Auto Insurance

Most states require car owners to carry auto insurance or show they can pay for damage they cause, but insurance matters for more than just following the law. Its main job is to limit your financial risk - and that goes well beyond paying for repairs to your own car.

Lawsuits do happen after accidents, and the costs can add up quickly. In the event of an at-fault accident, meaning you or an insured family member caused the accident, the costs can easily exceed the minimum coverage amounts required by most states. 

Depending on the severity of the incident and the damages claimed, legal defense fees, court costs, settlements, and judgments if you are found liable can amount to tens or even hundreds of thousands of dollars. So, if you're found responsible for damages in a car accident and don't have sufficient insurance, your assets and future earnings could be at risk to fulfill the legal judgment.

How Auto Insurance Plays a Role

While the absolute risk of a catastrophic accident may be slight, insurance can play a critical role in long-term financial planning. For many drivers, a policy that only meets the state minimum may not be enough to cover the financial risks of an at-fault accident.

Today, many states have a minimum bodily injury coverage requirement of just $25,000 per person per accident. But the cost of hospitalization, rehabilitation, loss of income, and damages to compensate for suffering could reach hundreds of thousands of dollars (or more). Without adequate coverage, anything over the policy limit would be your responsibility.

As a refresher, there are three main types of auto insurance:

• Liability Insurance - A policy that pays for damages caused by your car. These damages include property losses, medical bills, and personal injury compensation. 

• Collision Insurance - A policy that can help pay for damage to your car from a collision, whether or not another driver is involved. Payment is subject to your deductible, policy limits, and any exclusions. Liability and comprehensive coverage work the same way - what a policy pays is limited by its terms.

• Comprehensive Insurance - A policy that covers losses to your car that don't involve a collision. Examples include theft, vandalism, a falling tree, and other events that could damage the vehicle. 

In addition, other types of coverage you may consider, if not required in your state, include uninsured and underinsured motorist coverage, medical payments coverage, personal injury protection, and more. 

We can't cover the details of every type of coverage, but in the context of our long-term financial planning theme, purchasing liability insurance beyond the minimum requirement is important. Some guidelines point to $100,000 in liability coverage per person and $300,000 total per accident as a common starting point for comparison. The amount that fits your situation depends on factors like your assets, income, state requirements, and how much risk you are comfortable carrying.

But what if you don't have substantial assets? Remember that judgments can also garnish your future earnings. And not being able to pay right now doesn't remove your legal responsibility.

Minimizing Insurance Cost

Purchasing more than the minimum required coverage increases any policy's cost. While some factors used to calculate rates, like your age and location, are beyond your control, there are steps to consider that may reduce costs.
 
A Clean Driving Record
Maintaining a clean driving record is one of the more direct ways drivers can keep premiums lower. A single speeding ticket can cause a dramatic increase in rates that can last for years. The specifics vary by state and insurer, but in some cases, one ticket can increase premiums by nearly 50%. Getting quotes from other insurance companies can be worth your time if you get a ticket and a significant premium increase. 
 
Choosing a Higher Deductible
Another option for reducing costs is choosing a higher deductible, which is the amount you pay before the insurance company pays. For example, if your deductible is $500 and a hit-and-run driver damages your car, you would pay the first $500 before your coverage kicks in. In general, higher deductibles are associated with lower premiums, though the actual savings depend on your insurer, vehicle, and policy details. But this strategy is only effective if you can afford the higher deductible and your lender permits higher-deductible policies if your vehicle is financed.
 
Insurer Discounts
Some insurers will offer discounts if your car has optional safety and anti-theft features, is driven fewer than 5,000 miles per year, is not used for daily commuting, or your coverage is bundled with other policies (like renters or homeowners insurance). Some insurers even offer discounts for students with a certain grade point average. It can't hurt to ask about discounts on both existing policies and when getting quotes for new policies.
 
Maintaining a Good Credit Rating
Believe it or not, your credit rating may also affect insurance rates. Your "insurance score" is primarily based on your credit history and is used to predict how likely you are to file a claim. Each insurance company uses its own method for incorporating credit scores into rate calculations, but higher scores typically mean lower rates. A few states restrict or prohibit the use of insurance scores, while most currently allow it. Rules vary by state and can change, so it is worth checking the current rules where you live.
 
The Takeaway 

Whatever you decide on liability coverage amounts, remember that damages beyond your policy limits will be your responsibility. Boosting optional coverage does cost more, but the potential benefits are compelling for many individuals.

If you need clarification on how much liability coverage is appropriate for your situation, please consult a qualified professional.