Q

How does car insurance work?

A

Car insurance is financial protection in case you cause an accident with your car, or in case your car is damaged or stolen. You pay for a certain amount of coverage, and as long as your policy is active, your insurance will kick in if needed.

Zack SigelAnna Swartz 1600

Zack Sigel & Anna Swartz

Published October 23, 2019

Car insurance protects you from the financial liability of damage you cause to another person’s car, or an injury you cause to other people with your car. Car insurance can also protect you from damage to your own car, including damage from collisions, theft, vandalism, and bad weather.

Car insurance, like other insurance products, is essentially an agreement between you, the policyholder, and the insurance company. You agree to pay a monthly or annual premium, and the car insurance provider agrees to protect you financially from covered losses. .

But there isn’t just one type of coverage that makes up a car insurance policy: There’s liability coverage, personal injury protection, uninsured/underinsured motorist coverage, comprehensive coverage and collision coverage.

Then you have to set coverage limits and choose a deductible amount for your coverages. When you’re buying coverage, you’ll need to consider both the types of coverage you need, and how much of that coverage you’ll require.

When you purchase car insurance, your rates will be calculated based on the amount of coverage you buy, plus individual factors like your age, driving history, credit score and the make and model of car you drive.

You’ll need your car insurance if you cause an accident or if your car is damaged or stolen. You put your car insurance to work by filing a claim, which is how you redeem your coverage. If the incident is covered, your insurance company will pay for the cost of the damage you caused, or the damage to your car, depending on the situation.

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 medical providers treating the other party’s injuries.

If your car is a lease, car insurance claim payments may be made out to your leaseholder or creditor. Those are the basics of car insurance, now let’s get into the details.

In this article:

Types of car insurance

As we mentioned above, a car insurance policy is made up of different types of coverage that protect you in different situations. Here are the components that make up a typical car insurance policy:

Liability coverage

Liability insurance covers the costs if you cause an accident, damage property or injure someone with your vehicle. Liability insurance is required in most states.

Personal injury protection (PIP)

Personal injury protection covers medical and rehabilitation expenses if you or your passengers are injured in a car accident. Also covers other related expenses, like rehabilitation, or lost wages, up to your coverage limits. A type of no-fault coverage, PIP coverage can result in a payout regardless of who was driving.

Collision coverage

Collision insurance covers damage to your own vehicle after an accident, no matter who was at fault. Collision insurance isn’t required by law, but, along with comprehensive coverage, collision helps make up what’s usually referred to as “full coverage” car insurance.

Comprehensive coverage

Comprehensive coverage covers any damage to your car that can happen when it isn’t being driven, including damage from extreme weather, falling objects, flood, fire, vandalism and theft. If you’re putting your car in storage for a significant amount of 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

Uninsured/underinsured motorist coverage covers the costs if you’re in an accident caused by a driver who either doesn’t have insurance or whose insurance can’t pay for the full extent of the damage.

Gap insurance

If your car gets totaled or stolen, collision or comprehensive will usually only pay out the car’s actual cash value (ACV). But that amount, which factors in depreciations, might not cover the amount you still owe on a car loan or lease. Gap insurance pays out the difference, so you can pay off the loan or lease.

Roadside assistance

Roadside assistance, an optional coverage add-on, covers the types of emergencies that can leave you stranded on the side of the road, like flat-tire changes, jump-starts, fuel delivery or towing to the nearest mechanic. Roadside assistance is usually inexpensive to add to your policy.

How much car insurance do I need?

Almost every state requires you to have at least a minimum amount of car insurance coverage before you’re allowed to drive. States with car insurance requirements still mandate that you pay for any damage you cause in your car, so you’ll want to get car insurance even if you live in a state where it’s optional.

If you don’t know how much car insurance is required in your state, we’ve put together a handy guide here.

However, the minimum amount of insurance required in your state won’t be enough to fully protect you. Say your state requires you have have up to $15,000 worth of liability coverage, but you have an accident where you cause $50,000 worth of damages. Are you prepared to shell out an additional $35,000 once you surpass your coverage limit?

And your state may only require liability coverage, leaving your own vehicle unprotected. Unless you drive a car you don’t care about, maybe because it’s old or already damaged, you’ll want to include comprehensive and collision insurance in your policy, which cover the cost of damage to your vehicle.

Both comprehensive and collision coverages require you to set a 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. But don’t set your deductible higher than what you could reasonably afford — you may actually have to pay it someday.

