Determining the Right Auto Insurance Coverage

While we often worry about not having enough insurance, and this often is a valid concern, it’s also important to not have too much either. The key to getting the right amount of insurance of any kind, including auto insurance, is to realize what insurance coverage should be doing for us and then looking at how much of this we need.

Unless we realize that insurance is only designed for and should only be used to prevent our getting into financial difficulties that we cannot manage ourselves, we’re not really going to have a reference point to judge with.

People very often have a notion of insurance as protecting against losses generally, but we do not want to protect against all losses, only the ones that it makes sense to protect against. These are the big losses such as someone dying and leaving their loved ones without means of support, the loss of a home to a fire, the loss of an expensive vehicle to an accident, and so on.

Insurance, including auto insurance, should never be used to compensate us for losses that we can handle ourselves, because what happens is that we end up paying a lot more for this protection than it is worth. With some things, we have no choice because the consequences can be devastating, but with those things that can be handled financially, if we have the ability to bear the loss, we should never insure against these losses.

Once we understand this, then we can look at various events such as damage to our vehicle, damage to public property, injuries to ourselves and others we travel with, damage to other vehicles, and injuries to other people, and look to figure out which types of auto insurance make sense for us and how much.

Liability Auto Insurance

Liability insurance is the most basic form of coverage and is the one that the law requires one to have if being insured is mandatory where you live. This covers damage to other people’s property and other people’s injuries. This only kicks in if you are found to be at fault in a mishap, otherwise you are not liable to pay for other people’s property damage, injuries, or deaths.

The best way to think of liability insurance is protection against getting sued by other people, and if someone were to collect from you and you did not have liability insurance, they would need to sue you and win or have you settle the claim out of court.

Some areas require a more generous amount of liability insurance than others, with some being quite low indeed, perhaps not wanting to presume too much need where there may not be any. It would not make sense for someone who has no real assets to lose to buy more than a little liability insurance in fact.

The rule of thumb that is used here is to make sure that you are covered for the amount of your assets, although that’s not quite right, because someone may still be able to sue you if their claim is much higher than the amount your insurance company can pay.

With those who have significant assets to lose, higher net worth individuals in other words, it makes more sense to look at what sort of settlements for personal injury or death tend to be I their area, which is the way insurance agents approach this. If you do have quite a bit to lose, it is not unwise to seek to be adequately protected.

For those of more modest finances, they simply don’t have the ability to pay claims substantially larger than what most people already have for liability insurance, so this really isn’t an issue. If you are worth $50,000 or $100,000 and have a million dollars’ worth of liability coverage, it just won’t make much sense for someone to sue you for 2 million for instance rather than take the 1 million from the insurance company because your assets just aren’t significant enough.

Having enough liability insurance does mean protecting your assets and we do want to make sure that we do that, and this of course all comes down to how much we have to protect. If someone saw value in overprotection out of a sense of altruism for instance, that would be fine, just as long as they understood that they are exceeding the amount of personal protection they require and going beyond that to better protect others.

Often, the limits imposed by law will be more than sufficient, but if they are not, it is important to buy more coverage. It also makes sense not to buy coverage you don’t need, where for instance the minimum would represent an amount well above your assets and you don’t really have anything to lose if claims were larger.

Collision and Comprehensive Auto Insurance Needs

Most people are required by lenders to maintain both collision and comprehensive auto insurance, to protect the lenders against the risk of the property that has secured the financing on vehicles not be lost to mishaps.

If the car that you have a secured loan on or lease becomes damaged in an accident, lost due to theft, or by way of any other covered event, and you do not have coverage, the risk of your defaulting on your financial obligations to them goes way up. It’s not that you can’t afford the payments, but now you either have to pay out a lot of money to repair the vehicle or it might be lost completely to theft or damage, and you’re now without a vehicle but still have the payments.

This is what lenders are seeking to protect, not the vehicle itself so much, although if they did have to repossess it, they would like it to still be around and worth its typical residual value at the time. Lenders lose money when they do this but they at least get back a good portion of the money that is owed when they have to seize the vehicle due to people falling too far behind on the payments.

If our vehicles are owned free and clear, whether we have bought them outright, purchased them with unsecured lending or loans secured by something else, your home for instance, or if they have paid off their secured loans on them, we are now in a position to decide whether or not they wish to take out collision and comprehensive insurance on it.

We need to keep in mind what should be seen as the prime directive of insurance, which is that it needs to protect against unbearable financial losses, not bearable ones. If we could handle the entire loss of the vehicle, even if that meant losing a vehicle that is paid for and having to take out a loan for another one, then that’s not something we should be insuring against, as long as we can afford the payments.

If we cannot, which may be the case with people of little financial means, then this situation may be worth considering for them, although we do want to keep in mind that this insurance costs real money and if your cash flow situation is poor than you may not be able to afford the insurance either.

It’s always good to bear in mind that insurance always comes with a significantly negative expectation. With collision and comprehensive auto insurance, this means that you can expect to pay much more than the value of your vehicles over time. It’s not just the extra cost of the premium that you pay, it’s also the higher rates that come with making claims that could otherwise been avoided.

It’s not at all a stretch to say that insurance should only be used as a last resort in cases where there are no other good options, and we need to apply this to collision and comprehensive auto insurance as well.

Unless you are going to be put in a situation you cannot manage otherwise, it really does not make sense to buy these additional coverages. If there is no good alternative if the loss happens, then that’s the sort of thing we need to be paying more than something is worth to protect against.

Other Types of Auto Insurance Coverage

There are a number of other things that may be included in your auto insurance policy or may be added on separately if not, and we want to be especially diligent when assessing the need for these, as they often only involve fairly nominal amounts that generally can be managed without the coverage.

If you get in an accident and your car ends up in the shop for several days, you might pat yourself on the back for having coverage that pays for a rental car while yours is being worked on, but none of these things are provided for free.

You can expect to pay several times what you would have to put out if this happens, and if you had to pay all that money up front, this would be a lot more transparent. Smaller amounts over a long period of time much more easily escape our scrutiny though, and this is not about math, it’s about the principles of how insurance works. Companies make a profit from all insurance and that’s all you really need to know to want to avoid this if possible.

This does serve to simplify the decision though, as we need to ask ourselves if we would be placed in a bad enough financial situation if the event that we are considering insuring against happened, and if it turns out that the consequences would be unmanageable otherwise, then we should choose to be covered.

Otherwise, we should not choose the coverage, and while spending hundreds of dollars on something, including the first portion of a claim known as a deductible amount, is not anything that people enjoy, but they should enjoy less paying even more overall and being certain of this costing them money rather than just by way of chance.

The only exception to this is if someone represents a lot higher risk than their premiums would suggest, to the extent that their insurance is so underpriced that it might be a value in itself. This is not common though and might be the case if someone is subject to losing consciousness behind the wheel due to a medical condition or medication or other situations where the risk just hasn’t been captured by the pricing.

This is rarely the case though, and you can bet that the insurance companies have done their homework and are in a position to take considerably more of your money than they pay out. It is very wise to enter into such deals when we have to, but not so much when we don’t.

John Miller

Editor, MarketReview.com

John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.