How car insurance works

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How car insurance works

While most drivers know that car insurance is effectively mandatory in the U.S., it hasn’t always been this way. The first car insurance policy was written in 1897, a full six years after the first auto accident in 1891. It was entirely optional until 1925, when Connecticut passed a law requiring drivers responsible for an accident to take financial responsibility for the other driver. Between the 1950s and 1970s, nearly every state adopted laws requiring drivers to buy a minimum amount of auto insurance.

In fact, today only one state doesn’t have minimum auto insurance requirements: New Hampshire. However, like Connecticut’s 1925 law, New Hampshire does require drivers to pay for the costs of property damage or bodily injury from an accident they cause. The best way to do that? Auto insurance.

So, if you drive in America, you probably need car insurance. But not everyone needs the same kind of auto insurance, and the difference between policies can get surprisingly complicated.

What goes into a car insurance policy

Want to jump into the most confusing part of car insurance? Each car insurance policy is made up of either one or multiple different kinds of insurance, all of which cover a different aspect of the accident. Note that this list does not cover all of the possible car insurance types, but it does cover the four most important.

Liability insurance: This is usually what states require drivers to buy. Liability insurance doesn’t cover your vehicle – it covers the damage you cause to other people when you’re in an accident. It usually covers two components: bodily injury (BI) and property damage (PD).

Let’s say you accidentally swerve into the wrong lane and hit another car, and a passenger in that car breaks her leg. Your liability insurance would cover the property damage (the other car) and the bodily injury (the leg). You’d have to pay to repair any damage to your own car, however.

Personal injury protection: Personal injury protection (PIP) is designed to cover medical expenses, as well as potentially covering lost wages and other damages depending on the situation. It’s frequently required in states with "no-fault" laws because it’s designed to pay out regardless of legal liability. Typically, drivers with injuries make PIP claims to their own auto insurance company.

Collision and comprehensive: Both of these types of insurance cover damages done to your car. Collision specifically covers your vehicle in the case of a collision with another car or a building or traffic sign or what have you. Comprehensive covers damage done to your vehicle by non-collisions – a.k.a., pretty much everything else. Examples of non-collisions include fires, vandalism, theft, weather, and Acts of God such as tornados and hurricanes.

Uninsured and underinsured motorist insurance: Often referred to as UM/UIM, uninsured and underinsured motorist insurance is a frequently overlooked component of auto insurance. This coverage is designed to protect you in case you are involved in an accident where the driver at-fault does not have adequate (or any) auto insurance.

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How do you know what you need?

Knowing what types of auto insurance you need and how much to buy can be as simple as buying the minimum required by your state. But often, people need much than what’s just minimally required of them. State requirements are typically written with the other driver in mind, so if you just buy the minimum and then are at-fault in an accident, you’ll be left to cover your own expenses.

There are two questions you should ask yourself to help determine what kind of auto insurance you need:

  1. How much money can I spend on car insurance? Each additional component of auto insurance will cost you money, so know your budget ahead of time.

  2. What are my options and what do I think I need? Read up on the options available, and think on what you’ll actually need. It’s much easier to do with when you know what those options cost and what your budget is – it’ll help you out when you need to make tough choices.

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How are the rates determined?

There are a number of factors that go into figuring out your auto insurance rates. When it comes to liability, the most important factors will be your past driving record, where you live, and how many miles you drive in a year.

These risk factors are pretty easy to understand. If you have a history of car accidents, your rates will go up. If you live in an area where there are more auto insurance claims, your rates will go up to offset that cost. If you drive a lot, insurance companies figure there are more chances for you to get into an accident, and your rates go up.

When you throw in collision and comprehensive, the car you drive starts to have more bearing on how much you pay for auto insurance. (It matters for liability insurance as well – the better your car’s crash rating is, the lower you’ll pay.) If your car will be expensive to either repair or replace, you’ll end up paying more on auto insurance.

Image: Robert Course-Baker