Types of car insurance and terminology

To determine whether you should drop or downgrade your car insurance, you must first understand the various types of coverage. Your policy will include the following basic auto insurance coverages:

• Collision: Collision coverage pays for car repairs if you are in an accident or hit a stationary object. Collision coverage is typically an add-on.
• Comprehensive: Comprehensive coverage includes everything that collision coverage does not. If a tree falls on your car, you hit a deer, or your car is stolen, comprehensive coverage will pay to repair it. This insurance is typically optional, but if you have a car loan, your lender may require it.
• Liability: Liability coverage includes coverage for both property damage and bodily injury. If you cause an accident and there are injuries or property damage, liability coverage will pay out. All drivers must have liability insurance.
• Medical payments: Medical payments coverage will help pay for medical expenses such as x-rays or a trip to the hospital if you or someone in your car is injured in an accident. Medical payments coverage is usually optional, but in some states it is required.
• Uninsured/underinsured motorist: Uninsured/underinsured motorist coverage protects you if you are in an accident with someone who is not insured or does not have enough insurance. In your state, this type of coverage may or may not be required.

Most states require that you have at least liability insurance on your car, so we'll assume that you'll continue to have liability coverage in all cases. Liability coverage covers any costs or damage you may cause to other people or property while driving, including bodily injury to others and property damage. These insurances are typically quite inexpensive; the only thing you should be concerned about is that your coverage limit is quite high.

We're mostly concerned with comprehensive and collision coverage. We'll go over both of these insurance types in more detail later, but in a nutshell, collision insurance covers damage to your car when it collides with or is collided with another object, whereas comprehensive insurance covers losses caused by incidents other than collision – floods, damage caused by external forces, and so on.

You will have a deductible for each type of insurance, which is the portion of any bill that you will be responsible for. So, if you have a $1,000 deductible and the damage is $2,500, you will pay $1,000 and the insurance company will pay $1,500. You must also pay a premium to the insurance company in order to keep the insurance in force.

While not technically a type of car insurance, some people add accident insurance to their auto policy as a supplement. Accident insurance, like disability insurance, is a type of coverage that pays out if the policyholder is injured.

Is it worthwhile to purchase accident insurance? That is highly dependent on the individual. If you believe an accident is likely in your line of work, this could be a viable option.

Collision insurance vs. comprehensive insurance

Collision and comprehensive car insurance are two distinct types of coverage. They each cover different types of accidents and damages, so understanding the distinction between comprehensive and collision coverage is the first step in making any decision about changing your coverage.

What is collision insurance?

Collision insurance covers damage to your vehicle as a result of a collision with another vehicle. Collision policies vary, and some cover collisions with objects other than vehicles, such as trees or buildings. Some policies may cover repairs, while others may cover the vehicle's replacement cost.

When is it appropriate to drop collision insurance?

Maybe you have a sizable emergency fund. If your car is totaled, you will have to use your savings or emergency fund to pay for repairs or even a new car if you only have liability insurance. In this case, downgrading your collision insurance may be a good savings strategy as long as you can keep at least half of your savings after paying for a new car or repairs. When you should drop collision insurance is largely determined by the size of your emergency fund.

Furthermore, if the market value of your vehicle is less than your deductible, you may decide to forego collision insurance. Assume you own a 2000 Toyota Corolla that is in poor condition and is worth $850. Your insurance policy has a $1,000 deductible.

If you were in an accident and your car was damaged for $800, you would cover the cost of repairs because the damage amount is less than your deductible.

Given that collision insurance costs an average of $290 per year, it may not make sense in this case to pay for collision insurance that is unlikely to pay out. If the market value of your car is less than or very close to your deductible, you should consider dropping collision insurance.

When it's not a good idea to drop collision insurance

If your savings account is already low, if not non-existent, dropping collision insurance from your vehicle is probably not a good idea. If you would struggle to cover the costs of repairing or replacing your vehicle in the event of a collision, it is best to keep collision insurance in place.

If you're wondering, "Do I need collision insurance?" The answer should always be determined by what will happen financially to you in the event of a collision.

What is comprehensive insurance?

Damage to your vehicle caused by a non-collision accident is covered by comprehensive insurance. Non-collision accidents, on the other hand, are covered differently depending on the policy. Natural disasters and theft or vandalism are two common types of accidents covered by comprehensive insurance.

Based on the name, you might think comprehensive insurance covers everything — damages, liabilities, and so on. However, contrary to popular belief, comprehensive insurance provides only limited coverage and is not the same as full coverage insurance.

Comprehensive coverage is optional, which means it is not included in minimum coverage car insurance policies. Comprehensive insurance is a component of full coverage auto insurance, but the two are not interchangeable. As a reminder, collision insurance is included in full coverage car insurance.

When to drop comprehensive insurance

Is your car nearing the end of its useful life? For the time being, downgrading your comprehensive insurance may be a good option to help you save money. Dropping comprehensive coverage, like dropping collision coverage, is ideal if the market value of your car is less than or close to your policy's deductible. The average annual cost of comprehensive coverage is $134. However, if you are not going to receive a payout from your insurance company following an accident, it is not worth paying for.

