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How Does Car Insurance Work? Everything You Need to Know



How Does Car Insurance Work? Everything You Need to Know

Nearly 230 million licensed drivers use American roads, but most have no idea what their policies cover. Insurance policies are tedious to read, but we can assist.

Instead of a full policy, we’ll cover the essentials of vehicle insurance. With a greater grasp of how auto insurance works, you can make informed purchases that secure your vehicle while also shielding you from liability concerns.

This article will cover:

  • Car insurance fundamentals
  • Types of auto insurance
  • Limits on auto insurance
  • Deductibles on auto insurance
  • Exclusions
  • Car insurance is vital

Auto Insurance in Brief

Insurance is just the transfer of risk. With auto insurance, we’re moving risk from individuals to a group. A company’s insured group is its policyholders.

We all pay premiums, but we won’t all lose.

Individually, we can’t foretell when or if we’ll lose. We also don’t know the price. However, when insuring a bigger group, we can use probability and statistics to decide how much each insured person should pay.

Our premiums cover the claims of people in the insured group.

Our losses are covered by the premiums paid by the insured group, but only for coverage types, we’ve acquired. For example, if you do not have collision coverage on your car, your policy will not assist pay for repairs.

AAA has put the average annual cost of insuring a new automobile at $1,342. Your exact rates will vary depending on your coverage choices, but this amount helps you understand how premiums pay claims.

AAA’s average car insurance premium for 2021 includes comprehensive coverage. The $1,342 average cost is for drivers under the age of 65 who reside in the suburbs and have no accidents.

As of 2020, the III reports the following average losses:

  • Bodily injury liability: $20,235
  • Property damage liability: $4,711
  • Collision: $3,588
  • Comprehensive: $1,995

While $1,342 for car insurance may seem steep, the typical bodily injury liability claim is over $20,000. Notably, many injuries-related mishaps can be substantially more costly.

In this case, the many policyholders paying $1,342 per year cover the $20,000 claim.

With an average premium of $1,342, you’re also saving money on liability, collision, and comprehensive claims.

Types of Auto Insurance

Lenders typically require physical damage coverage, although most states only require liability coverage.

State requirements and coverage options vary, but coverage falls into the following categories.

Indemnity for Bodily Injury

Physical damage insurance includes collision and comprehensive. In 2020, collision claims averaged $3,588, while comprehensive claims averaged $1,995.

Coverage for damage caused by a collision with another vehicle or an immovable item. It also covers rollover damage.

Comprehensive insurance, often known as non-collision coverage, covers for damage caused by causes other than collision. Vandalism, glass damage, theft, falling (or flying) objects, fires, floods, etc. Animal-related damage is also covered.

Physical damage coverage is optional. However, most auto loan and lease lenders and leasing firms need physical damage coverage.

From a lender’s standpoint, the car is still theirs. Physical damage coverage protects both the lender’s and the policyholder’s financial interests in the vehicle.

Full-coverage Motor insurance includes necessary coverages such as auto liability and medical insurance.

PL Insurance

Most states mandate auto insurance, with liability coverage being one of the most common. Liability is our financial obligation to others.

Assume you accidentally hit a car at a stoplight. In most cases, you’d be judged at fault in the collision, making you liable for any damage to the other car or injuries to the occupants.

According to the National Highway Traffic Safety Administration, approximately two million auto accidents result in injuries each year. For physical injury claims, the III reports an average of $25,000, while property damage claims average around $4,000.

Because the costs can mount quickly, most jurisdictions require drivers to have coverage.

Auto liability insurance covers two specific risks:

  • Bodily injury liability
  • Property damage liability

Property damage responsibility isn’t usually as clear as physical injury liability. Others’ property damage responsibility pays for damages. There are no restrictions on what cars can be hit.

State liability insurance requirements vary, but it’s frequently advisable to choose a coverage maximum higher than the minimum.

For example, in New Jersey and a few other states:

  • Liability for bodily injury: $15,000
  • Liability for bodily injury: $30,000
  • Liability for property damage: $5,000

According to III statistics, New Jersey’s mandated bodily injury liability coverage per person is less than $20,000. Remember that the III values are typical claim amounts. Some claims totals exceed the average.

The state’s minimum coverage limits may not be enough. Fortunately, you can increase your liability limitations.


