This article is a part of Wikinvest's Personal Finance section and Guide to Investing. Please contribute or edit to improve it.

TOP CONTRIBUTORS

Vikram Parsani

Car Insurance, also known as auto insurance, is a type of insurance policy that protects the policy holder from the financial risk associated with bodily injury or property damage caused by car accidents, theft, vandalism or natural disasters. All states require drivers to purchase at least a minimum amount of liability coverage and, depending on the state, additional types of coverage may be optional or required. In addition, you may also be required to purchase more coverage if your car was bought using a car loan or leased from a car dealership.

No-Fault Insurance vs. At-Fault Insurance

In a no-fault system, your car insurance company will pay up to your policy limit for bodily injuries and property damage resulting from an accident, regardless of which party is at-fault. In an at-fault system, also known as a traditional tort liability system, the car insurance company of the at-fault party pays for bodily injuries and property damage to all parties involved in the accident. Provable negligence, or the ability to prove who was responsible for the accident, is used to determine the at-fault party.

Under current no-fault laws, drivers may only sue for damages if the case meets certain predefined thresholds. These thresholds relate to the severity of injury and usually belong to one of two categories:

• Verbal thresholds, which broadly define what (death, dismemberment and/or disfiguration) constitutes a serious injury; or
• Monetary thresholds, which are expressed in dollar amounts of medical bills.

Since high threshold no-fault systems restrict litigation, they tend to reduce insurance premiums and facilitate quicker payments against claims.

There are currently 12 states that operate under no-fault laws. Florida, Michigan, New Jersey, New York and Pennsylvania have verbal thresholds. Hawaii, Kansas, Kentucky, Massachusetts, Minnesota, North Dakota and Utah use a monetary threshold. In addition, New Jersey, Pennsylvania and Kentucky have choice no-fault laws. In these states, policy holders may opt into a no-fault system or choose to retain their right to sue for auto-related injuries.

Types of Coverage

Third-Party Coverage

Liability Coverage

Liability coverage pays for bodily injuries and/or property damage caused to third parties in an accident where the policy holder is the responsible party. As mentioned earlier, all states require drivers to purchase at least a minimum amount of liability coverage, of which there are two types:

• Bodily injury liability coverage pays for people expenses resulting from an accident, such as medical expenses, lost wages, pain and suffering; and
• Property damage liability coverage pays for property expenses resulting from an accident, such as the cost of replacing another party's car, a fire hydrant, street light or telephone pole.

Liability coverage also pays for the legal costs associated with defending the policy holder against lawsuits related to car accidents. More often than not, it makes sense for a policy holder to purchase more than the minimum amount of liability coverage required by state law so as to adequately protect his/her assets.

First-Party Injury Coverage

Medical Payments (MedPay) Coverage

Medical payments coverage pays for medical expenses and funeral costs for the driver and all passengers in the car, regardless of which party is at-fault for the car accident. It is designed to facilitate immediate, short-term care and is commonly required in states that operate under no-fault laws.

Personal Injury Protection (PIP)

Personal insurance protection extends medical payments coverage to include, among other things, lost wages and death benefits. Like medical payments coverage, it is designed to facilitate immediate, short-term care and is commonly required in states that operate under no-fault laws. In other states, assuming that a policy holder has sufficient health and disability insurance, personal injury protection may only be required to cover passengers not related to the policy holder. Since personal insurance protection provides coverage that is equal to and beyond medical payments coverage, there is no reason to buy both.

Underinsured Motorist (UIM) Coverage

Underinsured motorist coverage pays for medical expenses, funeral costs, lost wages, pain, suffering and other ongoing expenses for the driver and all passengers in the car when a third party is both at-fault for the accident and underinsured. This type of coverage only pays up to your policy limit after subtracting the amount paid by the at-fault party's insurance policy. Note that an underinsured driver is someone who has insurance that meets state-mandated minimum liability requirements, but whose policy limit is not high enough to pay for the bodily injuries caused by the accident.

Uninsured Motorist Bodily Injury (UMBI) Coverage

Uninsured motorist bodily injury coverage pays for medical expenses, funeral costs, lost wages, pain, suffering and other ongoing expenses for the driver and all passengers in the car when a third party is both at-fault for the accident and uninsured. Unlike medical payments coverage and health insurance, uninsured motorist bodily injury coverage pays for lost wages and, unlike disability insurance, it covers your passengers, family members and you as a pedestrian as well. Note that an uninsured driver is someone who does not have any insurance, has insurance that does not meet state-mandated minimum liability requirements or whose insurance company denies his/her claims or is financially unable to pay them. Hit-and-run drivers also count as uninsured.

Uninsured Motorist Property Damage (UMPD) Coverage

Uninsured motorist property damage coverage pays for repairs to your car or the cost of replacing it when repair costs exceed a certain predefined threshold of your car's value. Uninsured motorist property damage coverage is a good way for uninsured drivers to protect their cars, especially since it is often cheaper than collision coverage with comparable deductibles. Note that an uninsured driver is someone who does not have any insurance, has insurance that does not meet state-mandated minimum liability requirements or whose insurance company denies his/her claims or is financially unable to pay them. A hit-and-run driver also counts as uninsured.

