Saturday, January 3, 2009

Understanding Auto Insurance

Auto insurance comprises a number of different components, of which one is collision insurance.  Understanding these components and what you are paying for them is important.

Automobile Insurance can be very confusing - and expensive. Coverage is broken down into a number of categories, including liability, medical, collision, comprehensive, and uninsured motorists insurance.

Note that required coverages vary from State to State.  Most Agents, when preparing a price quote, automatically add on coverages that you may not need.  Scrutinize your policy carefully - it may turn out you are paying double for basic coverage, with add-ons that are pricey and provide little in real coverage for you or your vehicle.

1. Liability Insurance is the big ticket. If you smash into someone and they sue you, you don't want to be bankrupted by such an accident.  (Of course, if you are poor, you have no assets to protect, so buying additional coverage often makes no sense).  The best bet in this category is to get a standard rate of coverage (e.g., $300,000/$100,000) and then buy additional liability in an "umbrella" policy  if you need it.  Not only is it cheaper in terms dollars spent for coverage, it covers all sorts of different types of liability.

2. Medical Coverage is often overpriced and covers little. In one policy I had, the agent automatically added $10,000 of medical coverage for $150 in premium (six months). This is not a lot of coverage for quite a lot of money. If you already have health insurance, chances are, this medical policy will cover little more than your deductible. I cancelled this coverage, as it seemed like a lot of money for not a lot of payout.

3. Collision Insurance, like the name implies, will cover the cost of collision repairs if your car is damaged in an accident. If you have a loan on your car or lease your car, you are usually required to have this, with a $500 deductible. You can save a lot on collision by going to a higher deductible ($1000) which eliminates frivolous claims.  But check with your lender first to see if this is permissible.

Some folks would say "Well, then that doesn't pay for a minor collision!" And this sort of comment illustrates the two views of insurance, and why insurance is so expensive these days. Some people view insurance as a Chinese take-out menu, looking at the claims possible and then saying "I'll have one of these and these and these". They want an accident or other claim event to be like an all-expenses-included spa vacation holiday. Others, like myself, look at insurance as a safety net, for emergencies only, to HELP cover the cost of disasters. If you take the latter approach, you'll spend a lot less on insurance.

3. Comprehensive Insurance, like collision, covers damage to the vehicle from other sources, such as hail damage, or a tree limb falling on the car. Again, if you have a loan or a lease, you are required to have this coverage, usually with a $500 deductible. If not, you can raise your deductible to $1000 and save a lot of money.  Again, check with your lender, if any, to see if this is permissible.

At some point, of course, Collision and Comp don't make much sense, no matter how good condition your car is in. One mistake many folks make is in assuming that because their car is worth (to them) thousands of dollars, that the insurance company will pay out that amount. Most car insurance companies only pay out "book value" such as the KBB, NADA, or Edmunds values for a car. So, even if you installed a $5000 sound system in your car, your insurance company will not pay for it, unless it was declared as part of the policy.

For example, Jim buys an old Honda Civic. He takes it to a professional "tuner" and has $20,000 of work done on the car, including ground effects, suspension, engine mods, a big fiberglass wing, and a cool custom paint job. He re-does the interior in suede and puts in over $5000 in audio and video equipment. The car catches fire and burns to a crisp. His insurance company offers him a check for $5000, the "book value" of a used Honda Civic. Jim is outraged!

The problem is, Jim insured the car as a plain old Honda Civic, which is worth $5000. The insurance company assumed that is what they were insuring, and he paid a premium based on the base value of the car - not all the "mods" he added. You can't blame the insurance company for not paying off on a risk they did not assume.

Jim's experience illustrates why "mods" are not worthwhile. Chances are, even if he disclosed these "mods" to his insurance company, they would not insure him, as such modifications are worth far less in resale value than the cost of installation. So taking Jim's business is a sucker's bet - Jim would be motivated to torch his own car, once he realized the resale value was far less than the amount "invested".

