The average auto insurance cost is about $1,200/year or $100/month. So this expense isn’t going to have a large impact on your cash flow whatever you decide.
However, auto insurance can protect you from a devastating financial event so it’s important to make sure you take the time to understand your coverage and protect yourself.
First off, let’s discuss the basics of an auto policy. There is basically coverage for three different areas:
- Coverage for Others
- Coverage for You (and your family)
- Coverage for Your Vehicle
I recommend insurance to protect against catastrophic events. You don’t really need insurance on your cell phone or your refrigerator. Sure, it’s expensive if those things break, but they aren’t catastrophic.
You causing an accident that totals 2 cars and injures 4 people who all choose to sue you is catastrophic. You clipping someone’s bumper is certainly not catastrophic. So make sure you have proper coverage for the big risks and if you want to skimp, do so on the small risks.
1) Coverage for Others
This area is often overlooked, but this is where your big risk primarily lies. If you hit a tree, it might be pretty expensive. If you hit a person, it’s going to be devastating on many levels.
This is the area you don’t want to go cheap. Even if you don’t have much saved, and therefore think you don’t have much to lose, you can still have your wages garnished in these cases.
Bodily Injury Liability (BI)
Bodily Injury Liability coverage pays if you are responsible for another person’s injury or death in a car accident. It pays for expenses like:
- Medical expenses
- Loss of income
- Pain and suffering
- Funeral costs
- Legal defense costs
If you injure a surgeon in a car accident, you can bet that “loss of income” and “pain and suffering” are going to add up to a pretty sizeable amount. Hopefully, you’re a good driver and this never happens to you, but there is really no reason to be driving around with this liability.
Since this is a catastrophic type of liability, I would recommend aiming high. You really want seven figures of coverage for this type of liability. I recommend getting the minimum amount your insurer requires for you to purchase an umbrella liability policy (I’ll post on umbrella insurance in the near future) on top of your auto policy. This tends to be about $250,000 per person / $500,000 per occurrence.
Property Damage Liability
Property Damage Liability pays if you are responsible for damage to another person’s property. It also pays for your legal defense. This can get relatively high if you are responsible for a larger accident that causes damage to several expensive cars, public property, someone’s home, etc.
Just like with your Bodily Injury liability, this can be fairly catastrophic so you want to aim high and get that minimum amount your insurer requires for you to purchase an umbrella liability policy. This tends to be about $250,000.
2) Coverage for You
Now we move on to covering you and your family members, or friends who might be in your car.
First Party Benefits
These provide you, any family member who lives with you and sustains bodily injury from a car accident, anyone who is a passenger in your car, or a pedestrian who is struck by the insured auto with the following benefits:
- Medical expenses
- Loss of income
- Funeral costs
- Accidental death
Uninsured Motorist Bodily Injury
This will pay for injuries to you or any passenger in your car caused by a driver without insurance. I recommend matching this coverage to your Bodily Injury liability – $250k/$500k.
Underinsured Motorist
This will pay for injuries to you or any passenger in your car caused by drivers who don’t carry enough coverage to pay for damages. Again, I recommend matching this coverage to your Bodily Injury liability – $250k/$500k.
Tort Liability
This allows you and other household members covered under your policy to recover all medical and other out-of-pocket expenses, as well as financial compensation for pain and suffering. In Pennsylvania where I live, you are incentivized (pay a lower premium) to accept limited financial compensation in these cases.
Personally, I don’t plan on going after someone if I’m injured or killed in an accident. If you have adequate life insurance, disability insurance, and health insurance, then you can probably save some money here and opt for the limited tort protection.
3) Coverage for Your Vehicle
Interestingly, this is probably the type of coverage most people think about and focus on when shopping for auto insurance. However, it’s the least important.
Yes, these are the claims you’ll most likely have (and may have fairly frequently), but these are not the ones that are going to make or break you financially. Whether you pay a $500 or $1,000 deductible for an accident isn’t going to have much bearing on your financial future. In other words, if you want to skimp, this is the place to do it!
Collision
This coverage pays for damages to your vehicle caused by a collision or when it overturns.
In general, I recommend increasing deductibles on insurance to save money on your premium cost and having a well-stocked emergency fund to take care of deductible expenses.
A $500 deductible tends to be the default, but it’s worth comparing to a $1,000 deductible to see if you can save some money. It’s pretty simple to calculate a break-even analysis.
By raising your deductible from $500 to $1,000, for example, you increase your liability by $500. If that only reduces your annual premium by $50, you’ll have to go 10 years without an accident to break even. That’s not a real enticing deal.
But, if increasing your deductible reduces your annual premium by $100, you’ll break even in just five years. Unless you’re a really terrible driver, that probably makes sense.
Comprehensive
This coverage pays for damage to your vehicle not caused by collision, such as theft, flood, vandalism, explosion, hail, and fire.
Again, a $500 deductible tends to be the default so it’s worth conducting another break-even analysis on a $1,000 deductible. However, comprehensive tends to be pretty inexpensive and doesn’t offer large premium discounts for higher coverage. You might even be better off with no deductible or a $250 deductible.
Let me stress again, that the vehicle coverage is not the area to focus, although it’s the more familiar aspect of auto insurance. You can typically save some money with higher deductibles, which will likely offset the increased premiums from raising your liability coverage.
Wrapping Up
I hope this helps the next time you’re reviewing your auto insurance or shopping around for lower prices.
The bottom line for most situations is to increase your deductibles for vehicle coverage (collision and comprehensive) and increase coverage for liability (bodily injury and property) for others and yourself.
By doing so, you will significantly protect yourself against financial disaster while assuming a little more risk on fender benders.
If you have any questions, don’t hesitate to schedule a quick call with me to discuss. Thanks!
