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What Is Auto Insurance?

Auto insurance is made up of several parts that help pay for damages to cars and people as the result of an accident or vehicle damage. Drivers pay periodic payments (called insurance premiums) to an insurance company so that in a case of an accident, the insurance company pays all or most of the costs to repair the damage. The cost of insurance varies widely and is based on many factors, including driving history, age, gender, and more.

Car insurance works on the principle of fault. If a driver is at fault of causing an accident, he's responsible for paying the damages resulting from his driving. If he has insurance, his insurance should step in and pay for the damages.

Types of Car Insurance

Car insurance isn't one size fits all -- there are essentially 7 different types of insurance:

  1. Liability Insurance: This type of insurance doesn't cover your car. Instead, it covers any damage to persons or property that result from an accident that's your fault.
  2. Collision Insurance: This type of insurance covers damage to your own vehicle.
  3. Comprehensive Insurance: While liability and collision insurance pays for damage that results from an accident, comprehensive insurance covers damage that results from things like bad weather or theft.
  4. Uninsured Motorist Coverage: If someone else is at fault and causes damage to your vehicle, their insurance should pick up the tab. But if they're not fully insured, that's where uninsured motorist coverage kicks in, paying the cost of damages caused by someone else.
  5. Bodily Injury Liability Coverage: If you cause injuries as the result of a car accident, this type of car insurance should pay for an injury to another driver (and passengers). Frequently, these policies are quoted as "20/50" or "100/300" -- these numbers refer to the maximum amount of coverage for injuries to an individual (say, $20,000) and to a group (say, $50,000).
  6. No-fault Insurance: When somebody causes damage to someone else as part of a collision, they -- and their insurance -- are responsible to pay the damages. Because you can't control how comprehensive another person's insurance policy is, some people buy no-fault insurance. No fault pays for damages, regardless of who caused the damage.
  7. Gap Insurance: Gap insurance comes in handy if you're still making car payments. If you're car is totaled, gap insurance steps in to pay off your car -- especially useful if you owe more money on a car than it's currently worth.

Your Deductible: A Number With Big Meaning

All insurance comes with a deductible -- this is the amount of money that an insurance holder pays out of pocket first before an insurance company kicks in with its payment. Many insurance policies are cheaper to buy because they require a higher deductible before they start paying.

You can figure out how much you'd save by having a higher deductible in your insurance policy and decide whether it's worth going with a higher yearly premium payment or living with a larger deductible.

Cost of Auto Insurance

How much car insurance costs depends on many factors. The cost of your insurance policy is affected by things related to driving, including things like how many accidents you've been in, whether you've received speeding tickets, how many years you've been driving, and how many miles you drive per year.

And according to a recent survey, insurers are using more and more non-driving factors (like your gender, occupation, the neighborhood you live in, and whether or not you have a college degree) to determine how much your policy costs. Some of these factors can drive up policy costs by $2,000, leading some analysts to conclude that low-income families pay the most for car insurance. So, it's really important to shop around and try to get the best quote.

According to the National Association of Insurance Commissioners:

  • Average Cost of Car Insurance: The average cost of car insurance in the U.S. is $795 per year (this includes only liability coverage -- the minimum required by states).
  • State With Cheapest Insurance: North Dakota boasts the lowest average cost for auto insurance among all states at $529.
  • State With Most Expensive Insurance: New Jersey has the highest average cost for car insurance ($1157).

In just the first few months of 2013, the average policy has gone up $153, a 35% increase from 2012 (JDPower study).

By the way, did you know that according to the Wall Street Journal, Californians pay roughly the same for car insurance today that they did 25 years ago?

Why Do Riskier Drivers Pay More?

Insurance companies determine the likelihood of a driver getting in an accident before they give a quote for a new policy. So, it makes sense that riskier drivers pay more for their car insurance policies. What constitutes a risker driver?

A study published in Injury Prevention analyzed over 1,000 drivers with the following outcomes:

  • Young men are more likely to display risky driving behavior than young women
  • Certain personality characteristics can be blamed for risky driving (inattention, less attachment to traditional values, sensation seeking and impulsiveness)
  • High levels of aggression can be linked to a higher chance of causing a crash

It's pretty clear there is a connection between driver behavior and accidents. The AAA Risky Driving Report documented that drowsiness, driving too long, being angry behind the wheel and aggressive driving all lead to risky driving behavior.

Percentage of crashes or near-crashes and incidents where Driver States were present

Many states require risky drivers who have been caught driving without insurance or with accidents on their records to file a Form SR-22 (example from the Alaska Department of Motor Vehicles)

Risky drivers can get insured but it may take some more shopping around and they will typically pay more for car insurance.

Do I Really Need the Insurance Car Rental Agencies Offer Me?

The answer is maybe and it begins with understanding your own policy. It's worth taking the time to understand exactly what your regular car insurance policy covers before you get to the rental car counter. Many things are covered in your standard policy but some aren't -- like the loss of value to a rental car after an accident (could be thousands of dollars) or loss of rental income (the car rental can't rent it a car when it's in the shop).