If the premiums on Collision and Comp are more than 1/10th the BOOK value of the car, it is time to drop collision and comp, in my opinion.  For example, I have a 1995 Ford F-150. Since I have taken care of this truck, it looks like the day it was made. No rust, no scratches, no dents. Unfortunately, the "book" value on this truck is about $3500 on a good day. No matter how much I could plead and beg with the insurance company, they would argue (correctly) that I could buy a similar vehicle for $3500 all day long. So minus the $1000 deductible, $2500 is all they would pay out, period, and that is only fair.

Collision and Comprehensive insurance for that truck would run about $250 a year. Not a lot of money, but about 1/10th the value of the vehicle. Since most folks get into an accident about every 11 years (on average), statistics would argue that paying for Collision and Comprehensive insurance on this truck is not a good bet.

And that's all insurance is, a bet. It is a form of legalized gambling. You are betting that you are a horrible driver and will wreck cars all the time. The insurance company is betting that you are a good driver and will never file a claim. The lower the deductible and the higher the coverage, the better this bet is for you - and the higher the cost of the bet (lower odds). If you are a sharp gambler, you'll take the bet with the longer odds and the lower buy-in.

Most car owners obsess over their collision coverage, wrongly thinking that damage to the shiny objects parked in their driveway represents their largest exposure.  However, where their real exposure is, is in a wrongful death suit or a personal injury suit.  If your $20,000 car was totaled and you had no coverage, you could easily recover from such a setback. On the other hand, if you are sued for a million dollars, it would wipe you out, take everything you own, force you into bankruptcy, and destroy your credit rating. Where is the real risk?

4. Umbrella Liability Coverage on top of basic liability is the most important coverage you can get. Coverage for damages to vehicles is trivial compared to that exposure.  A better bet than buying additional liability is to ask about a separate "umbrella" policy that will cover you for all sorts of liabilities - up to $1 million or $2 million for only a couple of hundred dollars a year.

5. Rental Car Coverage: There are a number of other "junk" coverages usually added on by most Agents, without your authorization. If your Agent does this, change agents or companies, as the Agent is acting in their interest, not yours. Rental car insurance is one such coverage. This coverage provides a rental car in the event your car is damaged and needs to be repaired under the collision policy. The Agent will tell you it costs only pennies per day, but in reality, the odds of your collecting on this are slim. Again, a major accident should not be viewed as a trip to a day spa, with all expenses included. Based on an average 11-years between claims, you end up paying a premium for this coverage. If you have a second car, chances are, you might not even need this coverage at all.

6. Car Rental Coverage: Note that this coverage is different Rental Car Coverage above!  In the past, many car insurance policies would cover you if you rented a car - both from a liability standpoint and a collision/comp standpoint. Paying extra for liability or collision coverage at the rental car counter was deemed a waste of money. But today, many insurance companies are not automatically offering to cover the costs of car repairs to rental cars. Some may cover from a liability standpoint, and some may not even cover this. An umbrella liability policy may cover you in this regard. It pays to ASK your agent whether your policy covers these items before accepting or declining this coverage at the rental car counter.  Some credit cards offer to cover rental car collision if you book with their card. Again, though, it pays to check out the details. If you bring back a dented car to Hertz, you may be delayed for hours filling out paperwork and miss your flight - and repairs may be charged to your credit card and you may have to wait months for reimbursement.

7. Towing Insurance is another possible junk coverage. If you belong to AAA (recommended) you may already be covered. Again, the Agent will sell this to you on the basis that it costs "pennies per day" but in fact, it is rather expensive roadside assistance. I have been a member of AAA, and addition to getting free maps and trip routing, they paid for towing in an accident I was in 3 years ago, no questions asked. When the tow truck driver arrived, at night, in the rain, AAA was one of the few options he was willing to accept - no questions asked, no ifs, ands, or buts, and no payment needed in advance.

8 Uninsured Motorists Insurance (UMI) is a puzzle to many, including myself. What exactly does this cover? Why do I need it? Do I need it? How much do I need?  (UPDATE:  See THIS POSTING for more information about Uninsured Motorists Insurance).

