Car insurance definitions: what every driver needs to know

Just about everyone who drives has car insurance – but how much do you really know about auto insurance? Car insurance is required in nearly every state in the U.S. (New Hampshire being the notable exception). Almost all of us buy car insurance, but it has provisions that most people know little about.

With that in mind, let’s spend some time discussing basic car insurance definitions and coverage types. There’s more going on with this common car insurance coverage than most people think, and a little bit of knowledge will make you a more savvy shopper and potentially save you hundreds of dollars a year.

Almost everywhere, laws require that drivers have car insurance.

Although automobile insurance protects you – it can pay for your loss in the event your car is crashed, stolen, vandalized, or destroyed by fire – the laws that require car insurance are designed to protect other drivers and pedestrians from you.

For example, if you run down some poor old lady crossing the street, your car insurance will pay her hospital bill. And that’s good for both the public and you. (That’s because you can bet that old lady will sue you, in which case your car insurance can protect you financially.)

If you’re on a tight budget and driving a beater, it might be tempting to save hundreds of dollars and not buy car insurance. But if you put yourself in the old lady’s shoes, hopefully, you can see why laws require it.

If you were walking down the street and got hit by a drunk driver that didn’t have car insurance, you might have to pay thousands of dollars in hospital bills (or worse) on your own. You could sue the driver (and you would almost certainly win), but if he were broke and didn’t have insurance, there would be no money to collect.

An insurance claim is a formal, documented request that you make to your insurance provider for compensation in the event of financial loss. 

Your provider then verifies the validity of the claim and cuts you a check. 

Here’s some good and bad news about claims. 

Psychology says you should always deliver the bad news first, so here goes; the more claims you submit, the higher the likelihood that your provider will raise your rates. Submit “too many,” and your provider may not even renew your auto insurance policy. 

Unfortunately, this rings true even if you submit claims for stuff that wasn’t your fault. If you get rear-ended by an uninsured motorist and submit a claim, your provider may conclude that you live in a “high-risk area” and raise your rates. Similarly, if you submit a claim for hail damage, they may conclude that you live in an area with “inclement weather.” 

It sucks, but it makes sense. Your insurance provider calculates your premiums based not upon your skills as a driver, but the likelihood that you will submit a claim. 

Now the good news: the claims submission process has never been easier. To stay competitive, providers have hugely streamlined the steps with technology. Whereas before you had to spend 48 minutes on the phone with a sweaty agent in a strip mall, now you can do everything from your phone at the scene of the incident.

This is the part of your auto insurance policy that covers damage that you cause to other drivers in a car accident. More specifically, liability insurance coverage covers vehicle and property damage. It is a required provision in virtually all auto insurance policies.

This is another type of liability coverage, that covers the financial cost of an injury or even death as a result of an accident caused by you. It can cover medical bills, loss of income claims, as well as pain and suffering damages that may come about as a result of legal action. It’s worth noting that bodily injury liability will not cover your own medical payments.

This covers property damage to another person’s property caused by you. This primarily relates to another person’s motor vehicle, but it also covers other property, such as real estate and landscaping. This is typically not required in most states, and it does not extend to your vehicle or your own personal property.

This provision will cover you in the event that your car is damaged by someone who either doesn‘t have their own auto insurance coverage, or who is under-insured. It covers both liability and collision.

This insurance covers damage to your car and any other vehicles that you might be driving. However, comprehensive insurance covers damage that is the result of incidents and not collisions.

Comprehensive coverage includes damage to your car that is the result of vandalism, theft, floods, or a tree falling on it. Every car insurance policy defines specifically what is covered, which is why you should always pay close attention to the fine print.

This insurance covers you against damage to your vehicle from an accident, hence the name “collision”. It covers you whether you are hit by someone else, or if you are the cause of the accident.

Both comprehensive and collision coverage have deductibles. The lower your deductible, the higher your premium will be. Conversely, the higher your deductible is, the lower your premium will be.

I’ll get into a discussion of the wisdom of increasing your deductible to save on your premium in a little bit.

This is a provision you can add to your car insurance policy that will cover certain medical expenses. Even if you have health insurance coverage, this provision can help pay for your health insurance deductibles in the event of an accident and is especially valuable to have if you have a high deductible health policy – or no health insurance at all.

This provision will provide you with a car rental in the event your car is either damaged or stolen.

This provision will pay for the cost of a tow in the event that your car breaks down and can’t be driven to a mechanic. It often includes on the road service, such as a battery jump, or fixing a flat tire.

Sometimes referred to as an umbrella rider, gap insurance will pay the difference between the actual book value of your car, and the remaining balance on your car loan – if the amount that you owe on a car is higher than what the car is actually worth. The insurance company will pay this benefit in the event that your car is totaled in an accident.

Personal Injury Protection is like Medical Coverage but more comprehensive. Where Medical Coverage mostly just covers medical bills, PIP also covers injury-related expenses. These can include funeral costs, lost income, child care, and more. 

While Medical Coverage is only required in two states (ME and NH), PIP is required in 13: DE, FL, HI, KS, KY, MA, MI, MN, NJ, NY, ND, OR, PA, TX, and UT, plus Puerto Rico and DC.

If you live in a state that doesn’t require PIP, should you still get it? 

PIP is worth it if you regularly transport passengers who could hold you responsible for medical expenses after a crash. It’s also a good idea if you have high-deductible/low-limit health insurance. 