First-Party Property Coverage

Collision Coverage

In the event of a collision with another vehicle or object, collision coverage pays for repairs to your car or the cost of replacing it when repair costs exceed a certain predefined threshold of your car's value. If you decide to purchase collision coverage for your car, you'll also have to decide on the size of your deductibles. A deductible is the amount that a policy holder is responsible for paying per accident before his/her insurance policy kicks in. Deductibles vary by state, but are most often specified in amounts of $100, $250, $500 or $1,000. For most insurance companies, the higher your deductible, the lower your premiums. In other words, if you're willing to pay higher out-of-pocket costs, you can lower the total cost of your insurance. Note that collision coverage is paid regardless of which party is at-fault or whether another party is involved.

Comprehensive Coverage

If your car is damaged in some event other than a collision, comprehensive coverage pays for its repairs or the cost of replacing it when repair costs exceed a certain predefined threshold of your car's value. Depending on your insurance company, damages may be covered for events like theft, vandalism and natural disasters (fire, flood, hail etc.). As in the case of collision coverage, if you decide to purchase comprehensive coverage for your car, you'll also have to decide on the size of your deductibles.

Factors affecting Insurance Premiums

A number of factors affect how much a policy holder will pay in insurance premiums. Each of these factors is a statistical risk for a specific population. The higher the risk associated with a policy holder, the more he/she is likely to pay in insurance premiums.

Driver

• Age: Drivers under the age of 25 have a greater risk of being involved in an accident as compared to those over 25 years of age. In addition, drivers between 50 and 65 years of age tend to have the safest driving records. As a result, the younger you are, the higher your insurance premiums.

• Gender: Men drive more miles per year than women and females are involved in fewer collision than males. As a result, if you're a female driver, your insurance premiums may be lower than a male driver of the same age.

• Marital Status: Married individuals are less likely to be involved in a car accident as compared to unmarried individuals. Hence, a married individual will pay lower insurance premiums than an unmarried individual with a comparable driving record.

• Area of Residence: Car accidents are more common in congested urban areas with a lot of traffic as compared to areas with little to no traffic. Hence, if you live in an urban area, you will pay higher premiums than someone who lives in an area with little to no traffic. You will also pay higher premiums if you live in an area with a higher rate of car thefts.

• Driving Record: Drivers with a history of serious traffic violations (speeding tickets, driving under the influence etc.) are more likely to be involved in car accident as compared to drivers with accident-free records. Depending on which state you're in, insurance companies can penalize you based on your driving record for as many as five years from when the incident occurred. Hence, the worse your record, the higher your premiums, although many companies do lower their charges as your record improves.

• Driving Frequency: Drivers that commute to work everyday in their cars are more likely to be involved in an accident as compared to drivers that only use their cars on weekends. As a result, the more you use your car, the higher your premiums. Similarly, drivers who have a long-distance commute to work will often pay more in insurance premiums than those who live near their workplace.

• Credit Score: Most insurance companies consider poor or no credit history as suggestive of higher risk. Hence, the lower your credit score, the higher your insurance premiums.

Car

• Make and Model: Luxury and sports car models as well as models with a higher rate of theft tend to have a higher claims frequency. As a result, drivers of these vehicles can expect to pay higher insurance premiums. Larger cars, however, tend to be safer in collisions and lower-priced sedans cost less to repair and replace. Hence, drivers of these types of cars can expect to pay lower insurance premiums.

• Restraint Systems: Although new makes and models now come equipped with seat belts and airbags, older vehicles may not have them. Since these systems reduce the risk of injury, their presence is often a prerequisite for lower insurance premiums, especially in the case of medical payments coverage.

Coverage

• Deductibles: If you've purchased collision or comprehensive coverage, the higher your deductibles, the lower your insurance premiums.

• Policy Limit: The higher your policy limit, the higher your insurance premiums.

Discounts

Car insurance companies sometimes offer discounts that result in lower insurance premiums. Depending on your insurance company, you may qualify for a discount if:

• You've taken a Drivers Ed course.;
• You have a homeowners insurance policy with the insurer;
• You use an approved anti-theft device in your car;
• You've been with and had a good record your insurer for a significant period of time;
• You're a member of a professional association, like the American Automobile Association; or
• You park your car in a garage instead of on the street.

See Also

• Auto Insurance 101, About.com
• Auto Insurance Center, The Motley Fool
• Auto Insurance FAQs, Insurance.com
• How Car Insurance Works, HowStuffWorks
• Smart Shopper's Guide to Auto Insurance, Kiplinger.com
• Vehicle Insurance, Wikipedia
• Car Insurance Buyers Guide Swiftcover.com

References