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How Car Insurance Works

Wondering how car insurance works, which insurance company to choose, and how to make sense of deductibles? At first glance, it can feel pretty confusing but knowing a few important things about insurance coverage could save you a few hundred dollars per year.

How Does Car Insurance Work?

The best insurance policy for saving money is not necessarily the one with the lowest premium. There are really five aspects to choosing a car insurance policy, and every one of them can be used to save on insurance costs. Here’s what you need to know:

  • The importance of comparing car insurance quotes
  • Types of coverage and what kind you need      
  • How to qualify for a cheaper auto policy
  • When to pay your insurance premiums
  • How to handle an auto accident and insurance claims

What is Car Insurance?

Car insurance offers financial protection if your vehicle is damaged or if you’re involved in an accident that causes injury or property damages. The amount of protection or reimbursement varies depending on the coverage options chosen by the policyholder.

In the vast majority of states, auto liability insurance is mandated by state law. Check to see what type of car insurance is required where you live.

Types of Car Insurance

You generally have the ability to tailor your car insurance policy with different types of coverage and coverage limits, depending on how much risk you’re willing to assume. Car insurance coverage options include:

  • Liability coverage (BI/PD) covers costs associated with any damage or injury inflicted on third-parties. Liability insurance offers protection if someone brings a lawsuit against you for an auto-related incident, and will also cover your legal fees. Bodily injury liability covers costs relating to damage to people, and property damage liability takes care of physical damages to property.
  • Collision insurance covers auto damage or injury for yourself or your passengers in an accident with another car or an object.
  • Comprehensive car insurance covers damage to your car from non-collision incidents, such as theft, vandalism, fire, fallen objects, hitting an animal, natural disasters, or weather-related incidents.
  • Personal Injury Protection (PIP) or MedPay covers any medical costs or lost wages caused by accident-related injuries for you and your passengers.
  • Uninsured/underinsured motorist insurance (UM/UIM) covers situations involving a collision with an uninsured driver who is unable to pay for the damages to your vehicle or medical expenses for any injuries you might sustain.

How to Get The Best Deal on Car Insurance

You absolutely must shop around to get quotes from different car insurance companies—and do so every six months—to ensure you’re getting the most competitive rate for your situation. Nowadays there are so many online comparison tools to evaluate auto insurance policies and it’s certainly worth a few minutes of your time to visit one.

A while back, a blogger, Jeff, had this to report:“I think the most important thing to remember is to shop around. I recently looked around for a new policy for my ’96 Ford sedan and had one company offer me a plan for $1,000 a year (and I have a clean driving record) and another company offer me a plan for $155 for 6 months.”

While Jeff’s example may be a bit extreme, policies can vary by as much as $500 for six months’ coverage. Making sure you’ve found the best rate could literally mean $1,000 in your pocket that you otherwise wouldn’t have.

Understand How Commissions Work

If you understand where and how the money flows in the insurance industry, you’ll significantly increase the likelihood of getting your policy at a good rate.

There are basically three different sources from which you can purchase a policy:

  • Direct writers (Geico/Amica come immediately to mind) – Direct writers do not pay commissions, so their policies are generally lower. However, they are much pickier about who they insure, so if your driving record is a bit tarnished, you will likely not get the best deal going through a direct writer.
  • Captive Agents (State Farm, Allstate) – Captive agents work exclusively with one insurance provider. So an Allstate agent will work only for Allstate and will be paid a commission for each policy sold (usually about 15%). If your driving record has some blemishes, this should probably be your first look.
  • Independent Agents – Independent agents navigate the insurance waters on your behalf and are paid a commission from the insurer as well. They are not bound to one specific provider but can shop around and find you the best rate (though, honestly, many online comparison tools can do that for you as well).

The Real Dangers of Too Much Bargain Shopping

If you’ve found a deal that’s “too good to be true,” then it’s possible that it may be! You can go too far with the bargain shopping—where you perhaps run across some companies that aren’t as financially sound as they should be. To double-check this, you can usually go to your state’s .gov website and look at complaints filed and other potential red flags.

How to Qualify for Lower Car Insurance Rates

There isn’t real flexible pricing when it comes to policies because all of the numbers are spit out by a computer—however, an agent or customer service representative certainly can tell you more about potential discounts. These are simply new variables you can plug into their algorithm to lower the premium even further.

