cover this amount, this insurance policy served to protect your credit score.

Negative Impact

If you don’t have enough coverage or your deductible is too high, then an unexpected event could derail your credit score. Relying too heavily on credit for emergency situations could lead to a downward credit spiral.

For example, let’s say that you have an auto insurance policy with $10,000 in liability coverage, no collision coverage, and a $2,000 deductible. After an at-fault accident, you’ll have to pay a $2,000 deductible before the insurance company pays out a claim on your liability coverage. Beyond the high deductible, you are on the hook for car repairs without any assistance from your insurance company. It’s easy to see how in this situation you could get stuck slapping those repair costs on a high-interest credit card, which might make it difficult to get out of debt.

Credit Scores vs. Credit-Based Insurance Scores

When an insurance company is determining your premiums, they take several factors into account. According to the Insurance Information Insitute, auto insurance policies typically take your age, driving record, and zip code into account when determining your premium.

Your credit history is another factor that insurance companies often take into account. However, insurance companies don’t use your regular credit score. Instead, insurance companies in some states look at your credit-based insurance score when determining premiums.

A credit-based insurance score is different from your regular credit score. A credit-based insurance score is a three-digit number that is calculated by the information on your credit report. Although this insurance-related score is also based on your credit report and is sometimes referred to as an “insurance credit score,” it’s not the same thing as a regular credit score.

Here’s a closer look at what makes up your credit score versus what makes up your credit-based insurance score:

Credit Scores

FICO credit scores, the brand of credit scores used by most lenders, are made up of 5 components. Here’s the breakdown:

•     Payment history accounts for 35%: On-time payments have a positive impact on your credit score.
•     Debt accounts for 30%: Having too much debt, particularly revolving debt, can have a negative impact on your credit score.
•     New credit accounts for 10%: When you apply for new credit, you might see your score dip.
•     Length of credit history accounts for 15%: If you have accounts with longer ages, that has a positive impact on your credit score.
•     Credit mix accounts for 10%: A mix of different types of revolving credit accounts and installment accounts can have a positive impact on your credit score.

The FICO scoring model uses the information on your credit report and the scoring categories above to come up with a three-digit credit score.

Credit-based Insurance Scores

Credit-based insurance scores are also made up of 5 components. Here’s the breakdown:

•     Payment history accounts for 40%: On-time payments have a positive impact on your insurance score.
•     Debt accounts for 30%: Having too much debt can have a negative impact on your insurance score.
•     New credit accounts for 10%: When you apply for new credit, you might see your score dip.
•     Length of credit history accounts for 15%: If you have accounts with longer ages, that tends to have a positive impact on your insurance score.
•     Credit mix accounts for 5%: A mix of revolving credit accounts and installment accounts can have a positive impact on your insurance score.

A credit-based insurance score also uses the information on your credit report. But slightly different priorities lead to different scores.

Insurance Policies: The Basics You Should Know

When it comes to picking out the right insurance policies, there are some basic elements to be aware of. Of course, you’ll want to start your search with the appropriate insurance policy types. But you’ll also need to select the best coverage levels and deductible amounts for your financial situation.

Let’s explore these insurance basics.

Premiums

Your insurance premium is the amount you pay for your insurance policy. You may have the option to pay your premium monthly, annually, or semi-annually. Typically, the more coverage and benefits you get from your insurance, the higher your premium will be.

Coverage Levels

The right coverage levels can make all the difference. Without the appropriate level of coverage, you could get stuck footing the bill after an unexpected event. For example, signing up for an auto insurance policy with a minimum amount of liability coverage could mean you’ll end up paying for a portion of a legal battle out of pocket after an at-fault accident.

If you have substantial assets, it’s especially important to make sure you have enough insurance. Otherwise, your assets could be at risk. One way to find the right coverage level is to talk to a financial advisor or insurance agent. With their expertise, you can make sure you aren’t skimping on coverage.

Deductibles

A deductible is the amount you’ll have to pay out of pocket before an insurance company will pay out the rest of your claim.

For example, let’s say you have an auto insurance policy with a $500 deductible. After an accident, you file a claim for $2,000 worth of damage. With that, you’ll need to pay a $500 deductible before the insurance company pays for the remaining damages.

In general, a higher deductible leads to a more affordable insurance premium. Although it’s tempting to raise your deductible in pursuit of savings, don’t raise it too high. It’s important to choose a deductible you can reasonably cover. Otherwise, you could get stuck in a situation that pushes you into a cycle of high-interest debt.