State laws govern auto insurance. While most aspects of an auto policy are uniform, each state has its unique regulations. Medical coverage is one area where states differ from one another.

Others do not require medical coverage for you and your passengers.

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

They cover medical expenses if you or your passengers are injured in a car accident.

The easier of the two, med pay pays for medical bills if you are at fault in an accident. Liability insurance should pay your medical bills if you are not at fault.

PIP, on the other hand, covers medical bills regardless of culpability. PIP also covers other costs such as lost earnings and other expenses directly related to an auto accident.

Uninsured and underinsured motorist protection percentages vary greatly by state, with Mississippi having the highest (29.4% in 2019) and New Jersey having the lowest (0.1%). (3.9 percent). According to the Insurance Research Council, 1 in 8 drivers is uninsured.

Many more drivers undoubtedly lack adequate coverage. These drivers are known as uninsured drivers. The problematic issue is that we don’t realize we’re underinsured until a loss surpasses our coverage limitations.

Uninsured and underinsured motorist coverage, mandated in some states, allows your policy to cover losses caused by uninsured or underinsured drivers.

You may be obliged to carry the same limits as your liability coverage. UM and UIM protects you, even if the coverage is triggered by other drivers’ culpability (and their inability to cover that liability through an insurance policy).

The Add-Ons

Most automobile insurance packages have optional extras. Some of these are referred to as endorsements or riders. Most are part of an insurance policy, but others may be distinct products.

Here are a few popular vehicle insurance add-ons:

Rental reimbursement coverage might help pay for a new car if a covered claim compels you to hire one.

Rideshare endorsement: If you drive for Uber or Lyft, this endorsement helps fill in coverage gaps when you are signed in but have no passengers.

In the event of a total loss, gap insurance can cover the difference between the insured value and the loan balance.

Many insurances provide roadside repairs, towing, jump starts, and fuel delivery.

Limits of Auto Insurance

Your car insurance policy protects you up to the limits you choose, but two types are decided by market value. The value of your car is the coverage limit for collision and comprehensive insurance.

Physical damage coverage limits: As your vehicle’s value declines, so does your coverage limit. It insures your depreciated worth rather than your replacement cost (the cost to replace your vehicle).

Limits of liability: Even if your state mandates minimum liability limits, you can opt for larger limits or even an umbrella policy. A liability judgment does not consider your financial situation. Instead, a car accident’s financial liability can impact savings or future wages.

Medical coverage requirements vary by state, with some requiring a minimum level of coverage. In some situations, your existing health insurance may be able to serve as a primary provider, lowering your overall auto insurance premiums.

Deductibles for Car Insurance

Car insurance, like many other forms, employs deductibles to keep premiums low. The deductible is deducted from your claim settlement. But not all policies have deductibles. Liability coverage, for example, has no deductible.

Pick an affordable deductible for collision and comprehensive insurance. Medical insurance may have a deductible.

No-Fault Exclusions

Car insurance doesn’t cover all. Your policy also lists coverage exclusions. Exclusions vary by insurance but generally follow a pattern.

Personal insurance policies exclude commercial hazards. If you work from home, talk to a trustworthy agent about your coverage needs. You can often add a rider to cover a specific use case.

Auto insurance does not cover racing-related claims.

Similarly, motor insurance does not cover claims arising from criminal activities. Bank robbers in movies aren’t insured by their motor insurance, but that’s probably the least of their worries.

Car insurance does not cover mechanical breakdown or wear and tear. Instead, start saving for future auto-related expenses.

Using Your Car Insurance Policy

We all groan when our auto insurance payment comes, but your policy might protect you in unexpected ways. Full coverage protects your car and your finances by covering unexpected liabilities.

Review your coverage with a trustworthy agent once a year. Life changes, and so may your coverage.

Also, compare rates now and then. To calculate prices, vehicle insurance companies employ comparable elements, but each weighs them differently.

Car insurance can be costly, especially if you haven’t had to file a claim in a But not having adequate coverage can be considerably more costly.

Christian Edet is a movie and gaming freak. An experienced writer whose interests include games, cars, insurance, and tech provides relevant information to all interested. He graduated from Anglia Ruskin University, Chelmsford, United Kingdom, and studied Business Information Systems (BSc.)