How Does My Car Insurance Policy Work?

A car insurance policy’s function is for an insurance company to cover a driver’s losses in a covered accident and in exchange, the driver makes regular payments to the insurance company. All auto policies will meet your state’s minimum liability requirements but you can purchase additional protections, like coverage for your car if you are the at-fault driver, your car was stolen or you were injured in an accident.

Read below for more details on how auto insurance works and what kinds of coverage it can provide.

Key Takeaways Car insurance provides financial protection 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 takes care of 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 their insurance company in which the latter pays for the driver’s losses in a car accident and, in exchange, the driver pays a premium (and deductible in certain types of accidents). This arrangement keeps the driver from bearing the full financial burden anytime there is a sudden and unexpected accident.

Auto insurance will cover the driver plus other household members and usually anyone you have given permission to drive your car.

In general, the purpose of car insurance is to cover the costs of the other person’s medical expenses and property repairs if you are responsible for a collision. However, there are additional coverage options you can purchase that will cover your repair and medical bills even if you were at fault for the accident.

If your vehicle was totaled, the insurance company will usually pay out at its actual cash value (ACV). This means your insurer will take depreciation factors like age or wear and tear into account to determine the car’s value rather than today’s market price to replace it.

What Is Covered by Auto Insurance?

Auto insurance can cover incidents ranging from car crashes to theft, but not every policy provides the same depth of coverage. Below is an overview of some of the major types of car insurance you can purchase, how they work and when they might take effect

Coverage	Description	Example	Required?
Bodily Injury Liability	If you were the at-fault driver, 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, IL, KS, ME, MD, MN, NE, NJ, ND, 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, MD, 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, there are still some circumstances that generally are not covered by car insurance. 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 getting your oil changed.
• Intentional damage: Purposefully damaging your car to try to collect insurance money is considered fraud and may result in the cancellation of your auto insurance policy.
• Excluded drivers: While your car insurance will generally cover anyone you have given permission to drive your car, your policy may list specific drivers that won’t be covered. For example, if one of your children has been responsible for multiple car accidents in the past year, your insurance company may opt to exclude them from coverage (your child will need to buy a separate policy).
• Losses that exceed your policy limits: Insurance policies come with a limit to the amount of money the insurance company will provide for a covered loss. So, if 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, 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 likely 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 won’t 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 likely won’t cover damages 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.

Is Car Insurance Required?

Drivers are required to have some car insurance in almost every state, plus the District of Columbia. The only exception is New Hampshire where uninsured drivers must prove they have enough money to cover the costs of an accident.^[1][2]

In all other states, drivers are required to have some kind of liability insurance, with all but Florida requiring both bodily injury and property damage liability coverage. 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.)

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

Your Lender May Require Additional Coverage

You may face additional insurance requirements if you are financing a new or used car purchase. Usually, your lender will require you to buy full coverage, which will include your state’s minimum insurance requirements plus collision and comprehensive coverage. These two coverages provide physical damage protection, covering your losses if your car suffers a physical loss, such as striking another car or object or is vandalized or stolen.

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, where A is the bodily injury liability limit for any one person injured in an accident, B is the total bodily injury liability limit for everyone injured in an accident and C is the property damage liability limit.

For example, California has a minimum liability limit of 15/30/5. This means drivers must have a policy that provides $15,000 worth of coverage for a single injured person, $30,000 for multiple injured people in a single accident and $5,000 to cover property damage.^[1]

Even if you are meeting your state’s minimum legal requirements, it may still be a wise investment 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 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 in order to maintain your car insurance coverage. You will generally have to pay your premium once a month, once every six months or once a year. 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 of the factors that can influence the cost of your premium include your personal information, driving history, car model and location, plus the types of coverage included in your policy.

Deductibles

Your deductible is the amount of money that you are responsible for paying before your auto insurance will kick in. The higher your deductible, 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, then 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, then there would be no point in filing a claim with your insurer since the repair costs would not exceed your deductible.

How Do I Purchase Car Insurance?

The best way to shop for car insurance is to follow these six steps:

1. Compile necessary documents and information to receive a quote, including your recent number of accidents and tickets, zip code and vehicle information.
2. Find out your state's minimum coverage requirements.
3. Determine what type(s) of coverage and how much of it you need
4. Contact several insurance companies and compare quotes based on price and customer service.
5. Ask for discounts to lower your potential premium.
6. Buy your policy.

Using an insurance marketplace like SmartFinancial allows you to easily compare quotes from different companies after completing a simple online questionnaire. As a result, we can potentially match you with an insurance agent who can finalize your new auto policy — all while skipping the burdensome process of contacting individual car insurance companies.