Friday, August 28, 2009

When do you drop Collision and Comp?

Many people worry that a collision like this could cost them a lot of money or cause them to lose a "major asset".  But an older economy car is hardly a major asset, and certainly not worth paying thousands of dollars for collision coverage.

If you keep a car any length of time (as you should, if you want to save a LOT of money) there comes a decision point where you need to decide whether to drop collision and comprehensive insurance. For many people, this is an agonizing decision, as they do not want to risk losing a car in the event of an accident.

However, like most financial decisions, you have to rely more on logic than fear to arrive at a proper decision. And like most financial decisions, the rewards go to the careful risk-taker and rarely to those who "play it safe".

What is Collision and Comp, anyway?

While this may seem like an obvious question, it helps to know what you are paying for in the first place.

Collision insurance pays for repairs to your car for any accident which you are at fault. The insurance company will pay for repairs, up to the blue book value of the car, minus the deductible.

The key words here are Blue Book Value and deductible. If you wreck your car, the insurance company is not going to buy you a brand new car. They merely are going to send you (or your repair shop) a check for the damages, minus your deductible.

If the car is older, in many instances, the repair costs of even a minor collision can exceed the value of the car. For a 10-year-old car worth maybe $5000, the most you will get paid out is $4500, if you have a $500 deductible.

However, if you are in an accident and the other fellow is at fault, his insurance company pays for the damage to your car, with no deductible applied. If you drop collision insurance from your policy, you are not totally unprotected from accidents, provided you are not at fault.

Comprehensive works the same way, but for damage caused by storms, hail, falling tree limbs, garage fires, car fires, theft, and the like. Again, they will only pay out up to the value of the car, minus the deductible.

Some comprehensive plans have a "glass coverage" option that will pay to replace or repair broken, cracked, or chipped windshields (the latter generally being repaired) with no deductible whatsoever. These can be handy, as in many instances, a glass company will come to your place of work or home, replace a broken windshield, and bill the insurance company directly.

UPDATE:  Some companies, such as GEICO will repair rock chips in windshields free of charge, even if you don't have comprehensive coverage.  I got a free repair from GEICO this way!

Whether or not such glass coverage is of value to you depends on your risk adverseness, as we shall see below. Windshields are pretty cheap, and if you get out of the habit of tailgating dump trucks filled with rocks, they rarely break.

So What is the Value of These Policies?

That is the first question to ask. Bear in mind that, with few exceptions, the policies pay out book value only as a maximum limit. If your car is customized or enhanced, it makes no difference in the payout. Many a young person has found out the hard way that his $2000 stereo is not covered by his insurance policy unless declared at the get-go.

When a car is new and worth tens of thousands of dollars, it makes sense to insure it. And oftentimes, if you borrow money to buy the car, insurance is required. But as the car ages, the value of the policy declines as well. It is a declining value policy, just like mortgage insurance.

Determining the value of any policy is the first step in determining whether it is a worthwhile bargain.

To start, check the "blue book" value of your car on, and Be realistic on mileage and condition. Chances are, your insurance company is not going to give you the top dollar figure from these three "book" values, but something closer to trade-in or private party sale.

Once we have a book value, we know the dollar value amount of the policy. Bear in mind that these book values decline over time, and during even one given year, they can decline precipitously.

Next, What is the Cost of these Policies?

This is the easy part, although many insurance companies try to play "hide the main idea" here by presenting confusing documentation or not itemizing each element of the policy. Others, such as GEICO, let you review each dollar cost coverage online.

Take the cost of Collision and Comprehensive insurance for the vehicle in question and double it, if the premiums are calculated on a bi-annual basis. Now you have an annual cost and the value of the policy.

Next, Assess Your Real Risk

Most folks are not very good at risk assessment. They view fairly risk-free transactions (like an airplane flight) as a risky venture, and yet view far riskier actions (driving to the airport) with little concern. We tend to be concerned about protecting our expensive, shiny car parked in the driveway (worth maybe $20,000) but not our open-ended liabilities (which can run in the millions) if, for example, we run someone over.

Often, what is parked in your driveway is not your most expensive asset. If it is, then your finances are seriously awry.

Determining your actual risk for an accident is difficult, but not impossible.

On average, the average American motorist gets into an accident every 11 years. And by accident, this could mean anything from a fender-bender to a complete totaling of your car.

Statistics like this can be misleading, as they lump in the experiences of all people, of all ages, and at all locations. Thus, for example, if you are 18 years old, and driving a Mustang in an urban area, your chances of an accident are far higher than for a 67-year-old retired farmer driving a pickup truck in rural Montana.

For the young person, the math is simple. If they have a new car, chances are, they are required to have collision and comp, as they have a loan. If they have an older car, chances are they drop the coverage because it is so unaffordable.

But for older people, the calculation is more complex. For older cars, the cost of collision and comprehensive seems cheap, so why bother dropping it? However, if the risk of collision or damage is slight and the value of the car is low, even a policy that costs "only a few hundred" is no bargain.

There are a number of other factors in assessing your risk:

1. Where you live - city or country?
2. Do you garage your car?
3. Miles driven annually
4. Driving style - fast and aggressive, or slower and more cautious?
5. Risk of theft - which often depends more on make and model of the car.

