How does car insurance work?

Car insurance protects you from the financial risk of damage to your car as well as damage or injury you cause with your car.

Zack Sigel 1600

Zack Sigel

Published May 2, 2018

Car insurance protects you from the financial burden of being liable for damage you cause to another person’s car or an injury you cause to someone with your car. Car insurance also protects you from damage to your own car, including from theft, vandalism, and bad weather.

Car insurance, like other insurance products, is paid for with a monthly or annual premium, in return for which you’ll receive coverage for subcomponents including liability insurance, personal injury protection, and collision insurance. Beyond the minimum coverage amounts, you can choose how much coverage you want in each of several components to the car insurance policy.

Before purchasing coverage in each of the car insurance components, determine how much coverage you need and how much your state requires. Your rates will be calculated based on these amounts plus personal characteristics like your age, gender, driving habits, and credit history.

If you’re in a traffic accident and you’re at fault, or even if you suspect you might be, you probably need to file a claim. The insurance company will pay any of the resulting bills after you’ve paid the deductible, up to your coverage limit for the relevant provision. Depending on where you live, the insurer may pay you directly; otherwise, a payment may be made to the other party, to the entity servicing the car, or to the hospital treating the other party’s injuries.

The rules get more complicated if your car is a lease. In that case, car insurance claim payments may be made out to your leaseholder or creditor.

Here’s what you need to know to understand how car insurance works:

Components of car insurance

Car insurance is made up of several kinds of subcomponents, each of which describes a type of incident for which you can file a claim. Your premiums go to paying for coverage under each of these categories, and an increase in coverage in one category can cause an increase in your premiums. When determining how much car insurance coverage you need, you should calculate how much liability under each provision you can afford. The provisions are as follows:

Liability insurance

Liability insurance is coverage for when you cause bodily injury (otherwise known as bodily injury liability, or BIL) or property damage to another person with your car.

Personal injury protection (PIP)

Personal injury protection is coverage for when you cause bodily injury to yourself or your passengers. A type of no-fault coverage, PIP coverage can result in a payout regardless of who was driving. Up to the limits stated in your policy, personal injury protection covers not only medical bills but also lost wages.

Collision insurance

Collision insurance covers damage to your vehicle when it’s involved in an auto accident. While states require liability and personal injury protection coverage, collision insurance isn’t usually mandated.

Comprehensive insurance

Comprehensive insurance is coverage for damage to your car caused by something other than another vehicle. Comprehensive insurance is what protects you from theft, vandalism, and weather damage. If you’re not going to be driving the car for a long time, you can usually reduce your car insurance coverage to just comprehensive coverage, although be sure to switch it back before you get behind the wheel again.

Uninsured/underinsured motorist insurance

When the other party is at fault, but doesn’t have insurance, or his or her coverage is too small to cover your damages, uninsured/underinsured motorist coverage may pick up some or all of the remainder.

Gap insurance

Because of depreciation, your car may have an actual cash value lower than the amount you still owe on the auto loan you used to purchase it. If the car gets totaled or stolen, basic car insurance coverage will usually only pay out the car’s actual cash value. Gap insurance pays out the amount of the car’s value after depreciation and the amount left on the loan.

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Determining how much coverage you need

Almost every state requires you to have at least minimum car insurance coverage before you’re allowed to drive. States with no such requirement still mandate that you pay another person’s costs for damage you cause, so you’ll want to get car insurance even if you live in a state where it’s optional.

How much coverage you need begins with how much your state requires at a minimum. We’ve prepared a handy guide here.

However, the minimum may not be enough. That’s because it usually caps out at around $25,000 to $50,000 in coverage, leaving you completely unprepared for any liability that exceeds that amount. Say you cause $100,000 in damages: Are you prepared to shell out an additional $50,000 once you surpass your coverage limit?

You should also account for the deductible. The deductible is the amount you need to pay out of pocket before the insurance company picks up the rest of the bill. Usually, the deductible is around $500 to $1,000, and the higher the deductible, the less you pay in premiums.

You’ll want more car insurance coverage if you live in an area with elevated levels of crime. Take account of the cost of your car and make sure you have enough to replace the car if it gets stolen.

But your car isn’t the only asset you need to consider when determining how much car insurance you need. If you’re liable for someone’s medical injury or property damage, but you can’t pay their costs, your assets could be seized to cover the amount you owe. Make sure you have enough car insurance to avoid having to sell your home or going into serious debt.