Massachusetts Bay Ins. Co. v. Allstate Indem. Co. v. Joyner, 736 So.2d 877 (Mississippi Supreme Court--July 20, 2000) illustrates one example of where Uninsured Motorists Insurance is applied. On September 19, 1996, on an interstate outside Jackson, Mississippi, two cars were traveling in the left lane. A black sport utility vehicle (SUV) was passing them on the right and found its path blocked by a slow-moving truck. Rather than braking, the SUV swerved to the left. In the left lane, Evelyn Joiner swerved farther left in response to avoid a collision with the SUV, entered the median of the highway, lost control, flipped, and was killed. The other car in the left lane witnessed the tragedy as the black SUV continued speeding on into the night, never to be apprehended. After Joyner's death, her husband sought uninsured motorist benefits from Allstate (which provided $30,000 in such coverage) and Massachusetts Bay (which had uninsured motorist limits of $200,000).

The theory of uninsured motorist coverage is that it provides the coverage that would have been available had the policyholder been able to bring a tort claim against an insured driver. To the extent that the tortfeasor driver is uninsured or under-insured, the innocent driver may recover up to applicable policy limits from its uninsured or under-insured motorist coverage.

So, uninsured motorists insurance is an opportunity to sue your own insurance company. Such claims are ripe for fraud, which is one reason I think the premiums are so high (almost as high as regular liability insurance). One could stage an accident with an uninsured "friend" and then claim pain and suffering quite easily. Or one could claim that their car was "sideswiped" on the street by another motorist, when in fact you hit somebody.

As the example above illustrates, such insurance might be useful in a situation where you want to sue someone for wrongful death, but they are uninsured. The question I would have in this particular scenario, is whether $30,000 or even $200,000 really makes much of a difference to the husband after the death of his wife.  In the greater scheme of things, this hardly covers burial expenses, much less the emotional or financial loss.  Any amount of money really does not make one whole.

States are split as to whether a "hit and run" driver constitutes an uninsured motorist or merely an unknown motorist, the latter not being covered by uninsured motorist insurance in some States. Some States require that a "hit and run" driver actually HIT your car in order to collect (driving off the road to avoid an errant driver is considered your fault, not his).

So what WOULD this insurance cover? And is it worthwhile? From what I can ascertain, the "nightmare scenario" of the Uninsured Motorist would be that of an uninsured motorist hitting you can causing debilitating injuries for you and/or your passengers, to the point where you required extensive medical care and/or rehabilitation. If you have to take a year off from work to learn how to walk again, you might be devastated financially.  However, $25,000 of uninsured motorists insurance isn't going to do much for you, is it?

Your personal health insurance would cover a lot of those expenses, however. So the Uninsured Motorists Insurance would only kick in to cover deductibles and co-payments. In addition, it is not clear that Uninsured Motorists Insurance would cover lost wages and "pain and suffering." If it did, chances are you'd have to sue your insurance company to obtain the money, as they would dispute large payout amounts.

I am not convinced that a lot of coverage is necessary. One problem with all types of insurance is that if people think they are entitled to a payout, they will milk that payout for all it is worth - that is the nature of human beings. So if someone hits your car, of course you might claim pain and suffering and all sorts of things - and even hire a lawyer to sue them for damages. But if the same injuries occurred to you as the result of your own negligence, you might be more motivated to move on with life.

And as I noted earlier, I am not certain in what scenarios a wrongful death suit makes anyone whole. If you already have life insurance, then your spouse and children will be taken care of. In the case illustrated above, even if the surviving spouse win $230,000, how much of that went into lawyer's fees? And how did that money fix anything?

UMI is little more than the insurance company agreeing to be a defendant in a lawsuit filed by you, where the "bad actor" may be unknown, uninsured, or under-insured. One can readily appreciate why premiums for this coverage are so high.

Most umbrella liability policies require $300,000/$100,000 coverage on liability in order to obtain umbrella coverage. But they require NO UMI to get the umbrella policy. From my perspective, buying an umbrella policy is probably a better deal than UMI, and if you have to parse your insurance dollars, cutting back on UMI and buying an umbrella policy is probably a better bet.