Now, do the Math

Once you have this data in place, you can do a simple mathematical analysis and come to a reasonable conclusion.

Let's take for example one of my 1997 BMW convertibles. According to KBB, which is the highest of the three, this car has a retail value of about $10,000 on a good day. And that's probably an inflated value. By the end of next year, this value could be less.

My insurance company wanted about $60 for collision on this car and another $70 for comprehensive. That's for six months. So for each year, I am paying $260 for coverage of vehicle damage. The deductible on this policy was $1000 (hint: You can cut the cost of collision and comp if you increase your deductible as high as possible).

At first glance, this seems like a bargain. Only a couple of hundred bucks for nearly $10,000 in coverage! And if you plan on wrecking your car, this is probably a good bargain. But most of us don't plan on that. And with the deductible, the maximum payout would be, at most, maybe $9,000.

Over the 11 year "average" time between accidents, that comes out to $2860 in premiums. So if you are an average driver, over an 11 year period, you will pay out nearly 1/3 the value of the car in premiums. To many, this still seems like a "bargain".

If you put this in terms of a bet, though, would you take it? Suppose I offered to pay you $9000 if you rolled a 1 or 6 on a dice, and you made a bet of $3,000. Odds are, for every throw, you'd have a 1-in-3 chance of winning. While you might get lucky on a first roll, if you played long enough, the best you can hope for is to break even, as the odds (1-in-3) neatly mirror the payout (3-to-1).

And this example scenario is not by accident, either. Insurance companies figure their premiums based on actuarial tables, and then factor in a profit factor. So the "odds" in this case are about right. The cost of the premium is about equal to the risk of payout, with a little more thrown in for profit.

In my example, the insurance company believes that the odds of me having an accident are far less than once in 11 years, or that the payout will be a lot less. Why is this?

Well, for starters, I am not an 18-year-old with a Camaro. My driving style is older and more sedate. Older drivers, having been in or seen many horrific accidents, tend to drive more conservatively and defensively. So the 1-in-11 years odds are probably longer for me.

Second, not every accident totals a car. Most are fender-benders that can be repaired cheaply. And insurance companies are quick to recommend repair outlets that can do the work fast and cheap. So the odds of them paying out the full $9000 are even less.

Third, I drive this car maybe 3,000 miles a year. That is not a lot. The average American drives maybe 15,000 miles a year or more. So if you factor in the lower mileage, my risk factor jumps by a factor of five.

Fourth, I live in an area where the car is not likely to be stolen or damaged or in an accident. The biggest risk I face is a deer collision, which while costly, rarely totals a car. A car such as this, with a fairly sophisticated anti-theft system, is not a favorite of amateur thieves (teenagers) who prefer easier-to-steal cars from the 1980s and early 1990s.

If we take all this into account, the odds of an accident or payout probably jump to once in 20 years or maybe 30. At that rate, the value of the policy exceeds the book value, clearly, and is no bargain.

But, Can You Afford the Risk?

There is one other factor in any risk assessment and that is your risk adverseness. For me, this is one of five cars that I own. If it is stolen or damaged beyond repair, I can simply walk away from it and drive another car.

On the other hand, if I have to pay collision and comprehensive on all five cars, I can't afford to keep them. To me, $10,000 is not a huge amount of money, and I can afford to take a risk on it, with the reward being the $2860 in savings on insurance over a decade (A payout of 28.6% over 11 years is not a bad rate of return, either).

For others, to whom $10,000 represents the most expensive asset they own, such a risk may not be practical. And of course, if you drive in a congested city, for 15,000 miles a year, your risk factors may be much higher. However, if the cost of your car is so dear to you that you cannot afford to risk losing it, I would suggest that perhaps you are owning too much car for your income level.

There are other, ancillary factors as well. If a car is damaged in a collision, and insurance is paying, most consumers take the car to the most costly body shop for a top-flight repair. However, if your car is uninsured, you may be more inclined to shop around on price or even make repairs yourself. As it is a used car, there is no point it throwing mountains of money at it.

If your fender is dented, it may be a lot cheaper to simply buy a used fender from a junked car and bolt it on and have it repainted, than to spend thousands of dollars having the dealer install a new fender. By taking control of your own life and being willing to take responsibility when things happen, you can save even more.

So Should You Consider Dropping Collision and/or Comp?

There is no clear Yes or No answer here, as each person's situation is different. However, there are some factors to consider after doing the risk analysis above:

1. Is your car over 7 years old?

2. Is your car worth less than $10,000?

3. If you lost the car entirely, could you recover from the loss readily?

If you can answer YES to all three of these, then you might want to consider dropping Collision and Comp.

For my situation, "doing the math" resulted in saving about $1470 a year in collision and comp premiums on all five cars. About half the cost of my car insurance was in Collision and Comp. Over a decade, this would amount to $14,700, or more than the cost of any one car. The odds of me totaling more than one car over this time period are pretty slim.

Is there risk involved? Yes, but a calculated risk. In any financial situation, the rewards rarely go to the risk-averse. While there is a probability that I might wreck a car and come out "behind" on the deal, there is a certainty that if I pay nearly $1500 a year for ten years, I will definitely come out $15,000 poorer at the end (at worst) and maybe a break even (at best).

You can bet I'll be driving more carefully from now on.....