Car Insurance Basics: Simple Definitions & Coverage Explained


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What Is Car Insurance? The Basic Definition

Car insurance is a contract between you and an insurance company. Here's how it works: You pay the insurance company money every month (or every six months) and the insurance company agrees to pay certain bills, up to a maximum amount, if you have an accident. The money you pay is called your premium.  

A car insurance policy is a document that lists what the insurance company will pay for, how much they'll pay and what you have to pay yourself in the case of an accident or other damange to your car.

Why Do You Need Car Insurance?

You are required to have car insurance to drive. States require minimum level of car insurance coverage to drive legally. If you don't have car insurance, you will be responsible for damage that you cause and need to pay for accident expenses and medical bills.

  1. 1

    It's the Law

    State require you to have at least some car insurance before you can drive. If you get caught driving without it, you'll:

    • Pay fines (often $500 to $5,000)
    • Risk losing your license and having your car registration suspended
    • Pay more for insurance later
  2. 2

    Accidents Are Expensive

    Even small accidents cost thousands of dollars. Serious accidents where multiple people get hurt can cost hundreds of thousands of dollars. Without insurance, you'd pay all of this yourself. With insurance, you might pay $150 per month to have coverage that pays up to $100,000 per person hurt and $300,000 total per accident.

  3. 3

    It Protects What You Own

    If you cause a bad accident and don't have insurance (or don't have enough), the people you hurt can sue you and go after you house, your car, and part of your future paychecks.

Car Insurance Coverage Definitions

There are different types of car insurance coverage.  You can have liability-only coverage or multiple types of coverage in your car insurance policy. 

States require liability car insurance coverage to legally drive.  Comprehensive and collision (also called full coverage) protect your own vehicle from damage. You can also add optional protections like uninsured motorist coverage and personal injury protection depending on your needs. Learn the basics of each coverage type below.

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    Liability Coverage

    What it pays for: Your bills when you cause an accident and hurt someone or damage their property

    Liability coverage has two parts:

    • Bodily injury liability pays medical costs for people you injure. This includes hospital stays, rehabilitation and legal fees if someone sues you.
    • Property damage liability pays to fix or replace things you damage like other cars, buildings, fences or personal items in vehicles.

    What are the three numbers? Coverage is shown as three numbers like 100/300/100. This means $100,000 per person injured, $300,000 total per accident and $100,000 for property damage. You don't pay a deductible for liability coverage.

    Why you need it: States require this coverage because without it, you'd pay for damage out of pocket.

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    Collision Coverage

    What it pays for: Fixes your car after you crash into something or someone crashes into you

    How it works: You pay your deductible first (usually $500 or $1,000). Then insurance pays the rest up to what your car is worth. If repairs cost $3,000 and your deductible is $500, you pay $500 and insurance pays $2,500.

    If your car is totaled (too damaged to fix), insurance pays you what your car was worth before the accident, minus your deductible.

    Who needs it: Required if you have a car loan or lease. Collision is Important if your car is worth more than you can afford to replace, but you can skip it if your car is worth less than $3,000 and you can replace it yourself.

    What it doesn't cover: Theft, weather damage, vandalism or hitting animals. Comprehensive coverage covers these.

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    Comprehensive Coverage

    What it pays for: Fixes or replaces your car from damage that isn't a crash

    This includes theft, vandalism, and weather damage. It's called "other than collision" coverage because it covers what collision doesn't.

    How it works: You pay your deductible first, then insurance pays the rest. If hail causes $4,000 in damage and your deductible is $500, you pay $500 and insurance pays $3,500.

    Who needs it: Required if you have a car loan or lease. Also smart if you can't afford to replace your car, live where severe weather or car theft is common.

Basic Car Insurance Terms You Need to Know

Here are the basic car insurance terms you need to know.  We defined these with easy to understand language so you'll know what you are buying when you get your car insurance.

Basic Policy Terms

Premium

The money you pay for insurance each month or every six months.

Deductible

The amount you pay first when you file a claim. If repairs cost $3,000 and your deductible is $500, you pay $500 and insurance pays $2,500.

Policy

Your insurance contract. This document lists what's covered, what you pay and what insurance pays.

Declaration page

The one-page summary showing your coverage types, dollar limits and cost. Also called a "dec page."