Is there a grave risk of uninsured motorists? It would seem to be declining. In many States, such as Georgia and New York (my two homes) if your insurance lapses on your car, you are fined on a daily basis for lack of coverage.

In other States, like California, which borders Mexico, uninsured motorists have been a big problem, but a problem that is declining. The following table, from the California Motor Vehicle Bureau, illustrates how the percentage of uninsured motorists has been declining:

Registered VehiclesInsured Vehicles
Rate of

Number *
Change **

Change **
2003 23,987,0272.8%20,550,0672.7%14.33%
* Based on DMV Currently Registered Vehicles by ZIP codes interpolated to July 1 for the given year. The number of Registered Vehicles includes an estimated number of vehicles that are unregistered.
** Percentage change from the previous year.

Thus, even in high-risk California, the percentage of uninsured motorists is declining. The alarming statistics of a decade ago (routinely batted about by Agents) have dropped in half.

Again, Insurance Agents will regale you with horror stories as to how so-and-so was hit by an uninsured motorist and left crippled in a wheelchair. However, making a financial decision based on anecdotal data is hardly sound.

UMI was nearly 1/3 of my overall insurance bill, at the $300,000/$100,000 level of coverage. Rather than drop the coverage entirely, I lowered it to the lowest level available ($50,000/$25,000) with the highest deductible ($1000). This is, of course, a risk-taking exercise. With risks, go rewards. But also risks.

UPDATE:  I decided to drop UMI entirely, as having paltry $50,000/$25,000 coverage seemed kind of silly.  If I have a debilitating accident (in a wheelchair) from an uninsured motorist, 50 grand ain't gonna cut it.  You can buy a lot of UMI coverage to cover such catastrophic possibilities, but the cost is prohibitive.  I decided to take a calculated risk and get rid of this coverage.  I live on an island where the speed limit is 35 mph.  Hopefully, if I do get in an uninsured motorist accident, it will be a small one.  In the mean time, I can bank the difference.

By dropping collision and comp, medical coverage and UMI, and declining rental car, towing, and other "junk" coverages, I was able to drop my car policy to less than $50 a month for three cars.  I have an umbrella liability policy on top of this, which covers all liability for my home, car, etc. to $2 million.  This represents a lot of coverage for very little money, and also covers very real liabilities that could bankrupt me.

Many others will spend far more on covering things like collision and towing, and neglect or avoid paying for more than minimum liability.   If you have any assets at all, such coverage, I believe, is short-sighted.

Also, as I noted in another posting, Uninsured Motorists Insurance is popular with Tort Lawyers, who want to "stack" such coverage to obtain greater returns for their clients (and of course, themselves!).   Your lawyer will be happy you have uninsured motorists insurance.   Whether you are happy paying the premiums, is another matter.

UPDATE October 2014:  A relative recently died after an auto accident.  She was not wearing a seatbelt and hit her head on the windshield.  The other driver was uninsured.   She also had several major health problems at an advanced age.  She was fine after the accident, and then died suddenly (blood clot?).  Her uninsured motorists insurance paid out $100,000 to her estate, which divided nine ways means another $11,000 for her heirs.   While this is a nice (small) windfall for the heirs, does it really make anyone whole?   Was it worthwhile for her to pay for such coverage?   Bear in mind that had she survived, her collision insurance would have covered the car, and her health insurance would have covered her medical expenses.  Granted, she could have sued her own insurance company for "pain and suffering" and collected on the UM policy.   But is suing yourself such a swell idea?

For me, the costs don't seem outweighed by the benefits.

What decision you make is your own decision to make. Figure out what you are spending on each form of coverage and what risks and possible liabilities are involved, and then make a sound decision.  For me, I would rather put money in the bank and have that as a certainty, than to pay a lot of money for coverage of "what if" possibilities, which pay off only rarely.  It is called risk-taking, but not everyone is well suited to it.