While I was attending college, we had a visiting lecturer for my financial planning course who discussed the various types of insurance. In particular, he gave us a crash course on auto insurance.
I was astounded by how little we all actual knew about our own auto insurance. It’s like that commercial from awhile back where a lady asks various random people, “What should my deductible be? $500? $1000?” Not fully understanding is a problem common to many financial instruments…unfortunately.
#1 Let’s start with the basics – Risk
At it’s heart, insurance is the transfer of risk. For example, I have a wife and two kids. I know that they are going to get sick several times a year. Instead of bearing the “chance” of a financial crisis because I can’t pay the medical bills, I transfer that chance to a health insurance company in the form of premiums. In other words, I pay them to take the chance that our medical bills become really expensive. At the same time though, the health insurance company is taking the chance that my medical bills will be really low. So, don’t think of risk as being a negative thing – it’s not. Risk is just the probability that a certain outcome, both positive or negative, will occur.
In terms of auto insurance, you need to determine how much “risk” you want to transfer. Take a moment to evaluate your financial situation. Can you afford $1000 worth of damages to your car? Hopefully the answer to that question is yes since you have at least $1000 in an emergency fund.
#2 Accident lawyers are always smiling for a reason – Insufficient Coverage
Have you ever seen an ad for an accident law firm where every lawyer is not smiling ear to ear? Do you know why they smile from ear to ear? Because they make so much money from accident settlements. So they don’t care what your situation is. They are coming for you if you cause an accident.
So how much risk do you want? In my state, the required minimum coverage is 25,000 / 50,000 / 50,000. It’s very important that you understand what those numbers mean and how they can ruin your life. If I have 25k / 50k / 50k, then my insurance company will pay out up to $25k to any one individual in a car accident that I cause with a maximum payout of $50k. And the maximum property payout is also $50k. So really read those numbers as: Maximum Individual Payout / Maximum Total Payout / Maximum Property Damage Payout.
To help illustrate the amount of “risk” that I would be baring, I’m going to use several scenarios.
I hit a minivan with five scouts in it and they all spend three days in the hospital. A three day stay will probably run about $10k each. So I now owe $50k in medical bills. Of course, that doesn’t cover the minivan damage itself – estimated at $30k. So my auto insurance fortunately covered the medical bills but I am still left with a $30k bill for the minivan.
Let’s say that I don’t even hurt anyone, but I happen to hit a 2011 Cadillac Escalade. MSRP starts at $62,495 on a new Escalade and I just totaled one. My insurance company pays out $50k and I’m left owing $12k+. Personally, I don’t have that much under my mattress.
You cause an accident involving three average cars and four people take a trip to the hospital. I could do the math, but I bet you get the point. It’s very easy to rack up a large bill even in a simply accident.
But I’m just a college kid, they won’t come after me.
Oh yes they will!
Attorneys will not only consider your current financial situation but also your future earning power. If you are a college kid who will be graduating with a good degree, then they expect that you’ll be making decent money in the years to come. So they will have the court garnish your wages. Meaning, you’ll end up paying for years.
More coverage is pretty inexpensive
Assuming you don’t have a terrible record, auto insurance is very inexpensive. For example, after learning all of this myself, we changed our coverage to $250k / $500k / $500k for an extra $9 a month. Meaning, I can sleep a lot easier for only $9 a month. I want more things like this in life.
#3 Always kill Bambi – Acts of God
Please no one tell my two year old I said that. Imagine for a moment, though, that you are driving down the road and a deer jumps out in front of you. You of course swerve to miss it and crash into the barricade or a tree. As far as the insurance company is concerned, the collision was your fault. However, if you hit the deer, then that was an Act of God and you are not responsible.
Not being responsible will matter when you renew your insurance. If you now have an accident on your record where you were found at fault, then your rates will increase. So no offense to anyone, but always kill Bambi.
There is a lot more to purchasing the right insurance policy, but hopefully this brief overview gives you a good starting point for evaluating your current coverage. For more information on financial planning topics, sign up for our RSS Feed and receive new posts directly in your favorite RSS reader.