Car Insurance Fundamentals
- Last Updated: Monday, 01 March 2021
Insuring an automobile is more than just a good way to protect an investment. It’s also a good way to protect people too. In most states, owners are legally required to carry insurance to protect passengers, people that might be injured by the car, and damages it might cause to property.
In this article, we’re going to discuss why consumers need automobile insurance, as well as the categories of protection offered to individuals. We’ll also talk about some of the factors companies will use to determine policy premiums.
Insuring a Car
Nobody sits behind the steering wheel and intentionally rams into another car, deer, or telephone pole (criminal exceptions noted). The vast majority of individuals have accidents, and they can even happen when pulling out of a driveway.
In many countries throughout the world, it is mandatory, or compulsory, to purchase insurance before driving on public roads. In the United States, there are penalties for not having a valid policy including fines, revocation or suspension of a driver’s license or the vehicle’s registration, and even possible imprisonment in some states.
In general, car insurance provides coverage for the policyholder, the vehicle, and third parties; this includes passengers, individuals involved in the accident, as well as other owners of the vehicle such as a bank or lender. Each of these insured parties is protected by one or more categories of coverage.
Four Categories of Coverage
It’s no accident that insurance companies separate a policy into subcategories of coverage that fit very nicely with the owner’s needs. This provides the opportunity for the policyholder to tailor their coverage to their individual situation. Generally, the four subcategories of car insurance include:
- Collision / Comprehensive Insurance
- Medical Expenses
- Liability Insurance
- Uninsured / Underinsured Vehicle Operators
Each of these is discussed in more detail in the sections below.
Collision / Comprehensive Insurance
Collision insurance covers the damage to a vehicle when it’s involved in an accident; up to the book value of the car. Collision coverage is usually subject to a deductible; which is a cost-sharing agreement with the insurance company. The book value will be paid to the insured if the cost of repair exceeds the book value of the car.
Under certain conditions, the insured may wish to sign a collision damage waiver (CDW). When this happens, the owner would not be insured for collision damage. This type of waiver is sometimes selected when a car’s book value is less than the policy’s deductible.
Comprehensive insurance covers damages to the car caused by an unknown party or an “act of God.” This type of damage is sometimes referred to as “other than collision.” Examples include fire, theft, vandalism, weather (such as hail), or impacts with animals such as deer. These types of damage are known as comprehensive losses.
In most states, the insured is required to obtain a policy that includes payments for medical expenses. This applies to medical treatment for the driver as well as passengers involved in an accident.
Property damage or injury the driver might cause to others is covered under liability insurance. This coverage is normally provided at a fixed dollar amount. For instance, the policy might provide $100,000 in coverage. Liability payments usually occur when the insured is found to be negligent in some way. For example, if the driver of the vehicle damages a utility pole, their liability coverage would pay for the expense of repairing or replacing the pole.
Liability coverage is usually sold as a combined single policy limit or a split limit.
Combined Single Limit Policy
A combined single limit policy simply combines all types of liability coverage provided by the policy. Examples include bodily injury and property damage. All payments made during a single event are combined, and limited, by a single limit policy.
Split Limit Policies
A split limit policy allows the policyholder to purchase separate coverage for both property damage and bodily injury. For example, even during a single event, the maximum, or limit, for both bodily injury and property are not combined, but subject to the total maximum limit.
Uninsured / Underinsured
Unfortunately, even though it may be required by law, not everyone has car insurance. UM/UIM insurance helps the driver or passengers pay for damages or injuries that occur when the other party involved in the accident is an uninsured / underinsured motorist.
Special Types of Auto Insurance
The above items are the primary subcategories of car insurance; but companies may also offer additional policy features such as:
- Loss of Use: payments made to car rental companies if a vehicle is damaged and the owner needs to rent a car until the repair is completed.
- Loan or Lease Payoff: sometimes referred to as GAP Insurance, this feature provides protection that pays the gap between a car’s market value and the outstanding balance on the car loan if it’s totaled.
- Towing Insurance: a roadside assistance program that provides coverage for problems such as flat tires, dead batteries, or cars that run out of gasoline.
Most companies determine the policy’s cost, or premium, using a formula. If the driver is inexperienced, then they’re going to pay more. Insurance companies don’t have the time to follow each potential policyholder to see if they are a “wild child” or a “cautious kid.” The following is a short list of factors that determine the cost of insurance.
Age of Driver
Younger drivers, such as teenagers, are considered less experienced and would pay higher premiums. However, these same teenagers are sometimes offered discounts if they take driver education classes or get good grades in school. In general, premiums begin to decline when drivers reach age 25.
At the other end of the age spectrum, older drivers are often offered senior or retirement discounts.
Past performance is sometimes used as an indicator of future performance. The location where the car is stored, either at home or a place of employment, can also affect costs: urban rates are usually higher. Since men tend to drive more miles each year than women, they also have a higher chance of being involved in an accident. This means gender can sometimes be a factor when determining premiums.
Type of Vehicle Driven / Level of Coverage
The cost of insurance also takes into consideration both the expenses associated with replacing a vehicle and the type of vehicle driven (sports car versus minivan). Policy premiums would also reflect the level of deductibles chosen, or the level and / or breadth of coverage selected (more coverage simply costs more).
Distance Driven Each Year
Some insurance companies take into account the distance driven or how the car is used during the year. For example, pleasure use only versus commuting to work. These companies may ask drivers to estimate the number of miles the car will be driven each year, or require the policyholder to submit odometer readings at renewal.
More recently, some insurance companies have been using credit scores to adjust premium levels. Justification for using insurance credit scores is simply this: data indicates that consumers with lower credit scores are more likely to file claims and collect money on their policies.
In the following paragraphs, we describe several tactics individuals can use to help control costs. The first tactic will probably save the most money, but also subjects the policyholder to the greatest risk of loss: eliminating collision or comprehensive coverage.
Since collision and comprehensive cover the cost to repair damages to the car, policyholders don’t need to have this insurance. We need to be careful with blanket statements like this because if there is a loan on the car, or it’s being leased, it is very likely the company leasing the car or lending the money will require this coverage. If the car is damaged and there isn’t coverage for collision or comprehensive insurance, then the owner will need to pay for all repairs to the car or buy a new one.
It’s also possible to increase deductibles to lower costs. By raising a deductible, the policyholder is paying a larger share of the car’s repair cost.
Another way to lower cost is to see if the company that provides the owner’s homeowners policy or life insurance offers “umbrella” policies too. By consolidating these needs through one company or broker, the policyholder may qualify for discounts.
Taking Advantage of Discounts
Finally, it’s worth the telephone call to simply ask the carrier what discounts they provide. Many companies offer savings to students with good grades or individuals that have taken an approved defensive driving course. Some of the safety features of the car: anti-theft systems, air bags, and anti-lock brakes are designed to protect the vehicle and its occupants. They should also lower the cost to insure the vehicle against these same types of losses.
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