When choosing your car insurance limits and deductibles, think about how much you can reasonably pay out of pocket in case you cause an accident or your car is damaged, as well as the value of your car and the likelihood that it might be damaged or stolen.

Make sure to set your liability limits high enough that insurance will fully cover the costs of an accident you caused. 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.

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How much does car insurance cost?

Your car insurance premiums are determined by many different, individual factors, like age, ZIP code, credit score, and the make and model of car you drive. Costs are specific to every driver, which makes it hard to predict what any given person will pay for car insurance.

But we can look at sample quotes for an average driver. Let’s say our driver is a 30-year-old woman unmarried, with a clean driving record. Let's say she drives a 2014 Toyota Camry and lives in Minnesota, a state that falls in the middle when it comes to the average cost of car insurance in every state in the U.S.

Her quote for full coverage insurance from one of the largest auto insurers in the country came to an annual total of $1,136 for the year. That’s about in line with other average costs: AAA’s 2018 Your Driving Costs study examined the ownership costs associated with different types of vehicle and broke down the average cost of car insurance by vehicle type.

Type of carAnnual cost of car insurance
Small SUV$1,074
Medium SUV$1,102
Minivan$1,114
Hybrid$1,200
Large sedan$1,209
Electric$1,215
Medium sedan$1,232
Pickup$1,242
Small sedan$1,315

Averages aside, your premiums may be much higher or lower depending on your individual factors. Let’s take a look at how car insurance rates are calculated.

How are premiums calculated?

When you apply for car insurance, the carrier will look into your personal details to calculate the level of risk you pose. They’re basically trying to figure out how likely you are to file a claim.

Certain factors are obvious — having a poor driving record will raise your risk factor, meaning higher premiums. But others are less obvious. Here are some of the factors that go into calculating your car insurance premiums:

  • Deductible and coverage amounts. The lower you set your coverage amounts and the higher you set your deductible, the less you’ll pay for car insurance. But remember that you might have to actually file a claim someday, and you could wind up paying that high deductible, or your low coverage amounts could leave you on the hook for high costs if you cause expensive damage. If you’re setting low coverage amounts or a high deductible just to save on premiums, consider that doing so could cost you much more down the line.

  • Age, gender and location. Age can have a big effect on premiums — drivers under 25 pay significantly more because they’re seen as less experienced and riskier to insure. In some places, your gender will also affect premiums, although some states forbid car insurance companies from taking gender into account. Your ZIP code will also factor into your premiums — city drivers will pay more, because higher density means more chances for accidents, vandalism or theft.

  • Credit history. It may seem unfair, or unrelated, but your credit score will also affect your car insurance rates. Drivers with poor credit will be seen as riskier to insure, and will see higher premiums. Some car insurance companies are friendlier to drivers with bad credit than others, which makes it especially important for those drivers to shop around and compare quotes.

  • Driving record. If your driving history is marked with accidents and moving violations, you’ll almost definitely see higher premiums as a result. However accidents and violations don’t stay on your record forever. Typically, car insurance companies only look at the past 3-5 years of your driving history, meaning that, once enough time has passed, an accident will “fall off” your record and won’t affect your rates anymore.

Read more about how car insurance premiums are calculated here.

Filing a claim

No one wants to have to file a claim with their car insurance, but accidents do happen, and this is what car insurance is for. 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 first responders can assess everyone for injuries.

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, their liability coverage will render a payout to you.

You may also receive a payout from your own collision insurance coverage if your car has been damaged. 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 your provider will payout to them.

You’ll file a claim either online or by calling your representative at the car insurance company. Some car insurance companies also have mobile apps for smartphones that let you start a claim at the scene. At the scene of an accident, collect as much information as possible, including:

  • Policy numbers for everyone involved
  • Photographs of any damage and of the scene of the accident
  • License plate numbers and descriptions of the cars
  • Names of witnesses and 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 representative, will help you gather the documents you need for your claim, but they 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 may 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 raise your rates the next time your policy is up for renewal.

For that reason, you may want to avoid filing a claim, especially if the damage to your car is much less than your deductible. Say you back your car into a tree, scraping and denting the bumper. Since no one else is involved, and the cost to fix the damage could be less than the deductible for your collision coverage, it might not be worth it to make a claim.

However you must file a claim if there are two parties involved. You won’t know what kind of damage the other party suffered until you receive the invoice, and you could be on the hook for tens or even 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.