FINANCIAL FRESHMAN #076
TL;DR → Car insurance protects your finances from accidents, theft, and other unexpected vehicular events. This post breaks down the key terms on your policy, explains what each coverage does, and offers simple rules of thumb for how much insurance you actually need. When you understanding your options, you can pick coverage that balances protection and cost without relying on a salesperson (or your parents).
Car Insurance
Happy Sunday!
Recently on Financial Freshman, we spent a few weeks talking about car ownership. Specifically, we talked about the car-buying process and highlighted how significant the total cost of ownership can be. Until now, we’ve left out a significant part of the car ownership equation, and that is car insurance.
Anecdotally, I feel like most college students are still on their parent’s car insurance policy. One day, whether that’s when you start your full-time job or move out of their house for good, you’ll have to go shopping for your own. We’re here to help!
Car insurance policies are inundated with numbers and jargon, and they can be a little bit overwhelming to unpack from the outside looking in. With this post, my goal is to accomplish two things:
- First, I want to strip away the confusion and explain car insurance in plain English. You’ll learn what the most common terms actually mean, why they exist, and how they protect you.
- Second, I want to help you figure out how much coverage you actually need. Not what a salesperson thinks you should buy, and without defaulting to what your parents chose.
By the end of this post, you’ll be able to look at any car insurance quote and understand the limits, the trade-offs, and whether the coverage makes sense for your situation. Let’s get started!
The Big Picture
When you sign a car insurance policy, you are entering into a legally binding contract between you (the policyholder) and the car insurance company. This contract exists to safeguard your personal finances in the event of a car accident, car theft, or any other car-related incident that is out of your control. On this blog, we’re obviously all about safeguarding personal finances.
As a policyholder, you should expect this contract to cost you somewhere in the range of $85 – $165 per month, according to data from Progressive. When we start discussing how much insurance you specifically need, the reason for this range being so large will become more clear.
Included in the cost of your policy will be some things that are required by law, and some things that are optional. The line between those two can vary depending on the state you live in, but we’ll do our best to explain the details in the next section.
Time to go beyond the big picture; let’s crack open the car insurance dictionary of terms.
Some Vocabulary
To talk through our car insurance vocabulary, let’s use a declarations page as a guide. Once you have a policy of your own, the declarations page is the document that outlines all of the details of your policy.
Your first page will probably look something like this. It will have your personal information, your policy number, and outline all of the drivers that are included on your policy. Your declarations page may use the phrase “named insured” here—that’s just a fancy way of highlighting the people that have full rights to the benefits outlined in the policy.
Page two will typically move into the outline of coverage, where you’ll see a table like the one above for each vehicle included on your policy. Here’s where the vocabulary gets dense, so let’s talk through each term.
- Liability: In most states, this is the only piece of your car insurance that is going to be required by law. Liability coverage protects your finances from any injury or property damage that you cause to someone else.
- As you can see in the example above, it’s commonly split into Bodily Injury Liability and Property Damage Liability to represent these two distinct pieces.
- Limits: Across from each line item, your declarations page will provide your limits. Put simply, this is how much money your insurer will pay you for that specific line item. In some cases, as you can see, it’s split up into “each person” and “each accident.”
- Uninsured Motorists: This coverage protects you if you’re in an accident caused by a driver that doesn’t have insurance (or not enough) to cover the damages.
- Collision: This coverage pays for the damage to your car after an accident, regardless of who was at fault, or if another car was involved in the first place.
- Other Than Collision, or OTC: This is more commonly called comprehensive coverage, and…as you may expect, it pays out for incidents that are not collisions. Think fires, theft, or natural disasters.
- Actual Cash Value, or ACV: This figure represents the value of your car at the time of an insurance claim.
- Deductible: This is the amount of money you agree to pay out of pocket before your insurance starts covering a claim. Higher deductibles usually mean lower premiums.
- Premium: This is the amount that you pay, whether monthly, quarterly, or annually, to get the benefits outlined in the declarations page.
Your declarations page will also outline a lienholder if you have one. If you took out debt to purchase your car, that lienholder may require specific insurance coverages for as long as you owe them money.
This is not an exhaustive list of vocabulary words by any means, but much of what we’ve omitted here is self-explanatory. When you shop for a policy, things like rental car reimbursement, roadside assistance, and glass/windshield coverage will also be offered to you.
That’s where things get tricky…how much insurance do you need?
How Much Do You Need?
Now that we’ve unpacked the vocabulary, let’s get to the question that really matters: how much coverage should you buy? There’s no one-size-fits-all answer, but there are some solid rules of thumb that can help you make a smart decision.
Liability Coverage
Like we mentioned, this is the part of your policy that’s required by law in most states. A common rule of thumb is to aim for at least $100,000 per person and $300,000 per accident for bodily injury, and between $50,000–$100,000 for property damage. If you’re driving a more expensive car, or if your state has high medical costs, it’s worth considering higher limits.
Collision and Comprehensive
If you have a car that’s worth more than a few thousand dollars, it’s usually worth carrying collision and comprehensive coverage as well. For very old or inexpensive cars, the cost of these coverages might outweigh the benefits, meaning if your car is totaled, your payout may not justify the premium.
Medical Expense Benefits
Some policies offer optional medical expense coverage to pay for injuries to you or your passengers after an accident. Before adding it, consider how good your health insurance is. If you have strong coverage through your parents or your job, you may not need much extra. If your medical insurance is limited, even a small policy here can prevent huge out-of-pocket costs.
Gap Insurance
If you financed or leased your car, gap insurance can be a lifesaver. It covers the difference between what you owe on your loan and your car’s actual cash value if it’s totaled, so you’re not stuck paying out of pocket for a car you no longer have. It’s most useful in the first few years of a new car loan or lease, when your car’s value depreciates faster than you’re able to pay off the loan.
Deductibles
A higher deductible (like $1,000) lowers your premium but increases your costs if you file a claim. A lower deductible (like $250–$500) gives you peace of mind with smaller out-of-pocket costs, but your monthly premium will be higher. Choose a deductible you could realistically cover in an emergency.
Uninsured/Underinsured Motorist
For the sake of minimizing financial risk, I will always advocate for this specific coverage (if it’s not legally required for you). The Insurance Information Institute estimates that 1 in 7 drivers is uninsured…and that’s not a dice you want to roll in the event of an accident. If you select this, matching your liability limits is a good idea.
The good news is that most car insurance companies, once you provide some information about you and your vehicle, offer you a means to tweak these variables and see what impact they will have on your premiums. Don’t be afraid to shop around when the time comes!
Final Thoughts
Car insurance might seem complicated, but it’s really about protecting your finances from accidents and unexpected events. Focus on coverage that fits your car, your risks, and your budget. Revisit your policy as your life changes, and remember that the right insurance should give you peace of mind, not just another bill to pay.
See you next week!
