By Tim MaxwellHow Does Car Insurance Work?
Quick Answer
Car insurance works by paying for costs resulting from a collision, theft, natural events and other incidents. As long as you pay your premiums on time, the insurer is obligated to cover repairs, medical bills, liability claims and other eligible expenses according to your policy terms.
Car insurance protects you financially if you get in a car accident by helping to pay for accident-related injuries and repairs. Nearly all states require drivers to carry car insurance, as do lenders when you finance a vehicle.
But you have many types of insurance coverage, limits and deductibles to choose from, so it helps to understand your options. Here's what you need to know about how car insurance works to get the coverage you need at the best price.
What Is Car Insurance?
Car insurance is a way of protecting yourself financially if you're ever involved in a car accident, or if you experience losses due to theft, fire, vandalism or an act of nature. When you buy car insurance, you agree to pay the insurance company a premium for a certain amount of coverage. In exchange, they agree to cover certain qualified expenses, up to a set limit.
Virtually all states require that you carry a minimum amount of car insurance. And, if you finance your car, you may be required to carry additional coverage beyond legal state minimums. Regardless of minimum requirements, car accidents can be extremely costly. So, covering yourself is an important way of managing risk.
What Does Car Insurance Cover?
Car insurance covers damage to your vehicle from collisions and non-collision events like natural disasters, theft and vandalism. It also pays for property damage and injuries you cause to others while behind the wheel.
Car insurance policies offer many types of coverage, which most commonly fall into the following categories.
| Type of Insurance | What It Covers | Is It Required? |
|---|---|---|
| Comprehensive | Damage to your car from non-collision incidents, like theft, falling objects and natural disasters | Yes, if you finance or lease |
| Collision | Damage to your car from an accident with another car, animal or object | Yes, if you finance or lease |
| Liability | Bodily injury or property damage | Yes, in nearly all states |
| Personal injury protection (PIP) | Medical bills, lost wages and other losses | Maybe, depending on your state |
| Medical payments (MedPay) | Medical expenses | Only in Maine and New Hampshire |
| Uninsured or underinsured motorist bodily injury | Injuries and damages if you're in an accident with a driver without insurance or with insufficient coverage | Maybe, depending on your state |
Comprehensive
Comprehensive insurance is sometimes referred to as "other than collision" insurance because that's what it covers—damage to your vehicle other than car accidents. For example, damage from a fire, theft or a falling tree would all be covered under a comprehensive policy.
Lenders typically require comprehensive insurance when you finance or lease a car, but it's optional if you own your car outright. If your car is too expensive to replace out of pocket or you don't have enough savings to cover non-collision damage, adding comprehensive coverage could be a smart move.
Collision
Collision insurance covers damage to your car from an accident with another car, animal or object like a fence or tree. Like comprehensive insurance, collision insurance isn't mandated by law, but lenders usually require you to carry enough coverage to protect the vehicle until you pay it off.
If you get in a car accident, you can file a claim to help you pay for repairs or replacement to your car if you're involved in an accident—no matter who is at fault.
Liability
Liability insurance pays for costs stemming from an auto accident you cause. Liability insurance generally covers two types of expenses:
- Bodily injury: This coverage handles the costs of accident-related injuries or death caused by you or another driver operating your car.
- Property damage: This coverage pays for damage you cause to another person's car or property.
Most states require you to carry a minimum amount of both types of liability coverage. Keep in mind, your state's minimum coverage requirements may be considerably less than what an accident could cost—something to consider when choosing your policy's coverage amounts.
Personal Injury Protection (PIP)
If you live in a no-fault car insurance state, you must include personal injury protection (PIP) in your policy. This coverage pays for medical bills, lost wages and other losses incurred from an accident, regardless of fault.
Even if your state doesn't require you to carry PIP insurance, you might consider adding it to your policy since you don't have to wait for the insurance companies to determine which party is at fault before being paid.
Medical Payments (MedPay)
Medical payments coverage (MedPay) provides coverage for you and passengers in your vehicle in the event of an accident, regardless of who's at fault. It may also pay for medical expenses if you're hit by a vehicle as a pedestrian.
MedPay is typically available as an optional add-on to your insurance policy, but there are two states where MedPay is required: Maine and New Hampshire. If you live in a no-fault state, your state may require that you carry PIP rather than MedPay.
