Advice from Intellichoice: Insurance Overview

The only thing worse than paying for insurance is not having it when you need it. Insurance is the price you pay to protect yourself, your passengers and your car against unexpected losses. It’s required by law, and if you’ve ever insured a vehicle you know it makes up a substantial portion of your total ownership expense. Unlike depreciation, insurance is a very visible expense - your insurance bill is a regular visitor to your mailbox.

Although you pay a single vehicle insurance premium, you’re actually protecting several entities: your vehicle (the comprehensive and collision part of your bill), and yourself and others (the bodily injury and property damage portion).

In most cases, where you live and the type of car you own will determine the price of your comprehensive and collision coverage. The price of your bodily injury and property damage coverage (also known as liability coverage) depends on your driving record, as well as who you are, where you live and how much you use your vehicle.

Even though enhanced vehicle safety, declining theft rates and fewer drunk driving incidents have helped lower premiums in recent years, vehicle insurance is expensive. But by shopping around, eliminating coverage you don’t need and by getting no more than necessary on the rest, you may be able to trim your premium by hundreds of dollars.

Types of Coverage

Comprehensive - Pays for damage to your vehicle other than that caused in a collision (e.g. flood, fire, hail, theft or vandalism).

Collision - Pays for damage to your vehicle that results from a collision with another vehicle or object.

Personal Liability - Pays claims against you, and covers the cost of legal defense if your vehicle damages property or injures or kills someone in an accident.

Property Damage - Pays for legal defense and claims if your car damages someone else’s property.

Medical Payments - Pays for medical expenses of the driver and passengers of your car in an accident. Keep in mind that if your health insurance already covers these costs, you may not need medical coverage included with your auto insurance (unless you live in a no-fault state that requires some level of coverage).

Un/Underinsured Motorist - Pays for injuries caused by an uninsured or hit-and-run driver.

Towing Coverage - Many auto policies offer towing coverage - otherwise known as roadside assistance - for a small additional premium. If you’re a member of an auto club that already provides these types of services, you won't need the additional coverage.

Gap Insurance

Dealers and some insurance companies offer what is commonly known as “gap insurance” when you purchase a vehicle. Gap insurance is designed to cover the gap between the amount that you may owe on a financed or leased vehicle and the actual market value of that vehicle. In fact some lease contracts require it.

As you now know, a fair amount of depreciation happens immediately upon the purchase of a vehicle since it can no longer be considered “new.” Nonetheless, your financing payments are based on the purchase price, so it is not uncommon to be upside-down on your loan for some period of time.

Let’s look at the scenario where you buy a new vehicle, finance it, and a week later get into an accident resulting in the car being declared a total loss. Most insurance policies will cover only the current market value of your vehicle - meaning you might still be on the hook to the finance company for several thousand dollars after you receive your insurance settlement. A gap insurance policy is designed to cover this difference and make you financially whole. Some gap policies also cover your insurance deductible so you are truly not out-of-pocket at all.

Gap insurance isn’t for everyone. If you are financially secure enough that you could write a four-figure check to your finance company in the event that you are upside-down, it may be a risk you are willing to take. On the other hand, if you are on a tight budget and writing that check would put you a difficult spot financially then you might decide that writing a much smaller check upfront for gap insurance is a good risk management strategy.

Liability Coverage

(About 50% of your premium)

When it comes to insuring yourself against damage or harm to others you certainly don’t want to skimp, leaving yourself vulnerable to a lawsuit that could take away your assets. Most states require you to buy bodily injury and property damage liability coverage at a minimum.

While you may be able to satisfy the law with bodily injury coverage that pays $20,000 for each person you injure, up to $40,000 per accident, and property damage coverage that pays $5,000, these are minimum figures. Most insurance advisors recommend bodily injury coverage of at least $100,000 per person, $300,000 per accident, and property damage coverage of $50,000.

If your net worth is more than $300,000, you should carry coverage of $200,000 per person and $500,000 per accident, and perhaps an “umbrella” policy that will bolster coverage even farther. A $1 million umbrella policy will typically add $120-$150 to your yearly bill - which you could offset by choosing a higher collision deductible. Umbrella policies also protect against various other personal liabilities, which helps justify the expense.