Types of Insurance

Some types of insurance are fairly obvious. But some of the insurance policies you might need aren’t necessarily an obvious choice. Here’s a closer look at some of the most important types of insurance:

Auto Insurance

It’s illegal to drive without auto insurance in most states. But even if driving without insurance was legal, it’s likely not a risk you want to take. As a driver, you have several insurance policy options. A few include:

•     Liability coverage: If you cause property damage or injury to another person, liability coverage will kick in. However, a liability-only policy will not cover any repair costs for your own vehicle.
•     Collision coverage: If you get into an accident, collision coverage will help pay for repair or replacement costs.
•     Comprehensive coverage: Comprehensive coverage will pay to repair or replace your vehicle after a covered event. Some of the covered events may include vandalism, fire, hail, floods, and theft.
•     Uninsured and underinsured motorist coverage: This coverage applies if you get into an accident with a driver who doesn’t have enough insurance to cover your repair or medical costs.

Although liability coverage is the only required coverage in most states, opting for more extensive coverage can better protect your wallet if an accident occurs.

Homeowners Insurance

As a homeowner with a mortgage, you are likely required to pay for this type of insurance. But even homeowners with a free and clear home will likely choose to protect their property with this type of insurance.

•     Dwelling coverage: If something happens to your home, like a fire or vandalism, this type of coverage would pay to repair or rebuild the building.
•     Personal property coverage: This type of coverage protects the assets inside of your home. For example, a policy might cover replacement costs for your furniture.
•     Liability coverage: If someone gets hurt on your property, this coverage would pay for their medical bills and your legal fees.

Renters Insurance

You don’t need to own a home to get renters insurance. With renters insurance, you can get coverage for the cost to replace your belongings. For example, renters insurance can help you pay to replace your electronics after a theft.

Umbrella Insurance

Umbrella insurance provides extra liability coverage for your assets. You can think of this type of insurance as an extra layer of protection. But you must have an underlying homeowners, auto, or renters policy. If someone sues you for more than the policy limits of the underlying account, your umbrella coverage will step in.

Life Insurance

Life insurance offers a way to replace your income if you pass away unexpectedly. This can help protect your dependents from financial disaster if the unthinkable happens.

•     Term life insurance: Term insurance involves purchasing a policy for a set number of years. For example, you can buy a 15-year policy. After the 15-year term, your dependents are no longer covered. But at that point, you might have saved enough to protect them without an insurance policy.
•     Whole life insurance: Whole life insurance protects your dependents for your entire life. When you pass away, your dependents will receive a death benefit and the cash value of the investments tied into this policy.

Health Insurance

Health insurance can protect your finances from unexpected medical bills. Some can get this policy through an employer-sponsored healthcare plan. But others obtain coverage through the federal marketplace.

For those facing unaffordable premiums, consider a higher deductible health plan. Although the higher deductible isn’t ideal, it still offers some protection in the event of a major medical emergency.

Disability Insurance

If you become disabled and cannot work anymore, disability insurance protects your income. Typically, these policies replace between 40% to 70% of your base income. If you are concerned about surviving without your primary income, disability insurance is a worthwhile option to consider.

Long-term Care Insurance

Long-term care can involve getting assistance with everyday tasks or staying at a nursing home for an extended period of time. Many seniors need this assistance, but it’s not cheap. Long-term care insurance offers a way to cover these costs. Typically, buying this type of insurance in your 50s or 60s is the most cost-effective because your premiums will increase as you age.

Frequently Asked Questions

What are 2 things you can do to protect your credit score?

When it comes to protecting your credit score, there are plenty of options. Two of the most effective solutions include paying your bills on time and paying off debt.

Does insurance credit score affect credit score?

In some states, insurance companies can use an insurance-based credit score when determining your premiums. The score takes the details of your credit report into account. However, your credit score shouldn’t be impacted with an insurance company requests your credit-based insurance score.

Does canceling insurance affect credit?

An insurance policy isn’t a credit account. With that, canceling an insurance policy won’t directly impact your credit score.

The Bottom Line

It’s important to lock in the right insurance policies. Otherwise, your coverage might not go as far as you need it to when you file a claim. Take some time to explore all of your insurance options. If you have questions about your specific insurance needs, don’t be afraid to talk over the details with a financial professional or insurance agent.