How Does Car Insurance Work?

Car insurance works by covering a driver’s losses from a covered accident in exchange for regular payments to the insurance company. While most auto policies must meet your state’s minimum insurance requirements, optional coverages are often available, such as those that can pay for repairs if you’re the at-fault driver, replace a stolen vehicle or cover medical bills after a car accident.

Keep reading to learn how car insurance works, what types of coverage it can provide and what influences its cost.

Key Takeaways Car insurance protects against covered losses as long as the driver regularly pays their premium. Almost every state requires some kind of auto insurance, with liability coverage being the most commonly required. Liability coverage pays the other person’s medical bills and repair costs if you are responsible for an accident. Optional collision and personal injury protection coverage can cover your personal bills. Even if you meet the legal minimum requirements for car insurance, you may need additional coverage to better protect yourself from certain perils.

What Is Auto Insurance?

Auto insurance is a contract between a driver and an insurance company. The insurer pays for the driver’s losses in a car accident in exchange for the driver paying a premium, as well as a deductible for certain types of accidents. This arrangement helps protect the driver from bearing the full financial burden from a sudden and unexpected accident. 

Auto insurance covers the driver, other household members and usually anyone the driver has permitted to operate the vehicle.

In general, car insurance covers the costs of the other person’s medical expenses and property repairs if you are responsible for a collision. However, you can purchase additional coverage options to help pay for your own repair or medical bills even if you were at fault for the accident.

If your vehicle is totaled, the insurance company will usually reimburse you for its actual cash value (ACV). This means your insurer will consider depreciation factors like age and condition when determining the car’s value rather than today’s market price to replace it.

Is Car Insurance Always Required?

Drivers are required to carry car insurance in almost every state, plus the District of Columbia. The only exception is New Hampshire, where uninsured drivers must demonstrate they can cover the costs of an accident.^[1]

In all other states, drivers must have some kind of liability insurance, with all but Florida requiring both bodily injury and property damage liability coverage.^[2] Beyond that, individual states have different rules for what types of auto insurance they require. (We’ll go over each of the different types of car insurance more thoroughly in the section below.)

What Is Covered by Auto Insurance?

Auto insurance can cover incidents ranging from collisions to theft, but not every policy includes the same level of protection. Below is an overview of some of the major types of car insurance you can purchase, how they work and when they might apply.^[3]

Coverage	Description	Example	Required?
Bodily Injury Liability	If you were the at-fault driver, this coverage pays for another person’s medical bills, lost wages and funeral expenses, plus legal fees if they sue you	You hit a pedestrian with your car and break their leg	All states but FL and NH
Property Damage Liability	Pays for repairs to another person’s car, home or belongings if you crash into them, plus repairs to any public property you crash into	You run over your neighbor’s mailbox while backing out of your driveway	All states but NH
Collision	Pays for repairs to your car after colliding with another vehicle or object, regardless of who was at fault	You doze off at the wheel and crash into a nearby tree	No states
Comprehensive	Pays for repairs to your car after perils like fire, hail, vandalism and theft	A chunk of hail cracks your windshield	No states
Uninsured Motorist (UM)	Pays for your medical expenses and car repairs if you are hit by someone who doesn’t have car insurance or if you can’t identify the driver after a hit-and-run	Someone without auto insurance runs a red light and crashes into the side of your car	CT, DC, IL, KS, ME, MD, MA, MN, MO, NE, NJ, NY, NC, ND, OR, SC, SD, VT, WV and WI
Underinsured Motorist (UIM)	Covers the difference if you are struck by a driver who doesn’t have enough insurance to fully pay for your medical expenses or car repairs	A driver with $5,000 worth of property damage liability coverage deals $7,000 worth of damage to your car	CT, KS, ME, MD, MN, NE, NJ, ND, OR, SD and VT
Personal Injury Protection (PIP)	Pays for your medical bills, lost wages and funeral expenses if you are at fault for the accident	You get whiplash after crashing into another vehicle and need to take two weeks off work	DE, FL, HI, KS, KY, MA, MI, MN, NJ, NY, ND, OR, PA and UT
Medical Payments (Medpay)	Pays for your medical bills and funeral expenses if you are at fault for the accident but doesn’t cover lost wages	You are rushed to the emergency room after a car crash	ME
Gap	Covers the difference if your car is totaled or stolen and the ACV is less than what you owe on your auto loan	Your collision coverage provides $10,000 after you total your car but you still owe $12,000 to your lender	No states

What Isn’t Covered?

