How Does Car Insurance Work?

Car insurance works using the idea of indemnity. You as the policy holder are entitled to be made whole or restored to your original financial position in the event you need to use your policy. For example, let's say that you drive a 2010 Honda.

If you were to crash this car into a pole, your insurance would be responsible to restore you to your previous position. In this case, they might pay to get the car repaired - if you have the proper coverage. Your car insurance would not be responsbile to buy you a 2024 Honda as that was not your previous position.

Car insurance companies charge you a premium to cover you. You can pay this premium in monthly installments or in lump sums typically on a 6 month or yearly basis. If you do not pay your premium, your coverage can lapse.

In addition to the premium that you will pay, you may also be required to meet a deductible before you can use certain types of coverage. Typically, collision and comprehensive coverage require a deductible, whereas liability coverage does not. We will look at these in the next section.

So, how does a deductible work? Let's say that you caused an accident and incurred $5,000 worth of damage to your own vehicle and had a deductible of $500. If you had collision coverage on the vehicle, you would be able make a claim to cover this damage.

However, you would need to pay your $500 deductible before your carrier covered the rest of the damage. Car insurance companies apply deductibles to certain types of coverage to make sure that individuals are not taking advantage of them for smaller repairs.

For example, let's say that your vehicle was scratched and it was going to be $300 to repair. You could make a claim with your carrier, but the deductible costs more than the repair itself. In this case it would make more sense to cover the cost out of your own pocket.

You can typically put car insurance coverages into one of two buckets. The first bucket is coverage that protects other drivers, their property and your assets from lawsuits. The second bucket is coverage that protects yourself, and your property.

Coverage for other drivers on the road is commonly referred to as liability coverage. This type of coverage is designed to cover the costs of other drivers when you are at fault in an accident. There are two types of liability coverage.

a) Bodily injury - This covers the expenses that others incur from injuries or death when you are the at fault party in an accident. This coverage protects other drivers on the road, their passengers, and pedestrians.

b) Property damage - This covers expenses for other people's property as a result of an accident where you are the at fault party. For example, if you hit another driver's vehicle or ran into a homeowner's fence, this coverage would pay for these damages.

c) Protection of your assets - The coverages discussed above are designed to protect other individuals on the road. However, they also protect your assets by default. For example, let's say that you cause an accident that causes serious injury to another driver.

In this instance, the bodily injury coverage you carry on your policy would kick in. However, let's say that the amount of coverage that you have on your policy is not sufficient to cover the medical costs of the other driver's injuries.

This driver could hire an attorney and go after your assets to get compensated for the injuries that they sustained. This is why it is important to make sure you have substantial liability coverage to protect both other drivers, as well as your own assets.

a) Collision coverage - This covers the cost to repair damages to your car from collisions with other vehicles, as well as collisions with other objects including trees, poles, fences, and buildings. You can use this coverage even when you are at fault in an accident. Collision coverage will have a deductible you must meet in most cases.  

b) Comprehensive coverage - This covers your car in events that are not related to a collision with another vehicle or object. This can include fire damage, hail damage, vandalism, damage from falling objects such as a tree, damage from an animal, and reimbursement if your vehicle is stolen. Comprehensive coverage will have a deductible you must meet in most cases.  

c) Uninsured/underinsured motorist coverage - If you are hurt by another driver in an accident and that driver does not have car insurance or lacks sufficient coverage to protect you, this coverage can kick in. It is a coverage that you hold on your own policy to protect you from uninsured or underinsured motorists. The exact rules of this coverage can vary by state so make sure to consult a licensed insurance agent in your area.  
d) Medical payments - This covers any medical expenses that you or any of your passengers incur from an accident, regardless if the accident is your fault or the fault of another driver. Drivers who often opt for this coverage plan to use it to pay for their health insurance deductibles if they are injured so that they won't incur any out-of-pocket costs.

a) Roadside assistance - If you need a tow, a jump start, run out of fuel, get a flat tire, or get locked out of your car, this coverage can help reimburse you for some of those expenses. The services that are covered under this type of coverage can vary by carrier so make sure to discuss them with your insurance agent.

b) Rental car reimbursement - If your car is being repaired as a result of a covered claim, you can get reimbursed the cost of a rental vehicle. This coverage does not apply for normal mechanical maintenance. You must make a claim that is covered under your policy to use this coverage.

