Ask John: Insurance & Credit

The Impact of Credit Management On Your Insurance Premiums

Background

Please meet Chuck, a 36-year-old airline pilot who lives in Lexington, Kentucky, with his wife and two children. Chuck, and his wife, Kim, both work, although her income is much lower than his because she only works part time. They have established excellent credit, which they use to pay a home loan, two car loans, and several credit cards.

Chuck, like many junior airline pilots, spent some time out of work after September 11. They call this temporary layoff a “furlough.”

In Chuck’s case, “temporary” meant almost two years. This meant that the majority of their household income was gone.

Chuck’s Dilemma

The problem with being furloughed is that since he wasn’t being let go permanently, he didn’t get any sort of severance package. And, in what us non-airline pilots would call a ridiculous situation, if he were to get another pilot job at a different airline, he’d have to start over…low man on the totem pole with respect to salary and pilot privileges. So, in his case, it was better to wait out the furlough than to find a new pilot job with another airline.

So, for almost 24 months Chuck didn’t have a salary. He was forced to do what none of like to do and use his personal savings to make ends meet. In Chuck’s case, he didn’t have enough cash to survive so he had to begin taking out cash advances from his credit cards and then pay the minimum payments. He had gone from a cash-paying consumer to a consumer living off of his credit cards.

As a result, Chuck’s credit card debt skyrocketed to over $25,000 in a little under 6 months. But, Chuck never ever missed a payment. He felt that he still had excellent credit and excellent credit scores.

What Chuck didn’t know until it was too late was that his homeowners insurance company began depending on credit scores to determine if policy holders were still “insurance worthy.” This is perfectly legal and it isn’t a new phenomenon. It was just a new policy that his insurance company implemented.

Despite the fact Chuck hadn’t missed any payments, his increase in credit card debt dropped his credit scores by almost 100 points. His insurance company notified him that they were not going to be able to renew his policy and that he would have to find insurance elsewhere.

Needless to say Chuck was furious. He had never missed a payment on any credit account and he had never filed a homeowners claim in the 7 years he had lived in his house. How in the world could they simply drop him like this?

Chuck’s unfortunate job situation might potentially cost him his home, even though he has never missed a payment. You see, his mortgage company, like all mortgage companies, requires that he always have adequate insurance coverage on the home that THEY own. If his insurance company cancels his coverage and Chuck can’t find another insurance company to write him a homeowner’s policy, they could accelerate his payment and then take his home when he can’t pay his loan off.

Did Chuck make a colossal mistake by not taking another pilot job? At least that way he could have stayed out of such severe credit card debt. Or was there a way that he could get out of this current situation?

Chuck’s Options

Chuck has a couple of options that might help him save his home. They are:

• Reduce his credit card debt, thus increasing his credit scores to the point where his insurance company will renew his homeowner’s policy.
• Find another insurance company that doesn’t rely on credit scores to determine insurability. These companies do exist, but their coverage isn’t cheap.
• Sell his home before the bank forces him out of it. At least he would save his family the embarrassment of having their home foreclosed and their credit ratings trashed for seven years. That’s right, having your home foreclosed upon will stay on your credit reports for up to seven years.
• If possible, have his wife apply for a policy. She’s lucky; the credit cards are all in Chuck’s name only so the added debt didn’t make it on her credit reports. Her credit scores, consequently, are still pretty good and easily good enough to pass the insurance company’s criteria.

The Best Course of Action

Chuck felt that options 3 and 4 were out of the question. No way he was going to sell his home of seven years. Nor would his ego allow him to ask his wife if he could borrow her good credit despite the fact that he had NEVER missed a payment or filed a homeowner’s claim. For Chuck it was going to be either option 1 or 2.

Here’s what we did…

The insurance company was using a number to determine whether or not Chuck’s policy would be renewed, so we went to work on the number to see if we could get it high enough that it passed their criteria. After some research, we determined that if we could get Chuck’s credit card balances reduced by about $15,000, his scores would rebound enough to satisfy the insurance company. If need be, Chuck was going to break into his 401(k) savings (and take a significant financial penalty) to pay down his credit card balances. That was Plan B.

Plan A was to shop around and find an insurance company that didn’t use credit scores as a criteria. We found several, but all of them wanted to charge premiums that were 2 to 3 times more than Chuck used to pay. Remember, this is a man who has never missed a payment or ever filed a homeowner’s insurance claim. The problem was that these “no credit required” insurance companies had higher rates because they didn’t use credit scores to determine insurability. They were still in the dark ages with respect to how they determined insurance eligibility. Chuck didn’t want to have anything to do with them.

Since Chuck didn’t have the time to wait for his savings to build back, (and he didn’t have a rich uncle somewhere to loan him the money), he was forced to do what nobody wants to do. He broke into his retirement piggy bank and took out enough money to pay off almost 50% of his credit card debt.

Within 6 weeks, (the amount of time it took for his checks to clear the bank and for his credit card companies to update his credit reports with the lower balances), Chuck’s credit scores were high enough to get their policy renewed. They still had to pay a slightly higher premium, but it wasn’t 2 to 3 times higher like other companies were offering.

It’s Not Always A Nightmare

In this case, Chuck’s story doesn’t really have a happy ending. He still has his house but his 401(k) balance is almost $22,000 lower than it was. And, his insurance premiums still went up.

It isn’t always like this.

We had another emailer send us almost the exact opposite situation. They had excellent credit but had a history of filing homeowner’s claims. As such, their insurance company was going to cancel their coverage until they saw what an excellent credit score they had. In their case, the history of excellent credit actually cancelled out a poor history of filing too many claims.

Summary

Chuck was in the classic no win situation. He couldn’t let his bills go unpaid so he did the only thing he felt he could do, start living almost exclusively on credit cards. But, it almost came back to bite him because of the unintended impact to his credit scores.

If he had known what impact it was going to have, he probably still would have done the same thing. He was able to use someone else’s money, (the credit card company’s, to sustain his family until he was able to get back on his feet, or in his case…able to get back in the air.

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