How Does Car Insurance Work?

Car insurance is important, it’s what will make sure you don’t have to pay out of pocket for accidents. And it isn’t optional, 48 states require drivers to maintain current auto insurance in order to legally drive a car. There’s a lot that goes into your auto insurance policy, but don’t worry, we’ve broken down everything you need to know. 

What is Car Insurance?

Auto insurance is a contract between you and an insurance company. In the event of an accident, vandalism, or theft, the insurance company will cover your financial loss — with limitations. In exchange for this protection, you’ll pay a monthly or annual fee called a premium. An auto insurance policy usually lasts for six months or a year, and most providers allow you to choose the length you prefer. You’ll also likely have the option to pay for the entire term up-front, or on a monthly basis. 

Like other kinds of insurance, auto insurance covers specific perils with some conditions — it’s not a blank check for anything that happens to your car. While every policy is different depending on your provider and coverage options, in general, auto insurance covers:

• Property damage – for anything your car might hit
• Medical costs – for injuries
• Liability costs – for legal fees

How Does Car Insurance Work?

There are hundreds of auto insurance companies in the United States, from national providers like Amica, Allstate, and State Farm to regional ones like the New Jersey Manufacturers Insurance Group. Each company offers customizable policies depending on what coverage you need or want. 

In addition to basic liability and property damage coverage, you can also purchase add-on auto insurance options like:

• Collision coverage – for damage to your car as a result of a collision
• Comprehensive coverage – for damage to your car caused by other things, like theft, vandalism, and some natural disasters
• Personal injury protection (PIP) – for medical costs to the driver and/or passengers in your vehicle, and
• Uninsured/underinsured motorist coverage – in case another driver involved in your accident doesn’t have enough insurance.

Auto insurance also covers any additional family members you add to your policy and anyone who drives your car (with your permission). However, personal auto insurance won’t cover your car when you’re driving it for business purposes, like delivery or ride-sharing services. For that, you’d need specialized rideshare insurance. 

Many drivers have unique coverage needs that go beyond these fundamentals. If you own a custom or vintage car, you’ll need extended coverage. These are just a few popular coverages that can be added to your auto insurance for better protection:

• “Gap coverage” (loan or lease payoff)
• Accident forgiveness
• Roadside assistance and towing
• Rental reimbursement
• Umbrella liability insurance
• Rideshare insurance
• Custom parts and equipment coverage
• Pet injury coverage

Every insurance company has a different coverage selection. Compare a few of the best auto insurance companies to make sure you’re choosing a provider that fits your unique needs. If you’re not sure what those needs are, we recommend working with an independent agent who can help build your policy and compare insurers on your behalf.

What’s included in “full coverage” auto insurance? 

Many insurers claim their policies offer “full coverage” without detailing what that means. But here’s the thing, it doesn’t really mean anything. 

“Some agents use ‘full coverage’ as a shorthand way to describe auto policies that only meet state minimum limits for coverage,” says Jonathan O’Steen, personal injury attorney and partner at O’Steen & Harrison LLC. “True full coverage would provide unlimited protection for all losses arising from an automobile accident.”

Don’t be fooled by insurance jargon that might leave you underinsured. Talk through all your standard and supplemental coverage options with your agent rather than opting for a catch-all plan that sounds sufficient. The truth is, such a plan doesn’t exist.

Learn what true “full coverage” looks like

How Much Does Auto Insurance Cost?

According to 2021 data from Bankrate.com, the average cost of an insurance premium is around $1,674 per year for full coverage, though everyone pays a different rate based on where they live, their age and driving history. Nailing down exactly how much you’ll pay is easier said than done. Each company will have its own algorithm for calculating premiums, so your best bet is to compare quotes as often as you can. Car insurance premiums vary are based on a number of factors, including:

• Age
• Gender
• The state you live in
• Your car type
• Your driving history and habits
• Your credit score
• The coverage amount you pick
• The coverage type you pick
• Education level
• Profession

According to Bankrate.com, the state with the highest average premium for full coverage is Louisiana ($2,724 per year), while Maine enjoys the lowest average premium for full coverage ($965 per year).

Is Car Insurance Required?

There are two states, New Hampshire and Virginia, that don’t require auto insurance, though drivers are still financially responsible in the event of an accident. No matter where you live, auto insurance is the only way to protect yourself from paying tens of thousands of dollars for repairs, as well as medical and legal costs.

All drivers are required to prove “financial responsibility” for their vehicle and driving habits. In almost every state, that means purchasing at least the minimum required bodily injury liability and property damage liability insurance. (Those are the coverages that make your own insurer pay for another person’s losses if you’re at fault for a collision.) Some states also require drivers to purchase uninsured/underinsured motorist, medpay, or PIP coverage.

See auto insurance coverage requirements in your state

How much car insurance do I need?

All drivers have to purchase at least the minimum auto insurance coverage requirements in your state. For full financial protection, most experts recommend choosing higher limits than the state minimum for liability, as well as supplemental coverage. Though in the end, it’s up to you and your budget. 

To give just one example, O’Steen suggests buying at least:

• Bodily injury liability: $100,000 per person, $300,000 per collision
• Property damage liability: $50,000 per collision
• Medical payments: $50,000 per collision
• Uninsured motorist: $100,000 per person, $300,000 per collision
• Underinsured motorist: $100,000 per person, $300,000 per collision

Better coverage will cost a little more, but raising limits is often more affordable than people think. See for yourself: Most online quote tools let you check rates for different coverage tiers so you can see how much insurance fits comfortably within your budget.

When Should I Buy Car Insurance?

You’ll need car insurance on or before the first day you use your vehicle. The good news is: You get to select the start date for your coverage, so you can start shopping for insurance as early as you want without having to pay for coverage when you’re not on the road.

Even if you’re not insuring a new car, we recommend checking rates regularly to make sure you’re still getting a fair rate from your current insurer. It’s especially important to compare quotes after a major life event that can impact insurance rates, including:

• Adding a new driver to your policy
• Getting married
• Buying a home
• Moving to a new state or city
• Passing the three-year mark after an accident
• Passing a big birthday (25, 30, 40, etc.)

After all, 40% of drivers don’t shop for insurance as often as they should.

The Bottom Line

For the majority of states across the country, you must carry an auto insurance policy if you drive a car. Each state will have its own minimum requirement, but beyond that, how much and type of coverage you choose is up to you. Given there are so many car insurance companies out there, your best bet is to shop and round and compare as many quotes as you can.