The type of coverage needed can vary from person to person. At a minimum, you will need to meet your state's legal requirements, as well as any financial lender's requirements if you have a loan or lease on the car.

Most states require all drivers to carry a minimum amount of liability insurance to legally drive on the road. Remember that liability coverage is comprised of bodily injury and property damage coverage. It is a coverage that you pay for to protect other drivers, their property, and your own assets.

Depending upon your state, you may be required to carry additional coverage including uninsured and/or underinsured motorist coverage, medical payments coverage, and others. It is important to speak with a licensed insurance agent in your state to make sure you meet both minimum legally required coverages and coverage amounts.

In addition to state laws, you may also be required to obtain additional coverage if you have a loan or lease on your vehicle from a financial lender. A financial lender will require you to obtain collision and comprehensive coverage in addition to your state's liability coverage requirements. Why is this?

Remember, collision and comprehensive coverage cover the cost to repair or replace your vehicle in the event of damage incurred to your vehicle from an accident with another vehicle, object, or instances not related to an accident such as fire damage and theft.

Since your lender has a significant financial stake in your vehicle, you will be required to obtain these coverages in order to protect the lender. If you own your vehicle outright, you are not required to have collision and comprehensive coverage.

If you own your vehicle outright, you might be wondering if you should add comprehensive and collision coverage to your policy as it may not be a requirement. In this instance, it is a good idea to consider the value of your vehicle.

Let's say that your car is only worth $2,000. You may be comfortable foregoing comprehensive and collision and only having liability coverage on your policy since the value of your vehicle is low. On the flipside let's say that your car is worth $30,000.

Even if the vehicle is paid off, it would be a very good idea to carry comprehensive and collision coverage. If you are the at fault party in an accident and cause damage to your own car, you would have to cover the cost to repair or replace your vehicle since you do not carry comprehensive and collision coverage.

At the end of the day you need to assess your risk tolerance when deciding what types of coverages you want on your policy. Just because a coverage is not required does not mean it is always a good idea to forego that coverage.

For example, uninsured/underinsured motorist coverage is not mandatory in all states (for some it is) and you could save money by denying this coverage. However, if a driver hits you that does not have insurance or is underinsured, you could find yourself in a sticky situation. Your only option would be to sue the other driver.

According to the Insurance Research Council, one in eight drivers was uninsured in 2019. If you have a low tolerance for risk, it could be a good option to add on this additional coverage. If you have a high tolerance for risk, you might be comfortable denying this coverage. The point here is that if you would sleep better at night by adding on a few additional coverages, do it.

At the very least, you will need to meet your state's minimum requirements for liability coverage. For most states, this will be somewhere in the range of $25,000/$50,000 for the bodily injury portion of the coverage and $15,000 to $25,000 in property damage. (Make sure to check your state's requirements as this is simply a general range.)

Using the numbers above, you would have $25,000 per person and $50,000 total for bodily injury coverage to cover the cost of injuries if you caused an accident and someone else was hurt. The second set of numbers means that you would have $15,000 to $25,000 to cover expenses related to the damage of another person's property if you caused an accident.

Although these ranges are typical in most states, you must ask yourself the question is that enough? Your car insurance is not simply designed to protect your car and other drivers. It is also designed to help you protect your entire financial life in that proper coverage can help mitigate your liability if you cause an accident.

For example, let's say that you currently have car insurance, but you only carry the legal minimum requirement for your state. One day you cause an accident that results in injuries and damage to another driver's body and vehicle.

Lets assume that this accident was fairly severe, and that the other driver incurred injuries that costed $60,000 and significant damage to their vehicle that costed $30,000. If you only have the coverage listed above, you could be sued by the other driver to cover the additional costs they incurred as a result of the accident you caused.

With this in mind, it is well worth spending extra money on your car insurance each month to avoid a potential lawsuit that could derail your entire financial picture. The exact amount of coverage you need will vary, but a good starting place is to make sure you have at least $100k/$300k limits for bodily injury coverage and $100k for property damage coverage.  

The general rule of thumb is that the driver who is at fault is responsible for using their coverage to cover damages caused to others and themselves. So, if a driver crashes into you and damages your vehicle or causes injuries to you, you will make a claim against that drivers liability coverage on their policy to be compensated.

Keep in mind that an instance could happen in which another driver hits you and does not have insurance or is underinsured. In this case you could use your uninsured/underinsured coverage on your own policy if you have it or pursue legal action if possible or necessary.  

