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How Does Car Insurance Work?

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Updated November 8, 2023

It's an uncomfortable truth: Every time you get behind the wheel to drive, there's a chance that you'll be in an accident. Fortunately, that chance is relatively slim. But when an accident does happen, it's likely to involve financial losses related to property damage and possible injury. Car repair and medical costs following an accident can total hundreds of thousands of dollars. 

Car insurance helps lessen the impact of such a financial loss on you and anyone else involved in an accident.

What is car insurance?

Car insurance takes some of that risk of financial loss and offloads it to your insurance company. So, if you're involved in an accident, you won't have to shoulder the total cost of those medical or car-repair bills.

More specifically, car insurance protects you financially in four situations:

  • You cause an accident and are legally responsible for others’ medical or repair bills.
  • You have medical bills related to injuries you receive in an accident.
  • You’re in an accident caused by a driver who does not have insurance or who flees the scene.
  • Your car is stolen, is damaged in an accident, or is damaged while parked (for example, by severe weather). 

How car insurance works

A car insurance policy may include several coverages. Each provides insurance for a specific situation. Some coverages are required by law, while others are optional. Choosing optional coverages allows you to customize a policy to your needs.

You can find your policy’s coverages listed on a document called a declarations page. They’re also explained in fine detail in your policy’s contract. You receive these documents from your insurance company after you buy your policy. 

If you’re in an accident, you can file a claim with your insurance company. The insurance company should help pay for any property damage or injuries you cause to other drivers and their passengers. Depending on how the accident happened and the coverages on your policy, your insurer may also help you pay for your own medical and car repair bills.

Your car insurance company will charge you an amount of money called a “premium” in return for your policy. You may have the option to pay this premium in a lump sum when you buy the policy, or split it into monthly installments. 

Car insurance policies usually have a six- or 12-month term. When the term ends, you’ll need to renew your policy or get a new one from another insurance company. If you move and register your car in another state, you’ll need to get a new policy in that state. 

You can also choose to cancel your policy mid-term. In this case, your car insurance company should return a prorated portion of your premium minus any early cancellation fees. However, you should always be covered by an insurance policy when you drive. Most states have stiff penalties for driving without insurance. And if you buy a policy after a lapse in coverage, you’ll find that it’s much more expensive. 

Types of car insurance coverages

You choose coverages when you buy a policy. Some are required by law, while others may be required by a lender if you have a loan or lease. Other coverages may be completely optional. 

Common coverages include the following:

Coverage nameWhen it applies
Required by law in most states
Bodily injury (BI) liability
If you’re responsible for an accident that injures other drivers, their passengers, or any pedestrians, your BI liability ensures your insurance company will pay their medical bills.
Required by law in most states
Property damage (PD) liability
If you're responsible for an accident that damages other peoples' cars or property, your PD liability ensures your insurance company will pay the costs for repair or replacement.
Required by law in some states; optional in others
Personal injury protection (PIP)
If you’re involved in a car accident, no matter who’s responsible, PIP ensures your insurance company will help pay your medical bills.
Required by law in some states; optional in others
Uninsured motorist (UM)
If you’re involved in an accident, another driver is at fault, and that driver has no insurance, UM ensures your insurance company will help pay for your own medical and car repair costs.
Not required by law, but may be required by a lender if you have a loan or lease
Collision
If you’re responsible for an accident involving another vehicle, and your own vehicle is damaged, collision ensures your insurance company will help pay for your repair or replacement costs.
Not required by law, but may be required by a lender if you have a loan or lease
Comprehensive
If your vehicle is damaged or destroyed by something other than a collision with another car (for example: a flood, a falling tree, or a collision with a deer), comprehensive ensures your insurance company will help pay for the repair or replacement costs.
Not required by law, but may be required by a lender if you have a loan or lease
Gap
If your insurance company declares your vehicle a total loss following a theft or accident, gap helps ensure your claim payout is enough to pay off your loan or lease.