Coverage limit

The maximum dollar amount insurance will pay for something. You pay any costs above this amount.

Effective date

The exact day and time your insurance starts.

Renewal

When your six-month policy ends and starts over, usually with a new price.

Basic Shopping and Buying Terms

Quote
An estimate of what insurance will cost. Your final price might change if your information changes.
Underwriting
When the insurance company checks your driving record, credit and other information to set your price.
Bind
When you officially start your coverage by accepting the policy and making your first payment.
Policyholder
The person who owns the insurance and pays for it.
Lapse
When your insurance ends because you stopped paying. Even one day without insurance can make your next policy more expensive.

Basic Terms for Who Pays

Liability

Being legally responsible for an accident you caused. Your liability insurance pays for other people's bills.

At-fault

The driver who caused the accident. Their insurance should pay for damage to others.

No-fault

A system in 12 states where your own insurance pays your medical bills, no matter who caused the accident.

Per person limit

The most insurance pays for one person's injuries. In 100/300/100, the "100" means $100,000 per person.

Per accident limit

The total amount insurance pays for everyone hurt in one accident. In 100/300/100, the "300" means $300,000 total.

Bodily injury

When someone gets physically hurt, like a broken arm or concussion.

Property damage

When something gets physically damaged, like a car, fence or building.

Basic Terms to Know After an Accident

Claim

When you ask your insurance to pay for damage. You file a claim by calling your insurance company.

Claims adjuster

The insurance company person who looks at your damaged car and decides how much they'll pay.

Estimate

A repair shop's quote showing how much it will cost to fix your car.

Totaled

When your car is damaged so badly that fixing it costs more than the car is worth. Insurance pays you for the car instead of fixing it.

Actual cash value

What your car is worth today based on its age and condition. Usually what insurance pays if your car is totaled.

Replacement cost

What it would cost to buy a similar car today. Usually more than actual cash value.

Depreciation

How much value your car loses as it gets older. A five-year-old car is worth less than when it was new.

Salvage title

A mark on your car's paperwork showing it was once totaled. Makes the car worth less and harder to insure.

Subrogation

When your insurance company gets money back from the other driver's insurance after paying your claim. This happens automatically.

Loss of use

Loss of useMoney to pay for a rental car while yours is being fixed after an accident.

Optional Coverage Definitions

Liability, collision, and comprehensive are the primary coverage types in car insurance policies. The are other common coverage additions you can add to your policy.  Most of these are optional except of coverage like PIP that is required by some states.

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    Personal injury protection (PIP)

    Pays your medical bills, lost wages and rehabilitation costs after an accident, no matter who caused it. Required in some states and typically costs a few hundred dollars yearly.

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    Medical payments coverage (MedPay)

    Pays medical bills for you and your passengers after accidents. Doesn't cover lost wages like PIP does, but costs less.

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    Uninsured/Underinsured Motorist Coverage

    Pays your medical bills and car repairs when someone without insurance (or without enough insurance) hits you. About one in eight drivers has no insurance, making this coverage important protection.

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    Gap Insurance

    Gap insurance covers the difference between your car's actual cash value and your remaining loan balance. This coverage is important for leased vehicles and new car purchases where the loan may be more than the value of the car.

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    Rental car reimbursement

    Pays for a rental car while yours is being repaired. This coverage costs under $50 per year.

Basic Car Insurance Questions & Answers

Here are basic answers to the most commonly asked questions about car insurance:

  1. 1

    What's the difference between full coverage and liability only?

    Liability only covers damage you cause to others. Full coverage includes liability plus collision and comprehensive, which fix your own car after accidents, theft or weather damage.

    Read More: What is liability car insurance?

  2. 2

    How much car insurance do I need?

    Start with at least 50/100/50.  MoneyGeek recommends 100/300/100 coverage ($100,000 per person injured, $300,000 total per accident, $100,000 for property damage) for most drivers. If you own a home or have savings over $50,000, get 250/500/250 or higher to protect your assets.

    State minimums are often just 25/50/25, which means only $25,000 per person injured. A serious accident where someone needs surgery and hospital care can easily cost $100,000 or more. If you only have $25,000 in coverage, you'd personally owe the remaining $75,000.

    Read More: Recommendations on how much car insurance you need and your states minimum requirements.

  3. 3

    How much does car insurance cost?

