How Car Insurance Works
How Car Insurance Works
Car insurance is designed to protect drivers and their passengers from financial hardship after an accident or other vehicle-related incident. Auto insurance, or other proof of financial responsibility, is mandated in every state.
Insurance can be confusing, but it can help you to find the right coverage at the best price to understand more about how it works and why it's required.
Car Insurance Requirements
While the car insurance requirements vary by state, drivers must always prove they can pay damages in the event of an accident. This is called proving financial responsibility.
Some states allow drivers to prove their ability to pay damages by posting a bond or certificate; however, car insurance is typically the easiest way for drivers to fulfill the requirement.
To learn all about the types of car insurance coverage required in your state, visit our Insurance Requirements section.
Benefits of Car Insurance
Before car insurance was widely adopted and mandated, car accident victims would usually get no form of compensation in an accident. In the event that a victim did sue the driver at fault, those drivers often faced huge costs that could be financially crippling.
Requiring car insurance helps states protect drivers from the enormous costs that can be associated with an accident. It ensures that both:
- The at-fault driver can cover the costs of the injuries or property damages resulting from the accident without losing huge sums in a lawsuit.
- The victims of the accident can seek the medical care required, pay for funeral expenses, and/or fix their property in a timely manner without paying out of pocket.
Car insurance can give you the peace of mind knowing that you'll be financially covered after an accident.
Types of Car Insurance
The most common type of insurance that is legally required is liability insurance, which covers damages to the other party when you are at fault. However, there are numerous other types of coverage that can offer additional protection from the costs of injuries and property damage to you and your passengers. These include:
- Comprehensive coverage – Pays for property damage after an incident that is not accident-related.
- Collision coverage – Covers damage to your vehicle from a traffic collision.
- Uninsured/underinsured motorist bodily injury coverage – Helps pay your expenses when you've been hit by someone with no or insufficient insurance.
- Uninsured/underinsured motorist property damage coverage – Helps cover damages to your property if you've been hit by an uninsured or underinsured driver.
- Medical expense payments coverage – Helps you pay for your and your passengers' medical expenses, regardless of who was found at fault.
For more information on the various types of coverage available on the market, visit our Coverages section.
How Insurance Companies Manage Risk
Like all insurance, car insurance rates are assessed based on risk. This means that the insurance provider:
- Calculates your likelihood of making a claim.
- Bases your premium on that level of risk.
Car insurance carriers have found that certain factors statistically affect your chances of getting into an accident, so they use those factors to determine your premiums. They include (but are not limited to):
- Your driving record.
- Tickets, DUIs, accidents, etc. will make you riskier to insure.
- Your vehicle's make, model, and year.
- Your age, gender, and marital status.
- Your occupation.
- Your credit history.
- NOTE: Not all states allow use of your credit history to determine your rates.
- Your claims history.
- How many miles you drive per month/year.
If you are a low-risk driver, you'll have an easier time finding cheap rates. If you are high-risk, you'll find that you you'll pay higher premiums, and you may even have a harder time finding an insurance provider to offer you coverage.*
It's important to remember that not all companies calculate risk the same way. Some companies may place more weight on certain factors and less on others, and it may be reversed in another company. Your best bet is to speak to multiple car insurance companies and/or compare car insurance rates online.
Discounts may also factor into your rates. Make sure when you shop around for car insurance to ask about discounts that may apply to you.
* Drivers who've been denied coverage can find it through their state's automobile insurance plan, albeit at a higher premium.
Accidents and Your Auto Insurance
If you get into an accident and you are found to be at fault, you will file a claim with your car insurance company to cover the damages.
After the claim is processed and funds are paid out, your insurance company may consider you riskier to insure and may increase your premium as a result.
Note that if you don't file a claim but you are still cited by the police in an accident, your insurance rates can still go up due to the increased risk factor associated with your driving habits.
The best way to obtain and maintain low car insurance rates is to drive safely, avoid accidents, and keep your driving record clear.
How Car Insurance Providers Make Money
Car insurance companies make money by collecting premiums from their pool of consumers. The money collected from the company's consumers “in case" of an accident is put away to pay out claims that are submitted.
The large majority of consumers won't file a claim during the span of their relationship with their insurer. This means that the insurance company typically has enough money from their consumers' premiums to pay out their claims, so you can feel comfortable knowing if something happens you'll be covered.
Insurance companies also ensure they don't lose money by imposing coverage limits, meaning they put a specific cap on what will get paid out, based on the customer's chosen premium. Simply put, if the customer pays more, he can elect a higher payout. This helps the company manage risk and make money in the long-term.