How Does Car Insurance Work?

Car insurance protects you financially in the event of an accident. Read on to learn the different types of coverages and important terms to know when shopping for car insurance.

A.M. Steinbach
Written byA.M. Steinbach
A.M. Steinbach
A.M. SteinbachInsurance Writer
  • Full-time writer for 5+ years

  • Two-time Emmy Award nominee

A Harvard graduate, Mark has worked as a freelance personal finance and tech writer. He’s also written for Saturday Night Live.

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Chris Schafer
Edited byChris Schafer
Chris Schafer
Chris SchaferSenior Editor
  • 15+ years in content creation

  • 7+ years in business and financial services content

Chris is a seasoned writer/editor with past experience across myriad industries, including insurance, SAS, finance, Medicare, logistics, marketing/advertising, and many more.

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Updated March 19, 2024

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Car insurance helps you remain financially protected if you get in a car accident. Insurers like State Farm, GEICO, and many more charge drivers a monthly or yearly payment, known as a premium. In return for these premiums, car insurance companies cover a portion of the repair costs and medical bills you may face after an accident.

If you want to learn more about car insurance, you’re in the right place. Here’s what you should know about the different types of car insurance policies available, how companies determine rates, and strategies for finding affordable car insurance coverage.

Why is it important to have car insurance?

Costs can add up quickly after a car accident. Medical bills and repair estimates can total in the thousands. Luckily, your car insurance policy covers a certain portion of these bills, depending on the type of policy you purchase and the deductible you choose.

Every state except New Hampshire requires you to carry some form of auto insurance.[1] Failing to insure your vehicle sufficiently, or at all, can lead to fines or even criminal charges — not to mention financial ruin in the event of a serious at-fault accident.

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Car insurance terms to know

You’ll probably encounter some unfamiliar terms as you browse policies. Here are some common insurance-related terms you should know:

  • Policyholder: The person whose name is signed on an auto insurance policy. This person can add others to their policy, such as family members.

  • Premium: The amount you pay monthly, semi-annually, or annually for your car insurance policy.

  • Claim: A formal request for reimbursement, which a policyholder files with their insurer after a covered incident, like an accident.

  • Policy limits: The maximum payout your car insurance company will pay after a claim. Policyholders can adjust these limits but must meet certain state minimums. Keep in mind that a high policy limit generally translates into a higher premium.

  • Liability: Your legal obligation to cover another driver’s injuries and vehicular damage after an accident if you’re the at-fault driver.

  • Deductible: The amount a policyholder must cover out of pocket before their insurance coverage kicks in. For instance, if you cause an accident with $2,000 in damages and your deductible is $500, you’ll pay $500 and your insurance company will cover the other $1,500.

Types of car insurance coverage

Drivers have several different types of car insurance coverage to choose from, and these policies cover different types of damage. 

While certain types of coverage are required, others are optional and only necessary if you want some extra financial protection if you need to file a claim.

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    Liability coverage

    If you cause an accident, liability insurance covers the other driver’s damages. Bodily injury liability insurance covers the other driver’s medical bills, while property damage liability insurance covers the other driver’s vehicle repairs, as well as damage to structures like fences or buildings.

    Liability insurance is a requirement in every state except New Hampshire.

  • illustration card https://a.storyblok.com/f/162273/x/c8ad9d5019/driving-accidents.svg

    Collision coverage

    When you get in an accident, collision coverage kicks in to cover your car’s repairs, regardless of fault. Collision coverage is optional and is often recommended to drivers of new or high-value cars.

    This coverage provides protection for collisions with other cars, fences, buildings, and other structures. It even covers damage caused by potholes. Read your policy closely to figure out what it covers. Some types of damage may also be covered in your comprehensive coverage policy.

  • illustration card https://a.storyblok.com/f/162273/x/665da91bf7/comprehensive-coverage.svg

    Comprehensive coverage

    Collisions aren’t the only cause of damage your vehicle may suffer on the road. Comprehensive coverage, another optional addition to your policy, covers damage from non-collision events, like severe weather, fire, theft, or vandalism.

    Most car insurance companies offer full-coverage policies that include liability insurance, collision coverage, and comprehensive coverage. This robust coverage also means full-coverage policies come with a higher monthly premium.

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    Personal injury protection (PIP) coverage

    If you get in an accident, personal injury protection (PIP) covers your and your passengers’ resulting medical expenses. Personal injury protection pays for lost wages or even funeral costs.

    Some states require personal injury protection, especially “no-fault” states, where both drivers involved in an accident must file insurance claims for bodily injury with their own insurers, regardless of who was at fault.

    You may see personal injury protection used interchangeably with medical payments coverage, but these are different types of insurance. While both cover medical costs, medical payments insurance doesn’t cover lost wages.

  • illustration card https://a.storyblok.com/f/162273/x/5285c4cd74/uninsured-or-underinsured-motorist-coverage.svg

    Uninsured/underinsured motorist coverage

    If you get in an accident with a driver who doesn’t have enough insurance coverage or any coverage at all, uninsured/underinsured motorist coverage kicks in to cover your repairs and medical bills. Some states require uninsured motorist coverage to protect drivers in unfortunate situations where they’re in an accident with an uninsured driver.

    If your state doesn’t require such coverage, you may still wish to purchase an optional rider to protect yourself from such events.