Make sure you ask about:

  • Combining policies – Will they lower the price if you insure both cars through them, or also move your homeowner’s policy over? Most will.
  • Will they offer a discount if you take a defensive driving course? Many courses can be taken online and spread over several days or weeks. Having a certificate of completion can significantly reduce your premium.
  • Is your (or your child’s) GPA a 3.0 or greater? A high GPA can knock as much as 40 percent off the premium!
  • Are you retired? That means you’re driving less. Let them know!
  • Do they offer discounts if you belong to any associations, or groups? If you work for a large employer, you’re likely to receive a discount as well.
  • If you have college kids living further than 100 miles away, you’ll get your premium knocked down.
  • If your vehicle has certain features like anti-lock brakes, airbags, or automatic seatbelts, ask about a discount.
  • Once you’ve been with a company for a year, many of them will give you their “loyalty rate”. You can actually ask for the loyalty rate early and may be able to score it then as well. It never hurts to ask!

When to Start Shopping

You do NOT want to wait until you’re near the end of a policy to begin shopping around again. Many insurance companies view consumers looking early at policies as “responsible” and will give you an “early shopping” discount of up to 12 percent!

Know What Coverage You Need (and What You Don’t)

When It Makes Sense to Have a Higher Deductible

If you can afford it, you should immediately look at increasing your insurance deductible. The key is to “self-insure” up to a point that makes sense for you. As you begin to build an adequate emergency fund, that cash on hand will allow you to use this strategy. Simply increasing your deductible from $200 to $500 saves anywhere from 15 to 30 percent. Increase the deductible up to $1,000? You’ll likely save 40% or more.

Should You Drop Collision and Comprehensive Coverage?

If you’re looking at paying coverage of $1,000 annually for your car, use the Rule of Ten. Ten times your annual premium would be $10,000. If your vehicle is worth less than that amount of money, you may want to consider dropping collision coverage and comprehensive coverage.

Both of those options can account for as much as 40% of your premium and they only cover the car’s replacement value. If you’d ever have a claim that would exceed the cost of your premium (less your deductible), comprehensive insurance and collision insurance probably aren’t worth it.

Fine-Tuning Yourself

Yes, Your Credit Score Does Matter

While I’m not a fan of debt in any form–and certainly not a fan of credit scores (because they’re so inherently tied to credit)–I do want to stress that your insurance rates are very much influenced by your credit score. It’s not exactly a credit score (it’s actually an “insurance score”), but it’s based on the same basic inputs.

One sure-fire way to lower your insurance premiums is to raise your credit score. The first step in doing that is to know your score. You can get a free credit score every year. Once you know your score from all three credit reporting agencies, you’ll quickly be able to dial in on what you need to improve.

Let me reiterate—I’m not advocating becoming a credit score diva. Credit scores are mainly for borrowing money, and borrowing money, as a rule, is not good. This is specifically so you can save real dollars by lowering your car insurance premiums.

Stay in Your Lane, Literally

Your very first at-fault car accident could raise your rate 40 percent. Don’t text and drive.

Here’s a juicy tidbit that you may not have known about though. Many insurance companies have a “forgive the first accident” policy. Ask how to qualify and you might see a major positive correction on that premium rate. They obviously won’t go around advertising this, but many times it’s there — you only need to ask!

Teen Drivers

Just one note on teen drivers. Many parents believe that once their child turns driving age, they need to add them to the insurance—absolutely not! Only add them once they have a driver’s license.

How Often to Pay Your Insurance Premiums

Many insurance providers tack on “installment” fees if you pay monthly. Do your best to follow YNAB’s Rule Two (Embrace Your True Expenses) and save enough premium funds to only pay it once every six months—this can save you up to 15 percent!

Adding a Target to your YNAB budget helps break large expenses like insurance premiums into manageable monthly chunks.
Adding a spending target to your YNAB budget helps break large expenses like insurance premiums into manageable monthly chunks.

The Best Way to Handle an Auto Accident

In the horrible situation where you are in an accident, there are a few things to be aware of that will truly save you a bundle. For instance, many states allow you to make a claim against the insurance company of the driver that was at fault if your car has a diminished value even after repairs. It’s also worth investigating whether you live in a state where the auto insurer is required to pay your sales tax if your vehicle is totaled and must be replaced with a new car. Lastly, if you’re involved in an accident where an under- or uninsured motorist (UIM) is at fault, you may be able to “stack” your policies.

I know we’ve covered a lot of ground learning how car insurance works but hopefully you’ve found something in here that will save you a few hundred dollars each year on your car insurance premium.

Remember, if you pick only one strategy it should be to shop around! And don’t text and drive.

Safe travels.

Now that you know how car insurance works, are you ready to learn how to budget for it? Try YNAB for free for 34 days.

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