Uninsured or Underinsured Motorist Bodily Injury
Your state may require you to carry uninsured or underinsured motorist coverage—about half do—to pay for injuries and damages if you're in an accident with a driver without insurance or with insufficient coverage.
Even though nearly every state requires drivers to carry a certain level of liability insurance, about 1 in 7 drivers (14%) don't have it, according to a 2023 Insurance Research Council (IRC) report. Your uninsured or underinsured motorist coverage could pay for damages caused by uninsured drivers, including hit-and-run drivers, who are considered uninsured motorists.
Optional Coverages
As noted, many of the above coverages are required by states or lending companies. Car insurance companies also offer optional coverages to round out your policy or provide valuable perks.
- Rental reimbursement insurance covers the cost of renting a car while your vehicle is in the shop for repairs.
- Guaranteed asset protection insurance, or gap insurance, covers the difference between your car's value and the loan balance if your car is totaled. This coverage can be valuable if you owe more than the car is worth. Without it, you'd have to cover the difference out of pocket.
- Roadside assistance provides emergency help when your car runs out of gas, has a flat tire or breaks down. This coverage can be a lifesaver if your car breaks down in a remote area, during bad weather or late at night.
Learn more: How Much Car Insurance Do I Need?
What Isn't Covered by Car Insurance?
While car insurance can save you thousands of dollars in expenses resulting from covered events, it doesn't cover everything. For example, a standard auto insurance policy doesn't cover:
- Losses over your coverage amount
- Damage or theft to personal belongings
- Mechanical failures not caused by an accident
- Wear and tear to your vehicle
- Driving in service of a rideshare company (you may need a rideshare add-on to your policy for that)
Drivers who live in your household and others who regularly use your car must be listed on your policy or risk not being covered.
How Does Car Insurance Work?
Car insurance works by providing you with protection in exchange for paying the provider a set fee. It can help cover losses if you're involved in an accident, or if you suffer damage to your car.
To understand how car insurance works, you should know these key parts of an auto policy:
Premium
This is the amount you pay your insurance company in exchange for coverage. You might pay premiums every month, each quarter, every six months or once a year, depending on your policy. Paying your premiums is essential to avoid a lapse in coverage. The amount you pay in premiums depends on several factors, including your coverage limits and deductibles.
Deductible
A car insurance deductible is the out-of-pocket money you must pay on a claim before your insurance coverage kicks in to pay for the rest. You'll select your deductible amount when you purchase your policy, which could be between $250 to $2,000.
For example, if you file an insurance claim worth $3,500 and your policy has a $500 deductible, you would need to pay $500 on the claim and your insurer would cover the remaining $3,000.
| Type of Coverage | Deductible |
|---|---|
| Collision and comprehensive | $0 to over $2,000 |
| Liability | None |
| Uninsured or underinsured motorist | $100 to $1,000; varies by state |
| Personal injury protection (PIP) | You may or may not have to pay a deductible, depending on where you live |
Learn more: Is a High Deductible Better Than a Low Deductible?
Coverage Amounts
The coverage amounts for a given policy determine how much your insurer will pay out for qualified expenses in the event that you file a claim. States and lenders set their own limits for minimum coverage requirements, but carrying extra coverage can provide you with more peace of mind.
Do You Need Car Insurance?
If you drive a vehicle on public roads, you'll need to carry some level of auto insurance, depending on your state requirements. Minimums vary by state, but nearly every state requires you to have liability insurance, including bodily injury and property damage liability coverage. This coverage helps you pay for damage and injuries to others if you cause an accident. Additionally, many states mandate drivers to carry uninsured motorist coverage and medical payments or personal injury protection coverage.
If You're Financing Your Vehicle
If you're financing your vehicle with a loan or lease, your lender likely has their own insurance requirements to protect their investment. Typically, lenders want you to carry full coverage auto insurance, including collision and comprehensive coverage. Otherwise, these coverages are optional.
If You Own Your Car Outright
If you own your car outright, you may want to carry collision and comprehensive coverages to protect yourself financially if the cost of repair or replacement would be significant. On the other hand, you might drop them if you own an older vehicle worth less than a few thousand dollars. In that case, the cost of ongoing premiums may not be worth a claim payout, especially after factoring in your deductible.
