How Does Car Insurance Work?

Car insurance coverage financially protects you if your car is stolen or vandalized or an accident causes injuries or property damage. In this guide, we’ll give you an overview of how car insurance works and what the basic types of insurance cover. We’ll also recommend two of the best car insurance companies from our research.

Key Points:

• Car insurance is a contract between you and the insurance company to protect you financially in case of an accident or incidents such as theft or vandalism.
• Depending on your situation, you’ll choose between minimum and full coverage.
• Insurance rates are impacted by factors including where you live, your driving history, and the type of vehicle you drive.

Based on a contract between you and your insurance company, car insurance provides financial protection in case of an accident, theft, or damage that affects your vehicle. You pay an insurance premium, and in return, your provider agrees to handle up to a certain amount of costs associated with repairing or replacing vehicles or treating injuries resulting from a collision.

Car insurance helps you avoid huge, unexpected bills if something happens on the road.

There are several standard types of car insurance coverage, each with its own purpose. When selecting your coverage options, you’ll need to consider what’s required in the state where you live and what’s best for your situation.

Minimum coverage consists of the types and amounts of coverage your state requires. That typically includes liability insurance (for property damage, bodily injury, or both), with some states adding medical coverage or uninsured/underinsured motorist protection.

Full coverage generally includes liability insurance, as well as collision coverage and comprehensive coverage. When you have a loan or lease on your vehicle, your lienholder–the lender or leasing company–will typically require you to carry full coverage on the car until your loan is paid off or your lease ends.

Types Of Car Insurance

Below, we’ll explain six of the most common types of car insurance. Liability insurance, which is mandatory in most states, can be combined with the five other standard coverage types and optional add-ons to create the custom insurance coverage that works for your needs and budget.

Liability Insurance

Liability car insurance protects other drivers and their passengers in the event of an accident that’s your fault. It’s required in all states except for Virginia and New Hampshire.

If you’re at fault for an accident, your liability coverage will pay for the other parties’ injuries and property damage, up to the limits of your auto policy. Without property damage and bodily injury liability insurance, you’d be responsible for paying these costs out of pocket, which could be financially devastating.

Minimum liability limits required by your state may not be enough to cover the damages in a severe accident, so it’s recommended to opt for higher policy limits for greater protection.

Collision Insurance

Collision insurance covers repairs or replacement for your vehicle up to its actual cash value (ACV) regardless of who’s at fault for an accident. This type of coverage also covers vehicle damage from objects you hit, such as a fence.

If the repair costs are more than your vehicle’s ACV, your insurance carrier can declare a total loss. When that happens, your insurance company reimburses you for your vehicle’s ACV to put toward a new car.

Comprehensive Insurance

Comprehensive insurance covers damage to your vehicle that isn’t caused by a collision with another vehicle. This can include:

• Theft
• Vandalism
• Fire
• Natural disasters
• Extreme weather events
• Hitting an animal, such as a deer or a moose

Uninsured/Underinsured Motorist Insurance

Even though it’s against the law in most states, some people drive without auto insurance. Uninsured motorist coverage (UM) protects you, your vehicle, and any passengers in your car if you’re in an accident with someone who doesn’t carry insurance. Underinsured motorist coverage (UIM) provides the same protection if you’re in an accident with a driver whose policy limits are too low to cover all of your damages.

UM and UIM insurance can cover bodily injuries (UMBI/UIMBI) and property damage (UMPD/UIMPD).

Personal Injury Protection (PIP)

PIP insurance provides coverage for medical expenses, lost wages, and funeral expenses for you and your passengers. One of the benefits of PIP is that it doesn’t matter who’s at fault for the accident.

This coverage is required in no-fault states, where each party seeks reimbursement for medical expenses through their own car insurance regardless of who caused an accident.

Medical Payments Coverage (MedPay)

MedPay coverage also helps you pay for medical bills or funeral expenses for yourself and your passengers. Unlike PIP insurance, MedPay doesn’t cover lost wages. This type of insurance is available in at-fault states and doesn’t carry a deductible like other PIP often does.

Optional Coverages

In addition to the six most common types of auto insurance coverages, many insurance companies offer add-ons like these:

• Rental reimbursement: Pays for a rental car while your vehicle is in the repair shop after an insurance claim
• Roadside assistance: Covers the costs of services such as towing and fuel delivery 
• New car replacement coverage: Gets you a new model of your totaled car instead of just paying out its depreciated value
• Gap insurance: Pays the difference between your car’s ACV and the amount left on your auto loan
• Rideshare insurance: Additional coverage that protects you if you drive for a company such as Lyft or Uber

While your auto insurance policy may cover many things, there are situations where your coverage won’t apply. Some of those situations include:

• Damage you do intentionally, like breaking your car window to get your keys
• Normal wear and tear such as rust or small dents or scratches
• Aftermarket customizations such as tinted windows or special tires and wheels
• Routine repairs and maintenance

In most states, having car insurance is mandatory. Each state sets its own minimum amounts for coverage. A common minimum insurance requirement is 25/50/25, which has three parts:

• $25,000 in bodily injury liability coverage per person
• $50,000 in bodily injury liability coverage per accident
• $25,000 in property damage liability coverage

These are minimums, and you should consider higher policy limits to adequately protect yourself.

