What is Auto Insurance and How does it Work

Auto insurance is a policy that provides financial protection for you and your automobile. It is purchased to transfer the financial risks of owning and driving a car away from you and to the insurance company. In order for the insurance company to assume this risk you must pay them a monthly or annual “premium” payment. In return the insurance company will pay your losses as outlined in the policy.

Now, let’s look at a brief overview of the different types of coverages that are part of auto insurance.

1. Liability Coverage - There are two types of liability coverage.

Bodily injury - This coverage will pay if you are responsible for another person's injury or death in an auto accident. It typically also pays for your legal defense.

Property Damage - This coverage pays if you are responsible for damage to another person's property like a car or building. I personally carry $500,000 of liability coverage on my policy and I also have a separate umbrella policy for additional liability protection.


2. Collision Coverage - This coverage will pay the cost above the deductible (the amount you will pay out of pocket before the insurance kicks in) to have your vehicle fixed if you get into an accident. If your car is totaled beyond repair it will pay you the book value. If your car is old and not worth very much you can choose to not carry this coverage. If you are leasing or have a loan on the car then it will required to carry collision coverage.


3. Comprehensive Coverage - This coverage pays for loss or damage to your vehicle caused by non- accidents. Some examples include theft, vandalism, hail, falling objects, flood, collision with an animal and fire. Each comprehensive claim is subject to a deductible (the amount you will pay out of pocket).


4. Personal Injury Protection (PIP)- Also known as no-fault insurance will cover you, your family, and your passengers, regardless of fault, if they are injured in an accident. This typically covers hospital and doctor bills along with other health service expenses. It may also cover lost income and daily expenses resulting from the accident like transportation and housekeeping. This does not cover damage to your car.

5. Uninsured/Underinsured Motorist Protection - This coverage will pay for your injuries caused by a driver that either does not have insurance, does not have enough insurance to cover your damages or in the case of a hit and run. It also covers relatives living in your home and passengers in your car.


There you go! Those are the major components of an auto policy. A few other bells and whistles that you can add are glass coverage with $0 deductible, rental car reimbursement and emergency road service. I personally decided to add these to my policy for another $70 a year or so.


As a final note, if you are looking to reduce the cost of your auto policy and you have at least 3 months of expenses saved in an emergency fund it might be a good idea to increase the deductible on your policy. A higher deductible means you will have to pay more out of pocket before the insurance company will pay anything, but it will reduce the premium you have to pay for the policy. I personally always keep high deductibles to reduce the cost of having the policy.