Understanding car insurance limits and deductibles

Not only do you choose which coverages to have on your policy, but you also choose the amount of those coverages. You do this by selecting a limit or a deductible, depending on the coverage.

Car insurance coverage limits

A limit is the maximum amount of money the insurance company will pay for a claim. Any amount beyond the limit must come from your own funds. Choosing higher limits means you have more coverage, but you can also expect to pay a higher premium. BI and PD liability, PIP, and UM all have limits. State law determines the minimum limit you can buy for BI and PD liability.

BI and PD Limits are often expressed as three numbers separated by a slash, such as 25/50/25. These are referred to as “split limits.”

  • The first number is the BI limit for any individual involved in a claim. In the 25/50/25 example, the insurance company would pay no more than $25,000 to any individual for a BI liability claim.
  • The second number is the BI limit for an entire claim. In our example, the insurance company would pay no more than $50,000 for everyone involved in a BI claim. 
  • The third number is the PD liability limit for an entire claim. In our example, the insurance company would pay no more than $25,000 for everyone involved in a PD claim. 

Car insurance coverage deductibles

A deductible is your share of the cost to repair or replace your vehicle for a collision or comprehensive claim. For example, say your car insurance policy has a $1,000 collision deductible. You damage your car, file an insurance claim, and get a repair estimate for $5,000. The insurance company will pay $4,000 toward the repairs; you're responsible for $1,000. 

Your insurance company will give you a few options for deductible levels; $250, $500, and $1,000 are typical. Choosing a lower deductible means you pay more for your policy but pay less out of pocket when you have a claim. If your lender requires collision and comprehensive coverage, it may also require you to have a certain deductible level. Otherwise, you can choose a deductible level that suits your needs. 

What does car insurance not cover?

A car insurance policy typically has exclusions. These are situations the insurance company will not cover. Exclusions should be listed on your policy contract and may include the following:

  • Costs related to maintenance, or normal wear and tear.
  • Business use of the vehicle, including use for a rideshare service. 
  • Use of the vehicle for illegal activities.
  • Certain catastrophic events such as war, civil unrest, or nuclear accidents.
  • Driving outside of the U.S. 

Check your insurance policy to understand exactly what it does and doesn't cover. And be aware that many insurance companies offer "riders" or add-ons that cover activities such as business use or driving in Canada or Mexico. 

How much car insurance do I need?

Deciding how much car insurance you need means understanding which coverages, limits, and deductibles to select.

First, check your state's requirements for BI and PD liability coverage limits and any other coverages such as PIP. Your policy must include these minimum amounts (and no reputable insurance company will allow you to buy lower than the state-required minimum). 

If you finance your car with a loan or lease, check if the lender requires collision, comprehensive and gap coverage. Find out also if it requires you to have a certain deductible level.

Everything beyond these requirements is optional. But consider that state-required minimums are usually quite low, and remember that any expenses beyond your coverage limits will be your responsibility. 

Here’s an example: Say you have a policy with your state’s minimum BI liability limit of $50,000 per claim, and you cause a multi-vehicle accident resulting in several injuries and $250,000 in medical bills. You’ll be on the hook—legally required—to pay the remaining $200,000. 

So, you owe it to yourself to consider higher limits when you buy a policy. Again, an insurance agent can advise you on the limits to choose based on your needs.

How do you file a car insurance claim?

When you buy your policy, the car insurance company should provide instructions on how to file a claim. Typically, you can start the claim-filing process online at the insurer’s website or mobile app or over the phone. You may also be able to contact your insurance agent (if you use one) to file a claim. 

Your insurance company will typically ask for details of the incident and ask you to gather and send supporting documentation such as a police report, repair estimate, and photos. Be sure to pay attention to any deadlines for this information.

The company will assign an adjuster to review your claim. The adjuster may discuss the incident with you, request additional documentation, or contact any involved repair shops or medical providers. They will also review your policy to ensure it covers the claim. 

Once the adjuster is satisfied with the documentation provided, the coverage, and the cost of the medical or repair services, they can approve your claim. You may receive a check to cover your costs, or the company may pay providers directly. 