Virginia and New Hampshire don’t have laws requiring car insurance. However, Virginia requires uninsured drivers to pay a $500 fee each time they renew their vehicle registration, and New Hampshire requires them to demonstrate their ability to cover damages if needed.

The amount of car insurance coverage you need depends on many factors, like where you live, who drives your vehicle, and how often you drive. An insurance agent or broker can help you determine what coverage limits or add-ons might work best for you.

You may be inclined to purchase the minimum amount of insurance coverage mandated by your state’s laws. However, minimum coverage may not adequately protect you and your assets. Unless you drive an older or low-value vehicle and can pay for repairs and medical bills out of pocket, it’s better to carry more than the required coverage.

A good baseline to start from is carrying 100/300/100, or $100,000 per person and $300,000 per accident in bodily injury liability coverage and $100,000 in property damage liability coverage. Having uninsured motorist coverage is also a good idea.

The national averages for car insurance costs are $1,730 per year for full coverage or $635 per year for minimum coverage. That works out to about $144 and $53 per month, respectively. The amount you’ll pay will depend on your coverage choices and information about you and your car.

Factors That Affect Car Insurance Costs

Insurance companies assess the risk of insuring you based on many factors, which they evaluate to set your premium. Here are some of the most common factors insurance companies consider:

• Location: Where you live determines whether there is a greater risk of accidents, car thefts, and weather events. For example, drivers in urban areas usually pay more than those in rural areas.
• Age: Drivers who are teens or 70 tend to pay more for coverage.
• Gender: On average, men pay more than women for car insurance.
• Marital status: Married drivers usually pay less than single drivers.
• Credit history: Your credit report shows how well you pay debt and make on-time payments.
• Vehicle information: The type of vehicle you drive directly impacts the price of coverage, because it affects your car’s value and the cost of repairs.
• Driving record: Your driving record shows your safety record and demonstrates how capable you are of driving without incident.

Some states have laws restricting the use of age, gender, marital status, or credit history for setting car insurance rates.

Since different companies offer different rates, discounts, and add-on coverages, it’s a good idea to shop around for auto coverage. Here’s how to get car insurance:

Compare Quotes

Rather than getting a car insurance quote from a single provider, compare quotes from at least three. That way, you can see which company has the best price for the coverages you need. Most insurance companies offer quotes online or through agents.

Choose Your Deductible

Opting for a higher deductible (the amount you must pay before your insurance covers expenses) can get you a lower premium. However, you should only do this if you have the money to cover that deductible if you need to file a car insurance claim.

Find Discounts

Insurance companies offer discounts for a variety of things. Shop around for the car insurance discounts that apply to you, which can include things like these:

• Bundling multiple policies with one company
• Making automatic payments
• Being a good student
• Being a member of the military
• Enrolling in a telematics program that monitors your driving behaviors

Auto insurance protects you in a car accident or if your car is damaged by the environment, theft, or vandalism. Whether you’re at fault for an accident or not, it’s important to have enough car insurance coverage to help you pay for expenses related to damage or injuries. Work with your provider to find the best coverage, deductible, and discounts for your situation.

Recommended Providers For Car Insurance

Compare at least a few providers before buying a car insurance policy. We’ve researched the best auto insurance companies, and we recommend State Farm and Geico as good starting points for getting quotes.

State Farm: Best Overall Provider

State Farm is the largest car insurance company in the nation and often receives high scores in J.D. Power consumer studies. We gave it our Best Overall Provider award because of its excellent reliability and customer service ratings in our industry review. State Farm’s Drive Safe & Save™ program is a good choice for safe drivers looking for a discount for their habits.

Geico: Best For Discounts

As the country’s third largest auto insurer, Geico offers a full range of coverage options and discounts. We named the company Best for Discounts because it offers 16 savings opportunities and has some of the cheapest car insurance rates on average. Its usage-based program, DriveEasy, also gives discounts for drivers with good habits.

How We Rate Insurers

Our review process aims to deliver consistent and unbiased assessments of car insurance providers. While there are multiple qualities that make a car insurance company successful, our review team focuses on those we believe are the most important for consumers:

• Cost: Cost can be difficult to compare between insurers because so many factors impact annual premiums. The cheapest insurer for one driver may not be the cheapest for another. To determine our cost score, we look at insurance rate estimates generated by Quadrant Information Services, discount opportunities, and consumer reports.
• Coverage: To determine our coverage score, we look at the number of coverage options available as well as coverage limits and deductible options. Our ratings also take into account additional services and benefits like roadside assistance.
• Reliability: It’s important that an auto insurer is able to meet its claims obligations. Companies with a strong financial strength rating from AM Best score best in this category. Established insurers with a long history of reliable service also receive positive marks.
• Service: We comb through customer reviews on sites like the Better Business Bureau (BBB) to learn about customer experiences. Insurers with a low volume of complaints score well in this area. We also consider the claims process, giving higher ratings to car insurance providers that offer easy-to-use claims apps.

*Data accurate at time of publication.