    The national average is $80 per month for minimum coverage and $158 per month for full coverage. Your actual cost depends on your age, location, driving record, credit score and the car you drive.

    Read More: How much does car insurance cost and cheapest car insurance companies.

  4. 4

    What affects my car insurance rate?

    Several major factors determine your car insurance rate:

    • Your driving record: Tickets increase your rate for three to five years. At-fault accidents raise costs even more. A DUI can double or triple your premium.
    • Your age and experience: Drivers under 25 pay the most because statistics show they have more accidents. Rates typically drop at age 25 and remain lower through middle age.
    • Where you live: Cities cost more than rural areas due to more accidents, theft and vandalism. Some states cost more than others due to state mandated coverage.
    • Your credit score: Better credit score means lower rates because insurers claim credit helps predict who will file claims.  Some states don't allow insurers to use credit scores.
    • Your vehicle type: Expensive cars, sports cars and vehicles that get stolen often cost more to insure than practical sedans.
    • How much you drive: The fewer miles you drive yearly, the less you pay since you have less chance of having an accident.
  5. 5

    How do I save money on car insurance?

    Get quotes from at least three companies since rates vary widely between insurers. Ask about all available discounts like bundling home and auto insurance saves up to 25% in our analysis, good student discounts to save 10% to 15%, and safe driver discounts for accident-free years save 10% to 30%.

    Consider raising your deductible from $500 to $1,000 to lower your monthly payment, but only if you can afford to pay $1,000 out of pocket after an accident. 

    Maintain a clean driving record since tickets and accidents increase rates for three to five years. Improving your credit score can also reduce your rates.

    Read More: How to lower your car insurance rates.

  6. 6

    How do I file a car insurance claim?

    Call your insurance company immediately after an accident. They'll assign you a claim number and a claims adjuster who will handle your case.

    At the accident scene, take photos of all vehicle damage from multiple angles, get the other driver's name, phone number and insurance information, and call police to file a report. Get the police report number since your insurance company will need it.

    Your claims adjuster will contact you to discuss what happened and explain next steps. They'll inspect your vehicle damage, get repair estimates and tell you which repair shops you can use. Some insurers require you to use their approved shops, while others let you choose your own.

  7. 7

    What happens if someone without insurance hits me?

    If you have uninsured motorist coverage, your insurance pays your medical bills and fixes your car. About one in eight drivers has no insurance, so this coverage protects you when they cause an accident.
    If you have collision coverage, it will fix your car no matter what. But it won't pay your medical bills unless you have uninsured motorist coverage.

  8. 8

    Where can I get car insurance?

    You can buy car insurance directly from insurance companies through their websites or by calling them. Major companies like GEICO, State Farm, Progressive and Allstate all sell directly to customers.

    You can also use online comparison sites, like MoneyGeek, to get quotes from multiple companies at once. These sites show you prices side by side, making it easier to find the best deal. 

    Insurance agents are another option. Agents provide personal service and help with claims, but may cost slightly more than buying online.

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CAR INSURANCE BASICS: READ MORE

Below are additional guides to help you understand how car insurance works:

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MoneyGeek's car insurance analysis draws from multiple authoritative sources to ensure accuracy and comprehensiveness. We analyzed rate data from state insurance departments, reviewed policy documents from major insurers and contacted customer service departments to test claim procedures and response times.
Our research team gathered quotes from 15 top-rated insurance companies across all coverage levels and driver profiles. We verified state requirements through official insurance department websites and cross-referenced coverage recommendations with industry experts and consumer advocacy organizations.
All cost estimates reflect 2024 market conditions and include data from the National Association of Insurance Commissioners, Insurance Information Institute and individual state regulatory filings. We update our analysis quarterly to reflect changing market conditions and regulatory requirements.

About Mark Fitzpatrick


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Mark Fitzpatrick, a Licensed Property and Casualty Insurance Producer, is MoneyGeek's resident Personal Finance Expert. With over five years of experience analyzing the insurance market, he conducts original research and creates tailored content for all types of buyers. His insights have been featured in publications like CNBC, NBC News and Mashable.

Fitzpatrick holds a master’s degree in economics and international relations from Johns Hopkins University and a bachelor’s degree from Boston College. He's also a five-time Jeopardy champion!

Passionate about economics and insurance, he aims to promote transparency in financial topics and empower others to make confident money decisions.


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