How much does car insurance cost?

According to a recent study by MarketWatch, the average full coverage policy (including BI and PD liability and collision and comprehensive coverages) costs $2,008 per year or $167 per month. The average policy with state-minimum coverage costs $627 per year or $52 per month. 

Car insurance costs vary by many factors.

  • Your car insurance company. The MarketWatch study showed a $597 variance among five large insurance companies for the annual cost of a policy. 
  • Your driving record. Accidents and violations such as speeding tickets can drive up your policy cost.
  • Your history of filing car insurance claims. Filing numerous claims can lead to an increase in your cost of insurance. 
  • Your home address. Some areas of the country have higher rates of accidents, theft, and vandalism, which can drive up the cost of car insurance. 
  • The number of miles you drive annually. Driving less may help you save money.
  • Your gender and age. Men and younger drivers tend to be involved in more accidents. 
  • The car you drive. The car’s year, make, model, likelihood of theft, safety features, and engine size all affect insurance costs.
  • Your credit-management habits. Insurance companies have discovered a connection between a person’s credit use and their likelihood of filing an insurance claim. A good credit history may help you pay less for your car insurance.
  • Your policy’s coverages, limits, and deductibles. A policy with higher limits, lower deductibles, and optional coverages will cost more.

How to save money on car insurance

Car insurance is a significant expense, and it’s only gotten more expensive in recent years. Fortunately, there are some money-saving strategies you can use.

First, you owe it to yourself to periodically comparison-shop policies from several companies. As we've seen, insurance costs can vary among companies by hundreds of dollars. Keep in mind that insurers are constantly adjusting their rates based on the needs of their business. So, a company that may have been relatively expensive for you a year ago could today be much cheaper.

Next, ask your insurance company about discounts. Buying multiple policies from the same company can often earn you a "bundling" discount. For example, Liberty Mutual's Bundle and Save discount advertises potential savings of up to $950. 

Liberty Mutual

Liberty Mutual Auto Insurance

Liberty Mutual Auto Insurance

Liberty Mutual Auto Insurance
Monthly premium
$90
A.M. Best Rating
A
J.D. Power UBI
823 (4)
Bundle savings option
You could save $950 on customized auto and home insurance.

Paying for your policy in full rather than in installments can earn you a discount as well. And many insurers offer discounts for maintaining a clean driving record or not filing any claims.

Finally, consider talking to an independent insurance agent. Independent agents are licensed professionals who typically represent multiple insurance companies. They can take time to understand your coverage needs, then check with their companies to get you the best combination of coverage and price. 

TIME Stamp: Car insurance reduces the financial risk of owning and driving a car

Car accidents are, fortunately, relatively rare. But when they do happen, they can lead to tens or hundreds of thousands of dollars worth of medical and repair bills—costs for which you may be responsible. Car insurance helps lessen that financial risk.

Frequently-asked questions (FAQs)

How does car insurance work, in simple terms?

Car insurance can help pay for medical or vehicle repair costs if (1) you cause an accident and people or property are damaged, (2) you are injured in an accident, (3) you or your car is damaged by an uninsured driver (or one who flees), or (4) your car is stolen—or is damaged in an accident or when parked.

How do I file a car insurance claim?

Check your policy ID card, declarations page, or insurer’s website for instructions on how to file a claim. Many companies request that you file a claim at the company’s website or by calling a toll-free claims-reporting number.

Why are car insurance claims denied?

A claim may be denied because the policy lacks certain coverages. A state minimum policy with only BI and PD liability, for example, would not cover damage to your own vehicle, nor would it cover your own injuries from an accident. 

An insurer may also deny a claim if it's due to an activity that's excluded by the policy. Standard exclusions are routine vehicle maintenance, damage that occurs during business use of the vehicle (including rideshare), or damage that occurs if the vehicle is used for an illegal activity.

The information presented here is created independently from the TIME editorial staff. To learn more, see our About page.

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