Getting a quote

Your car insurance premiums are determined by many different factors. When you apply for car insurance, the carrier will look into your personal details to calculate the level of risk you pose that you’ll do something dangerous (or that something dangerous will be done to you) and the car insurance company will have to pay out. The higher the risk, the higher your premiums. You’ll need to keep paying your premiums to keep your car insurance policy in force.

Some of the determining factors are inherent to you, but others can be improved. See what can be managed to make sure you’re getting the best rate.

  • Deductible and coverage amounts. If you would cost the insurance company less money to settle a claim, they’ll offer you a lower premium in return. But taking out a low-deductible plan may not be cost-effective when comparing the increase in premiums over the plan’s lifetime versus how much you’d save by just eating the cost of a high deductible. Get the coverage you need at a deductible that won’t raise your premiums too much, and you’ll be glad you paid a little more each month.

  • Age/sex/location. According to the car insurance company, if you’re a younger driver, you may have to pay higher premiums, because you lack the experience of older drivers. If you’re male, you may also have to pay higher premiums than female drivers, due to statistics the insurance company has showing that male drivers pose higher risk. Certain zip codes may also trigger an increase in premiums, usually if they indicate an area with more crime.

  • Credit history. Having substandard credit could result in higher premiums.

  • Driving record. If your driving history is marked with accidents and moving violations, you’ll almost definitely be assessed a higher rate. The insurer will also look at how many miles you put on the car each year (more driving means more risk) as well as the type of car you drive (expensive cars mean higher claim payments).

Read more about how car insurance premiums are calculated here.

Filing a claim

If you get into a car accident, regardless of who was at fault, the first thing you should do is call 911. You’ll need an officer on hand to make an official report and an ambulance may be necessary if someone is injured. Stay on the scene long enough to exchange information with the other party and give a statement to the police officer as well as take photos of the damage for evidence. (Don’t discuss the accident with anyone besides the cop, including details such as who was at fault.)

When there are two parties at fault, you’ll want to file a claim with both your insurance and that of the other party. For bodily injuries and damage to your car caused by the other driver, his or her liability coverage will render a payout to you. You may also receive a payout from your own collision insurance coverage. While it may seem counterintuitive to involve your own car insurance in another person’s obligation, your car insurance carrier can actually provide the resources you need to make sure the other party’s insurance fulfills your claim.

If you’re at fault, the other party will make a claim through your car insurance company, and the coverage you’ve been paying for will result in a payout to him or her.

You’ll file a claim either online or by calling your representative at the car insurance company. Make sure you have the policy number, a description of the accident, information about the damages or injuries, and the names of witnesses or the responding police officer.

The car insurance company will assign you a claims professional, who will guide you through the process. This person, who is also known as a claims adjuster or a claims representative, will help you gather the documents you need for your claim, but he or she will also make an evaluation and adjust the amount of money you’re owed. A thorough investigation may be performed, including visiting the car at the body shop or reviewing your medical records related to the incident.

Once the investigation concludes, the car insurance company will make a payment. In the case of collision coverage, the car insurance company will make the payment to the body shop or car repair service to cover their invoice, in what’s called a first-party claim. (Check your state laws, however, as some states require the payment to be made to you so that you can pay for the repairs.)

When you’re claiming liability coverage, the at-fault party’s insurance will make the payment directly to you, in what’s called a third-party claim. The payment is also made directly to you with a personal injury protection claim, but the amount you can receive is dependent on how much your health insurance will already cover.

When not to file a claim

Your car insurance rates are contingent on you being a good driver. If you cause an accident, the car insurance company may reevaluate the risk you pose and assess you a higher rate the next time your policy is up for renewal. For that reason, you may want to avoid filing a claim.

However, tread carefully. You must file a claim if there are two parties involved, as you never know what kind of damage the other party suffered until you receive the invoice, and you could be on the hook for tens or hundreds of thousands of dollars. But if you’re the only driver involved, and the damage is either minor or nonexistent, you might save on higher premiums if you just cover the bill out of pocket. If the damage is just slightly higher than the deductible, you may also consider just paying it yourself, as you’ll have to pay the bulk of it anyway.

What happens if I travel out of state?

Your car insurance should cover you when you travel out of state. If you get into an accident covered by your policy while out of state, and you only have the minimum coverage required by your own state, the car insurance company will make up the difference with the other state’s minimum coverage. Read more about how your car insurance works when you travel out of state here.

Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.