How car insurance rates are calculated

Your car insurance company takes certain factors into account when determining your rates. Known as rating factors, these include your age, gender, marital status, vehicle make and model, ZIP code, driving history, credit history, and more. (Note that most, but not all, states allow car insurance companies to consider your credit history.)

Good to Know

While certain rating factors are out of your control, many can be controlled. For example, maintaining a clean driving record will make it easier for you to find affordable rates, as will choosing a vehicle with numerous safety features.

Five ways to lower your car insurance premiums

These strategies can help you lower your insurance costs:

  • Take advantage of discounts. Most car insurance companies offer discounts to drivers who insure multiple vehicles, purchase homeowners insurance and renters insurance in addition to auto insurance, or maintain a strong driving record. Speak to your insurance agent or visit your company’s website to find out which discounts might be applicable to you.

  • Drive safely. If you get too many traffic violations or at-fault accidents on your record, car insurance companies will see you as a high-risk driver and charge you higher premiums to offset the likelihood of future claims. By the same token, if you generate a long period of safe driving, many insurers will lower your premiums.

  • Choose a safe car. Vehicles with advanced safety features and a strong safety record are typically cheaper to insure. For instance, a family-friendly sedan is cheaper to insure than a speedy sports car.

  • Don’t purchase too much coverage. You may not need full coverage at high coverage limits. Perhaps you only drive occasionally or own an older used car. If you’d buy a new car in the event of a total loss, cheaper liability-only insurance could be sufficient.

  • Shop around and compare quotes. Get quotes from at least three car insurance companies when looking for a new policy. Comparing quotes side by side helps you find not just the best price but also the best coverage for your needs.

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How to file a car insurance claim

If you get in an accident, you may need to file an insurance claim. To do so, follow these steps:

  1. Decide if you need to file a claim. In most cases, filing a claim is the right decision. But if the vehicle damage is minor and repairs would cost less than your deductible, it might not be worth risking higher future rates to file a claim.

  2. Choose how to file a claim. Most car insurance companies let you file a claim on your insurer’s official app. You could also call your insurer’s claims line, which is usually operated on a 24/7 basis.

  3. Include pictures. Use the app to take pictures of the accident scene. This will give your claims adjuster more information.

  4. Wait for your claims adjuster’s verdict. The claims adjuster is the insurance company employee who decides your claim payout. You can check the status of your claim on the company’s website or app. Recognize that the claim may take time to be paid.

The consequences of not having car insurance

Driving without car insurance is very risky. If you cause an accident, you’ll have to pay the other driver’s bills out of pocket. This could add up to thousands of dollars in losses for you.

If you get pulled over and don’t have proof of insurance, you’ll also have to pay a fine. You may even have your license suspended for up to a year, depending on your state’s laws. Additionally, having a significant lapse in coverage could make it harder or more expensive to find coverage in the future.

How car insurance works FAQs

Car insurance is important — but that doesn’t always mean it’s simple to understand. Drivers seeking insurance commonly ask the following questions. The answers presented here can hopefully help you purchase car insurance with confidence.

  • What is car insurance, and why is it necessary?

    Car insurance offers financial protection if you’re involved in a car accident. Vehicle repairs and medical bills can be very expensive. Car insurance companies disperse these risks by charging policyholders monthly premiums. These monthly premiums collectively help pay out claims on expensive repairs and bills.

  • What are the main types of car insurance coverage options you can choose from?

    Car insurance companies offer liability insurance, which covers the other driver’s medical bills and repair expenses. You can also purchase collision insurance, which kicks in to cover damage from a collision, while comprehensive insurance kicks in to cover damage from non-collision events, like fire or severe weather.

    Policyholders have plenty of optional policy add-ons to choose from, too. Talk to your insurance agent to see which coverages might be right for you.

  • How do insurers calculate car insurance costs?

    Insurers use a process known as underwriting to figure out your premiums. Car insurance companies will consider your driver profile and figure out how likely you are to file claims in the future. This process often involves advanced statistical analysis to reach an accurate assessment of insurance risk.

  • What factors affect the cost of your car insurance premium?

    Car insurance companies consider several rating factors when determining your car insurance costs. Age, driving history, ZIP code, vehicle choice, and other factors help insurers determine the likelihood of future claims. If your driver profile shows you’re likely to file a claim, they’ll charge you more to manage the risk of insuring you.

  • How do insurance companies assess and resolve car insurance claims?

    Car insurance companies have claims adjusters who assess the damage involved in a claim and reach an accurate estimate of repair costs. They consider local spare part costs and repair fees, which is why claim payouts and insurance costs can vary from city to city.

Sources

  1. Insurance Information Institute. "Automobile Financial Responsibility Laws By State."
A.M. Steinbach
A.M. SteinbachInsurance Writer

A.M. is a Brooklyn-based writer, editor, and content marketing strategist who's worked with major brands in insurance, tech, finance, and healthcare. He also contributes to The Average Joe, a personal finance newsletter that reaches over 250,000 daily readers. Since 2019, he's written for Insurify, breaking down a diverse range of insurance topics into crisp, readable prose.

Chris Schafer
Edited byChris SchaferSenior Editor
Chris Schafer
Chris SchaferSenior Editor
  • 15+ years in content creation

  • 7+ years in business and financial services content

Chris is a seasoned writer/editor with past experience across myriad industries, including insurance, SAS, finance, Medicare, logistics, marketing/advertising, and many more.

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