Oh, and if you live in Michigan and wonder why your car insurance is so expensive, it’s because your state requires unlimited PIP limits. Unfun fact!

Why would certain states require this specific type of auto insurance? Well, PIP is actually the linchpin of something called a “no-fault” system.

While insurance protects you, no-fault insurance protects both you and your insurance provider. 

Let’s say you rear-end someone at a gentle five mph. The other driver claims he has whiplash, hires an unscrupulous personal injury lawyer whose number he got from the back of a bus, and together they sue you and your insurance for $25,000. To avoid going to court, your provider emits a heaving sigh and settles. 

It sounds ridiculous, but it happens every day. Now, many personal injury lawsuits are valid but many are exploitative, used to gouge insurance companies out of millions. To financially withstand these lawsuits, insurance companies must raise everyone’s premiums. 

To mitigate the more exploitative lawsuits and keep accident-related cases out of courtrooms, in the 1970s several states instituted a “no-fault” system, severely limiting drivers’ rights to sue each other. 

Instead, you got state-mandated PIP insurance. It’s for this reason that PIP is also known as no-fault insurance. In no-fault states, regardless of who’s at fault, everyone just submits a claim for medical expenses to their own insurance provider. 

Lawmakers and economists continue to debate the merits of a no-fault system. Several states have since instituted and repealed it. Those in favor of no-fault cite its efficacy at its intended purpose; it does tend to keep courtrooms clear and reduce exploitative lawsuits. 

But those against, feel that drivers should retain the right to sue each other’s insurance. If you get rear-ended and end up with $50,000 in medical bills, your insurance shouldn’t have to pay, and you shouldn’t have to pay the deductible – the dingbat responsible and his insurance should have to pay. 

An SR-22 is a stamp on your driving record that tells insurance providers that you’re high risk. 

If you have any of the following convictions on record, your state may require you to file an SR-22 through your insurance provider. 

• Un- or underinsured driving.
• DUI or DWI.
• “Too many” at-fault accidents or violations.
• Not paying court-ordered child support.
• Hardship license (a license enabling drives to/from work when your regular license is suspended or revoked).
• Repeat offenses (i.e. five similar moving violations in six months).

Essentially, an SR-22 is a court-ordered label that says you’re a high-risk driver. To legally drive, you have to file for specialty SR-22 insurance with a provider. The provider then files an SR-22 form with the state, signifying that you are adequately insured and in good standing. 

Because SR-22s denote high risk, some providers will not insure you. Those that do will charge much higher premiums. 

There are two ways you can reduce your premiums if you require an SR-22 filing. 

The first option is to immediately downgrade your car and your coverage. Drive a cheaper car with less coverage until the points on your license expire and you fall out of the “high-risk” category. 

The second option is to sell your car entirely. This qualifies you for Non-Owner SR-22 Car Insurance; you can’t own a car, but it’s much cheaper than driving with SR-22 insurance.

Auto insurance coverage levels are typically expressed in a three number format, that looks like XX/XX/XX.

Each of the three numbers has a specific meaning:

1. XX/XX/XX – The bodily injury liability maximum for one person injured in an accident,
2. XX/XX/XX – The bodily injury liability maximum for all injuries in one accident (which is why it’s almost always higher than the first number), and
3. XX/XX/XX – Property damage liability maximum for one accident.

The primary consideration regarding how much auto insurance you need is usually determined by your state’s minimum auto insurance coverage requirements.

For example, in New York, the minimum requirement is 30/60/25, meaning that the requirements are $30,000 for bodily injury liability for one person, $60,000 for bodily injury liability for all injuries from one accident, and $25,000 for property damage liability per accident.

This number varies from one state to the next. In California, the required minimum coverage is 15/30/5; in Illinois, it’s 25/50/20; Florida 10/20/10; Texas 30/60/25.

Many people carry nothing more than the state-mandated minimum. This can be a problem, however, particularly if you have a significant amount of assets. While the primary purpose of insurance is to cover car damage and personal injuries, it has an equally important purpose of protecting your financial assets.

The less coverage that you have – down to the state-required minimum – the more exposed your financial assets will be to claim or legal action by an injured party. If you have a substantial amount of net worth, you want to carry considerably more than the state-mandated minimums.

Your car insurance deductible is the amount you have to pay out-of-pocket in the event of a claim before insurance kicks in.

Your premium is the amount you pay annually for car insurance.

A favorite way to lower car insurance premiums is to increase your deductible. Sometimes it makes sense, other times…it could be a disaster waiting to happen.

Roughly speaking, if you increase your deductible from $500 to $1,000, you might up to 20% on your auto insurance premium. At the extreme, increasing the deductible from $250 to $2,500 could even save you 50%.

That’s a big savings, but that doesn’t mean that you should raise your deductible. Before doing so, make sure that you can cover the deductible.

For example, let’s say you have a $500 deductible on a policy that costs $1,500 per year, and you can save $300 – or 20% – by increasing the deductible to $1,000. Understand that the $300 you’re saving will more than be offset by the additional $500 you’ll need to put out of pocket to pay the deductible on just one accident.

Here’s something else to consider…increasing your deductible only makes sense if you have the savings to cover it. If you normally have several thousand dollars in savings, increasing the deductible won’t be painful, since you’ll have the cash to cover it. But if you normally have an empty bank account, you’ll be better off with the lower deductible.

Make sense?

Never forget that protection – and not state requirements – are the primary purpose of having auto insurance, and be sure to get the coverage level that you need.