How Does Auto Insurance Work? Everything You Need To Know

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Millions of licensed drivers traverse the roadways, yet the majority of those possessing auto insurance often remain oblivious to the extent of their coverage.

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It’s a universally acknowledged truth that insurance policies can be painfully dull to peruse. However, fret not, for we’re here to shed light on the fundamental facets of car insurance that every policyholder should grasp.

Armed with this knowledge, you’ll be equipped to make informed decisions when procuring insurance, ensuring the protection of your vehicle and mitigating liability risks.

A Concise Primer on Auto Insurance

At its core, insurance is the art of risk transfer. When it comes to auto insurance, it entails the shift of risk from an individual to a collective group of insured individuals, represented by policyholders of an insurance company.

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We all contribute premiums, but not all of us will face losses simultaneously.

The occurrence, timing, and magnitude of individual losses remain unpredictable.

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However, when insuring through a larger group, probability and statistics come into play, allowing us to calculate the fair share each insured person should pay to cover the collective risk of the group.

When a member of the insured group incurs a loss, the premiums paid by all policyholders contribute to covering their claims.

It’s essential to understand that we’re only covered for the specific coverage we’ve purchased with our policy.

For instance, without collision coverage, you won’t receive assistance in repairing your vehicle following an at-fault accident.

Recent studies, such as AAA’s, estimate the average annual cost of auto insurance for a new vehicle to be around $1,342.

Although your chosen coverage will influence your actual premiums, this figure offers a helpful perspective on how premiums fund insurance claims.

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Specifically, AAA’s data reflects full coverage costs for a 2021 model vehicle and considers drivers under 65 living in suburban areas with a clean accident history.

Types of Auto Insurance Coverage

While lenders often mandate physical damage coverage, individual state auto insurance requirements primarily focus on liability coverage.

Coverage types typically fall into the following categories, although state-specific mandates and available coverage may vary:

Physical Damage Coverage

Physical damage coverage encompasses both comprehensive and collision insurance. According to data from the Insurance Information Institute (III), in 2020, the average comprehensive claim amounted to $1,995, while collision claims averaged $3,588.

Collision Coverage

This component covers damages resulting from collisions with other vehicles or stationary objects, including rollovers.

Comprehensive Coverage

Also known as “other-than-collision coverage,” this facet safeguards against damages from various non-collision incidents like vandalism, theft, falling objects, fires, floods, and more. It even covers damage caused by animals.

While physical damage coverage isn’t legally mandated, it’s typically required for auto loans and leases from lenders and leasing companies.

It safeguards both the lender’s financial stake in the vehicle and the policyholder’s financial losses due to damage.

The term “full-coverage auto insurance” typically refers to coverage that includes physical damage in addition to mandatory coverages like auto liability and medical insurance.

Liability Insurance

Auto liability insurance is a legally mandated coverage in most states, and drivers must carry it. This coverage addresses our financial obligations to others in the event of an accident.

For instance, if you inadvertently rear-end the vehicle in front of you at a stoplight, you’d likely be considered at fault, potentially rendering you liable for injuries or damage to the occupants of the other vehicle.

According to the National Highway Traffic Safety Administration, nearly two million car-related accidents annually result in injuries.

The III reports that bodily injury liability claims typically average over $20,000, while property damage claims average nearly $5,000.

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Auto liability insurance encompasses two specific facets:

  • Bodily Injury Liability
  • Property Damage Liability

Property damage liability is often less understood than bodily injury liability, although the latter’s meaning is self-evident.

Property damage liability covers damage to other individuals’ property, which can include other vehicles, street signs, guardrails, traffic lights, and even buildings.

Each state imposes its own requirements for liability insurance. However, it’s usually advisable to select coverage limits exceeding the state’s minimum mandates.

For example, consider the minimum requirements in New Jersey and a few other states:

  • Bodily Injury Liability (per person): $15,000
  • Bodily Injury Liability (per occurrence): $30,000
  • Property Damage Liability (per occurrence): $5,000

Notably, New Jersey’s required bodily injury liability coverage per person falls short of the average claim amount, which exceeds $20,000.

Additionally, these figures represent average claim amounts, with some claims substantially exceeding the average.

It’s entirely plausible that your state’s minimum insurance limits might prove insufficient in protecting you financially. Fortunately, higher liability coverage limits are available.

Medical Coverage

While car insurance is subject to state regulation, variations often arise in medical coverage. Some states require medical insurance for both you and your passengers, while others do not.

State-specific distinctions in medical coverage options include personal injury protection (PIP) and medical payments (med pay) coverage.

These options enable you to cover medical expenses for yourself and your passengers in the event of an accident.

Med pay is the simpler of the two, covering your medical expenses up to the chosen

coverage limit in cases where you are at fault. If you’re not at fault, the liability insurance of the other driver should cover your medical bills.

Conversely, PIP covers medical expenses irrespective of fault, including additional costs like lost wages and other expenses directly tied to an auto accident.

Add-Ons and Riders

Most auto insurance policies offer additional options or add-ons, frequently referred to as riders or endorsements.

Some may be distinct products billed separately from your insurance policy but included in your premium.

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Common auto insurance add-ons encompass:

  • Rental Reimbursement: This coverage assists with the cost of renting a replacement vehicle following a covered claim.
  • Ride sharing Endorsement: If you drive for ride-hailing services like Uber or Lyft, this endorsement can fill coverage gaps when you’re logged into the app but haven’t yet picked up a passenger.
  • Gap Insurance: In the event of a total loss, this coverage bridges the gap between your vehicle’s insured value and the amount owed to the lender.
  • Roadside Assistance: Many insurers offer services like towing, jump starts, roadside repairs, and fuel delivery.

Car Insurance Coverage Limits

Certain coverage types, particularly collision and comprehensive, rely on your vehicle’s market value as coverage limits, which determine protection up to those limits.

This approach contrasts with liability coverage, where the coverage limits are explicitly stated in your policy and safeguard your assets against judgments following a liability incident.

Limits for Physical Damage Coverage

As your vehicle’s value depreciates over time, the coverage limit for your vehicle decreases accordingly. In essence, the insurer covers the actual loss, i.e., the depreciated value, rather than the cost of replacing your vehicle.

Limits of Liability Coverage

While states specify minimum liability limits, you can opt for higher limits or supplement your coverage with an umbrella policy. In liability cases, a judgment doesn’t consider whether you have the financial means to cover your liabilities; it can affect your savings or future earnings.

Limits on Medical Coverage

Medical coverage options vary from state to state, with some mandating at least some coverage. In certain instances, your existing health insurance can serve as your primary provider, potentially reducing auto insurance expenses.

Car Insurance Deductibles

Deductibles play a pivotal role in auto insurance, similar to other insurance types. As the name implies, a deductible is the amount subtracted from your claim settlement.

However, deductibles don’t apply to all coverage types, with liability coverage being a notable exception. Deductibles may also come into play with medical coverage.

When selecting a collision and comprehensive insurance deductible, it’s prudent to opt for an amount that’s financially manageable.

Deductibles serve to lower premiums, as policyholders assume part of the financial risk.

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