How Much Does Car Insurance Cost?
On average, it costs $2,304 a year to insure your vehicle, according to Experian data. Of course, your insurance costs may be higher or lower depending on your age, vehicle type, driving history and a whole host of other factors insurers consider.
The amount you pay for car insurance also depends on your policy options, coverage amounts and deductibles. To find the best balance of coverage and price, the Insurance Information Institute recommends getting quotes from at least three insurance companies. It's essential to use the same coverages and limits when obtaining quotes to make sure you're making apples-to-apples comparisons.
How to File a Car Insurance Claim
Being involved in a car accident can be a stressful and traumatic experience. On top of that, the process to repair your vehicle or recover from injuries can be a long one. Auto insurers usually process claims within 30 days, so it's essential to file yours as soon as you can. Here's how to file a car insurance claim:
- Gather the vital accident details. Before you contact your auto insurer, have the details handy such as the date and location of the accident and the other driver's name, contact information and insurance details. Also be prepared to submit supporting documents such as a copy of the police report, accident photos and accident-related expenses you've incurred.
- Contact your auto insurer. Most insurance companies allow you to file a claim on their website, app or over the phone. You'll need to give the agent a full account of what happened and submit the supporting documents you've gathered. Your agent should detail how your policy covers the incident, if you'll need to cover any costs out of pocket, such as a deductible, whether you'll have access to a rental car during repairs and so on.
- Work with the claims adjuster. Within a few days of filing your claims, your insurance company's claims adjuster should contact you to arrange an inspection. The adjuster may review police reports, talk to accident witnesses and perform other tasks to determine how much the insurer will pay for damage to your car and any injuries you sustain.
- Repair or replace your car. If the cost to repair your car exceeds its value, the insurance adjuster will total the car. In that case, your insurer will either pay you or your lender the value of the vehicle, after subtracting the deductible. If your car is fixable and damages are less than its value, you can repair your car at a repair shop your insurer works with or with your preferred mechanic, up to the adjuster's claim limit.
How to Save Money on Car Insurance
It's always wise to regularly compare what you're paying for car insurance rates versus the competition. Switching to a new carrier could ensure you're not paying more than you need to for car insurance. Along those lines, there are also a number of methods you can turn to to save on car insurance, such as:
- Take advantage of discounts. Insurance companies offer many auto insurance discounts that could lower your premiums, including safe driving, good student, multi-car and bundling discounts.
- Increase your deductible. Generally, higher deductibles tend to come with lower monthly premiums and vice-versa. If your premiums are too high, consider raising your deductible to lower your rate. Just be sure not to raise your deductible so high you would struggle to pay it if you ever needed to file a claim.
- Reduce your coverage. You might consider lowering your coverage limits to fit your budget, but be sure you're carrying at least what's required by your state and lender. Beyond that, you should factor in the replacement cost of your vehicle, plus your ability to pay out of pocket in the event that you cause an accident, when weighing whether it makes financial sense to reduce your coverage limits.
- Drop coverage or add-ons. Comprehensive and collision insurance can be expensive. If you have an older car with a lower value, you might consider dropping this coverage to save money on your premiums. Talk to your agent about other coverage options you're paying for that you might be able to do without. Just remember that you'll be on the hook for repair or replacement costs if you have an event that is no longer covered.
Learn more: Top Car Insurance Discounts
Frequently Asked Questions
Your Credit May Affect Car Insurance Rates
Many states allow auto insurers to consider credit-based insurance scores when calculating your premium. Just another reason why maintaining good credit could help you save money—in this case, on your auto insurance. If your credit score is less than you'd like it to be, consider checking your credit report and score for free with Experian. You'll be able to see what shape your credit is in and, if necessary, take steps to improve your credit.
Don’t overpay for auto insurance
If you’re looking for ways to cut back on monthly costs, it could be a good idea to see if you can save on your auto insurance.
Find savings
About the author
Tim Maxwell
Tim Maxwell is a former television news journalist turned personal finance writer and credit card expert with over two decades of media experience. His work has been published in Bankrate, Fox Business, Washington Post, USA Today, The Balance, MarketWatch and others. He is also the founder of the personal finance website Incomist.
Read more from Tim