You also won’t want to skimp on uninsured or underinsured motorist coverage. This pays for injuries to your passengers and for expenses that health plans don’t cover if you are involved in an accident with an uninsured driver. Keep in mind that one in ten drivers in the U.S. has no auto insurance.

On the other hand, don’t buy more coverage than your net worth requires. A crafty insurance salesman may lead you to believe that you need more coverage than your situation truly warrants; they are salesmen after all. If you don’t own a home and you’ve wiped out your bank account to put a down payment on a new Porsche, you may not need high coverage limits or that $1 million umbrella policy - instead, you may need a new financial advisor!.

Comprehensive and Collision Coverage

(About 50% of your premium)

Comprehensive coverage pays for damage to your car caused by risks such as theft or fire, while collision coverage pays for damages to your car caused by an accident. Many people can save a significant amount of money over time if they understand the tradeoffs between premiums and deductibles and can determine the appropriate level of coverage for their financial situation.

Unlike liability coverage, comprehensive and collision coverage is often subject to a deductible - an amount you must pay before you can make a claim. Having a high deductible can save you substantial sums of money on the comprehensive and collision portion of your total insurance bill.

For example, one insurer charges $99 a year more for a policy with a $300 deductible than for one with a $500 deductible. This means you’d pay almost $100 per year to save, at most, $200 if you have an accident. Instead, if you put that $100 in the bank each year, you’d have enough to pay the full deductible in the event of a collision in just short of two years. Alternatively, you could use that $100 to boost your liability coverage for some added protection. If you typically have more than one accident every two years, that’s another matter entirely and you should probably spend the money on a driver training course instead!

Because you don’t want to collect on minor mishaps and risk raising your premiums, you really want to have a reasonably high deductible anyway. Collecting $50 beyond a $250 deductible to replace a $300 cracked windshield could in theory prompt the insurer to raise your total premium, which would cost you much more than $50 over time.

How the Insurance Business Works

The insurance business is essentially a gigantic bookmaking operation that bets premiums against the probabilities of having to pay out on an accident or injury claim (keeping the spread, of course). It is up to each insurer to develop its own probabilities and to set its rates accordingly; this is what actuaries do. Rates and underwriting guidelines will reflect the market segments an insurer wishes to target and how efficiently the company is managed.

Through years of experience, insurance companies have realized that certain luxury and high-performance cars are more expensive to repair or are more likely to incur extensive damage in a collision, so they hedge these risks with higher premiums. Also, some cars are more likely to be stolen; the Highway Data Loss Institute says cars with especially low theft claims are larger four-door family sedans and station wagons, while cars with especially high theft claims include convertibles and sports cars (wow, imagine that). So, ratings are adjusted for these risk factors.

Insurers use a car rating system to determine the premium for comprehensive and collision coverage. In one example, every car is given a rating symbol between 1 and 70; the higher the rating number, the more costly the premium. All things being equal, two identically priced cars should have the same insurance rating - but as we've just said, some vehicles are a greater risk than others, thus insurers adjust their ratings and premiums appropriately. IntelliChoice uses insurance ratings or symbols in our analysis of insurance costs in order to compare apples-to-apples across the country.

There are three major types of insurance firms:

Captive insurance firms have local offices that sell products from only a single carrier through agents that are employees of the company. State Farm, Allstate, Farmers, Nationwide and USAA are among the largest captive firms. You'll need to get a quote from several of these in order to price-shop them.

Other insurance companies sell their products primarily through independent agents or brokers. Companies such as Travelers, Hartford, Infinity and MetLife do business this way. An independent agent can shop rates for you across multiple carriers but not rates from captive companies.

Direct-to-consumer firms sell only their own insurance but without the overhead of local offices. Instead, they spend heavily on direct-response marketing. Unless you've been living in a cave, you've no doubt seen one or two Geico or Progressive commercials on television.

The reality is that rates for the same driver and car can vary dramatically from company to company. You’ll find that premium prices can differ by as much as 50% for the same coverage!

We recommend that you evaluate quotes from all three types of insurance firms.