Paying for a rental car with a credit card that has rental car insurance may also help you avoid for paying extra for insurance. What credit cards cover varies -- here's a useful chart to compare credit card rental insurance.

What Could Possibly Happen If I Drive Without Insurance?

Driving without insurance -- even if you're just driving a rental -- isn't a good idea. Too much can go wrong. Here are just a few examples of the consequences of driving without car insurance.

  • Fines: If you're caught driving without insurance (remember, states require insurance to drive a car) you could be fined $200 to $1000 for a first time offense, rising with repeat infractions.
  • Suspended License: You may face getting your license suspended for 3 months or more if you are cited for driving without insurance.
  • Marks on Your Driving Record: You may receive marks on your driving record if you are found driving without insurance.

A Brief History of Car Insurance

It wasn't too long after the first automobile was created by Karl Benz (1885) that the first car accident occurred in Ohio City, Ohio (1891) when an engineer ran his buggy into a tree. From that point on, the beginning of the auto insurance industry took root. (Source)

  • First Car Insurance Policy (1897): Ohio was also the home (Dayton, to be exact) of the first written auto insurance policy. Gilbert J Loomis paid $1000 to be covered in case his car injured another person or his property.
  • First Auto Insurance Company (1897): When Loomis bought the first car insurance policy, he did so from a firm that would turn into the Travelers Insurance Company.
  • First Laws Governing Auto Insurance (1925): Connecticut and Massachusetts became the first states to require financial responsibility (read: insurance) before getting behind the wheel. (Source)
  • Move to No-fault Insurance (1970s): Throughout the decade of the 1970s, 24 states adopt no-fault insurance laws.
  • Revenues: The car insurance industry has $178 billion a year in revenue which is pretty much where the industry was about 5 years ago.
  • Employment: The auto insurance industry employs 249,051
  • 5 biggest players: In terms of market share, the five largest car insurance firms are State Farm Insurance (18%), Allstate (10%), Geico (9%), Progressive Insurance (8%) and Farmers Insurance (6%)
Source: IBISWorld, A.M Best Auto Insurance Market Share

Tips on Lowering Your Costs

Car insurance is a highly regulated industry in the United States. Rules and regulations are handled at the state level -- different geographies have different requirements and laws. Some of these differences in local regulation account for the wide differences in the cost of auto insurance throughout the country.

  • Shop Ahead: Spend time searching out the best car insurance policy for you at the best price.
  • Go With Higher Deductibles: The easiest way to lower your costs for automobile insurance is to take a policy with a high deductible. It's risky -- but over the life of your car, it could make a lot of sense.
  • Hunt Out Discounts: Your insurance agent may not offer them upfront, but there are a lot of discounts available out there for the taking. You can see your premiums reduced for so many things: good grades, good driving, taking a defensive driving course, telecommuting a couple days a week, being married, even liking your insurer on Facebook. If you don't ask, you may not get these discounts.
  • Remove Towing: By being responsible -- making sure you don't run out of gas, have a spare tire on hand, keep your car in working condition -- you can save money on your policy by removing coverage for towing. In the case of an accident, towing is probably covered by your collision coverage.
  • Don't Buy a Teen His Own Car: In many cases, it will be cheaper to add a teenage driver to an existing policy if he or she drives the parents' cars and not his or her own (the insurer assumes the teen will drive less).
  • Drive Safely: Understand the risk you take by driving aggressively or inattentively. The better you drive, the cheaper it will be to insure you.
  • Consolidate Your Insurance Policies: You might be able to save money by using one insurance company to handle all your insurance policies
  • Pay Yearly: Though it may feel easier to pay for a policy monthly, most insurance companies charge a few bucks more per month for this type of billing. Try paying every year instead.
  • For Teens -- Get Your License Early: insurance companies ask you when you were first licensed. It doesn't even matter how much driving you've done. You'll thank yourself later if you get your license young. (Source: Reddit)

Future of Auto Insurance

With iPhone apps like social-driving Waze or in-car systems like GreenRoad that continuously monitor driving behavior, the future of auto insurance may include more personalized policies and pricing. Think about it -- right now, if you're a good driver (and really cheap to insure), part of your policy pays to insure all the risky drivers in your area. If technology can really determine how good a driver you are, insurance companies can tailor make policies, personalizing risk.

Many have called for national regulation of the car insurance industries (instead of states like it is now). According to this analysis, service quality would be improved and prices come down as the whole system becomes more efficient.

Technology is also helping to make driving safer. Like Google's self-driving cars, the future of auto insurance will see fewer accidents due to automatic braking, telematics, location awareness, vehicle-to-vehicle (V2V) communications, improved stability control for large commercial vehicles, and collision avoidance sensors. Auto Insurance will definitely look different in this future environment.

U.S. Vehicles Reported Stolen (1960-2013)

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