If you are at fault in an accident, your car insurance would cover the cost to restore the other driver and yourself if you have the proper coverage. You want to make sure that you have substantial coverage in this instance to protect other drivers and yourself from lawsuits.

The amount that you will pay for your car insurance will vary depending upon a multitude of factors which we will look at below. For most states you can expect to pay between $500 to $1,500 for minimum coverage and $1,500 to $3,600 for full coverage.

Keep in mind that these are general ranges. Your premiums could be the same, lower, or higher. If you want to reduce the cost of your premiums many carriers offer discounts such as a bundling discount, low mileage discount, safe driving discount, good student discount and more. Make sure to ask your insurance agent about the discounts that you qualify for.

1) Age - In general, a younger driver will cost more to insure than an older driver. A 16 year old who just got their license is a much higher risk to the insurance company than a 30 year old due to a lack of driving experience. Age becomes a less important factor once you reach 25 years old.

2) Geographic Location - If you are located in a higher populated urban area, you will tend to pay more for coverage than you would if you are in a rural area. Higher populated areas have more accidents, theft and vandalism so car insurance companies tend to charge more to cover these costs.

3) Type of Vehicle - The more expensive your vehicle, the more expensive your premiums will be. If your car is susceptible to theft, you can pay higher rates. If your car has a higher safety rating that protect both the vehicle as well as the passengers, your premiums will typically be lower.

4) Driving Record - All car insurance companies will evaluate your driving record when determining the price of your premium. Any accidents or traffic violations in the past 5 years can result in a more expensive premium. If you have a clean driving record, your premium tends to be lower.

5) Driving Frequency -  If you don't drive that often you can often qualify for cheaper premiums or a low mileage discount as you are less of a risk to insure as you are on the road less. The reverse is also true. If you drive more than the average driver you can incur higher rates.

6) Gender - In general women tend to pay less than men for coverage as they have fewer accidents overall and fewer accidents related that involve drugs or alcohol when compared to men. Single men will pay more for coverage than married men as drivers who are married tend to have less accidents.

7) Credit History - If you have poor credit, you will pay more for coverage. Poor credit is correlated with a higher likelihood of making a future claim which means you are more expensive to insure. If you have strong credit or improve your credit, your rates will be cheaper or drop.  

8) Type of coverage - The more coverage you have, the higher your premiums will be. If you opt for lower coverage (think liability only at the lowest coverage amount) your premiums will be lower. Keep in mind that cheap is not always best when it comes to car insurance.

If you are shopping for quotes, one of the easiest ways to do it is to go directly to the insurer. You can go directly to the website of a particular insurer such as State Farm or Progressive to request a quote. You can also call the insurer and ask for a quote over the phone.

Insurance brokers do not represent a single insurance company. Instead, they work with lots of different companies and can offer lots of different policies. If you want help comparing quotes from different companies, brokers can be a good option.

There are many online services that allow you to compare quotes from a variety of carriers. Simply go to the website of a comparison service and enter the necessary information. You will then be provided with a range of quotes to review. Quotewizard would be an example of a popular comparison service. Keep in mind that the quotes you get are not always accurate and are more of an estimate.

When shopping for car insurance it is important to compare several quotes to make sure you are getting the best possible price for your desired coverage. In general, wait until you have at least 3 to 5 quotes and compare them. It can be tempting to go with the cheapest option, but as previously stated cheap is not always best when it comes to car insurance.

Make sure that you have proper coverage and understand your coverage. Check the reputation of the company and make sure that the company has strong customer service so that you can rely on them when needed.

Once you have found a quote that you like with a reputable company, you can set the policy up. Most of the time individuals pay monthly, but carriers will also allow you to pay a lump sum for your policy if you desire. After your new policy is set up, you can cancel your old one. Make sure that you do not cancel your old policy until your new one is in place in order to avoid a lapse in coverage.

The bottom line is that car insurance is designed to protect yourself, your property and assets, and other drivers and their property. There are a wide variety of coverages available, but at a bare minimum you will need your state's minimum legal requirement of liability coverage as well as comprehensive and collision coverage if you have a loan or lease on your vehicle.

Car insurance is not a product in which cheap is always best. More than anything, you want to ensure you have proper coverage to protect yourself. It might be painful if you send a bit more money out for your monthly premium, but you will be glad you did when you need to use your policy.