Even if you purchase all of the coverage types mentioned above, car insurance generally does not cover some circumstances. You may be able to account for some of these by purchasing car insurance add-ons, while you may simply have to pay for others out of pocket. Examples of common auto insurance exclusions include:

• Personal property inside your vehicle: If any belongings are stolen from your vehicle, this would likely be covered by your homeowners insurance rather than your car insurance.
• Routine repairs and maintenance: Your insurance company will not cover general maintenance costs associated with owning a car, such as changing your oil.
• Intentional damage: Purposefully damaging your car to collect insurance money is considered fraud and may result in your insurer canceling your auto insurance policy.
• Excluded drivers: While your car insurance will generally cover anyone you have permitted to drive your car, your policy may list specific drivers that won’t be covered. For example, suppose one of your children has been responsible for multiple car accidents in the past year. In that case, your insurance company may exclude them from coverage (your child will need to buy a separate policy in this case).
• Losses that exceed your policy limits: Insurance policies limit the amount of money the insurance company will provide for a covered loss. So, suppose you have a $30,000 limit to your bodily injury liability coverage but cause an accident that results in $40,000 worth of medical bills. In that case, you will be responsible for paying $10,000 out of pocket, plus your deductible.
• Commercial use: If you use your car for business purposes, you may need to purchase a separate commercial auto insurance policy. For example, your personal auto insurance might not cover an accident that occurred while delivering materials for your construction job. Likewise, you may need to purchase separate rideshare insurance if you work for a company like Uber or Lyft.
• Rental car reimbursement: Unless you purchase separate coverage, your insurer probably won’t pay for you to rent another vehicle while your car is being repaired.
• Driving an unlisted car: If you forget to add a new car to your insurance policy, you may not be reimbursed if you crash it.
• Added accessories: You will likely need to purchase extra coverage to be reimbursed for modifications like subwoofers or custom paint jobs after an accident.
• High-risk activities: Your insurer probably won’t cover damage incurred while participating in dangerous activities like racing and, in some cases, off-roading.
• Roadside assistance: Unless you purchase a roadside assistance policy endorsement, your insurance company will not pay for services like towing, jumpstarts and fuel delivery.

How Much Car Insurance Do I Need?

How much car insurance you need depends on the state you live in. States generally express their coverage requirements in an A/B/C format:

• A: The bodily injury liability limit for any one person injured in an accident. 
• B: The total bodily injury liability limit for everyone injured in an accident.
• C: The property damage liability limit. 

For example, California requires a minimum liability limit of 30/60/15. This means drivers must have a policy that provides $30,000 worth of coverage for a single injured person, $60,000 for multiple injured people in a single accident and $15,000 to cover property damage.^[4]

Even if you meet your state’s minimum legal requirements, it may still be wise to purchase a policy with higher coverage limits. For example, the total bodily injury liability limit required by most states is only double the individual bodily injury liability limit. As a result, if your policy only meets the minimum requirements, you may have to pay a significant amount out of pocket if you injure more than two people in a car accident.

How Is Car Insurance Calculated and Priced?

The two kinds of payments you will have to make to receive car insurance coverage are premiums and deductibles. Paying these enables you to keep up your end of the auto insurance contract and ensures that your insurer will cover additional expenses in the event of an accident.

Premiums

Your premium is the regular payment you must make to your insurance company to maintain your car insurance coverage. You will generally have to pay your premium once a month, every six months or once a year.^[5] Since the purpose of your premium is to maintain your contract with the insurance company, you must make this payment regardless of whether or not you have had an accident.

Auto insurance companies calculate the risk of insuring each individual, meaning exact rates vary from person to person. Some factors that can influence the cost of your premium include your personal information, driving history, car model and location, along with the types of coverage included in your policy.

Deductibles

Your deductible is the amount you are responsible for paying before your auto insurance will kick in. The higher your deductible is, the lower your premiums will be, since your insurance company would be responsible for fewer costs in the event of an accident.

If you have a $500 deductible and cause $1,000 worth of damage to your car, you would pay half of the repair costs yourself, and your insurance company would cover the other half. However, if you cause $250 worth of damage, there would be no point in filing a claim with your insurer since the repair costs would not exceed your deductible.

Do Car Insurance Rates Increase or Decrease Often?

Some scenarios may cause your rates to change. For example, your car insurance rates may change if you’ve altered something about your policy, such as adding a teen driver to your coverage or removing an optional rider. Alternatively, your rates may change if certain life events happen, such as moving to a new area. 

If you make any claims on your policy or get a moving violation, you’ll likely see a rate increase, but typically not until your policy renewal.

Even if nothing changes about your policy, you may see changes to your rates at your policy renewal, which could happen once or twice a year, depending on your policy.^[6] These changes could be to keep up with inflation or to account for the rising cost of claims, such as materials being more expensive for repairs or increasing legal fee costs. On average, auto insurance rates rose by about 54% between 2020 and 2024.^[7]

What Happens if I'm Caught Driving Without Car Insurance?

If law enforcement catches you driving without car insurance, you may face tickets and fines, the suspension of your license and even imprisonment. Exact penalties depend on your state, and some states have harsher penalties for repeat violations.