When it's not a good idea to drop comprehensive insurance

If you just bought a new car, chances are your budget is tight while you're still making car payments. If you change your car insurance to only cover liability, you will have to pay for any non-collision damages to your car out of pocket. In this case, downgrading your comprehensive insurance would be risky unless you had enough cash on hand to completely repair or replace your car.

Is it necessary to have car insurance?

The state in which you live determines whether you are required to have car insurance. In fact, only two states do not require auto insurance: New Hampshire and Virginia. Virginia, on the other hand, charges a fee for not having insurance. Furthermore, some states are no-fault and have their own rules.

Each state has its own requirements for required auto insurance coverage. They determine the type of coverage required as well as the minimum amount of coverage that each driver must have. Personal injury protection (PIP) insurance is required in no-fault states as part of the minimum coverage insurance.

This is how mandatory car insurance coverage looks: bodily injury coverage per person/bodily injury coverage per accident/personal property liability coverage.

In California, for example, the minimum requirement for drivers is 15/30/5. This means that drivers must have at least $15,000 in bodily injury coverage per person, $30,000 in bodily injury coverage per accident, and $5,000 in personal property liability coverage.

However, drivers are frequently advised to purchase coverage that exceeds the state's minimum requirement. There is no guarantee that you will be fully covered after an accident if you have minimum coverage insurance. If you are underinsured, you will be responsible for the difference between your coverage limit and the cost of the accident out of pocket.

Should you downgrade your insurance?

Unfortunately, there is no clear and simple answer to this question. Because of this lack of clarity, people tend to over-insure – and personal finance suffers as a result. Simple statements like "eliminate your insurance and raise your deductible to save money!" can be used by writers.

However, the ongoing coronavirus pandemic is causing a shift in car insurance norms. People are not driving as much as they used to because they are working from home and going out less frequently. As a driver, you face less risk when you spend less time on the road.

If you've been considering reducing your coverage, now is a good time to do so. However, keep in mind that the decision to reduce your insurance coverage is entirely personal. As you begin to drive more, you may want to reconsider downgrading your coverage and adjusting your limits.

If you're thinking about reducing your coverage, you should consider what your deductible should be.

Your deductible amount, in our opinion, should always be directly related to your emergency fund. A single car accident should not be able to deplete your emergency fund entirely. In fact, we frequently advise people to have an emergency fund that is at least twice as large as their deductible.

Given that, you can quickly calculate the amount of deductible you require based on your emergency fund. If you have a sizable emergency fund, for example, you may not need comprehensive or collision insurance at all because you have enough cash to pay for repairs or replacement yourself.

If you have enough emergency funds to pay for an entire replacement car in cash and only reduce your fund by half or less, you don't need collision or comprehensive insurance, in my opinion. You should only require liability insurance. However, most people aren't in that situation because it necessitates a much larger cash emergency fund than most people have access to.

Similarly, at what point should you drop collision and comprehensive coverage on an older vehicle? It's a difficult question to answer.

Consider a pickup truck that is more than a decade old and has nearly 200,000 miles on it. It has a low Blue Book value at this point, and the owner is hesitant to drive it any significant distance. The family plans to replace it by the beginning of next summer.

In this case, it may make sense for the owners to reduce the vehicle's coverage to just liability. This would save the family several hundred dollars, and if something serious went wrong with it again, they would sell it.

Ask yourself an honest question: if a major repair was required on your current vehicle, would that be the final push you needed to replace it? If that's the case, do you still require collision or comprehensive coverage on that vehicle?

What to consider before dropping full coverage?

There are a few things you should think about before cancelling your full coverage insurance. Consider the following factors:

• The cost of coverage: To begin, consider how much you currently pay for full coverage auto insurance and compare it to the cost of minimum coverage insurance. If the price difference isn't significant, you might as well keep full coverage insurance, especially if you can afford the monthly payments. Insurance with minimum coverage provides significantly less protection than insurance with full coverage. If you're only going to save $20 or so per month, it may not be worth it to downgrade.
• The age of your car: Newer cars are generally much more expensive to insure, as well as much more expensive to repair. If you own a newer vehicle, having full coverage car insurance means you'll spend less money out of pocket to repair it after an accident. If you drive an older car that you don't really care about, downgrading your coverage may make sense if you're planning to buy a new one.
• The value of your car: If you drive a high-value vehicle, such as a newer truck or SUV, having full coverage car insurance makes sense. Expensive cars are more expensive to repair, especially if they have a lot of bells and whistles. If you reduce your coverage to the bare minimum, the cost of repairs will be borne entirely by you. In that case, keeping full coverage insurance would have most likely been less expensive.
• Your loan: If you are leasing or financing your vehicle, keep in mind that you may not be able to downgrade coverage. Most lenders require drivers to have full coverage car insurance so that they can continue to make their loan payments if their car is damaged. Every loan company has different requirements, so make sure you know how much car insurance you need before you downgrade.
• Your car's replacement cost: If you are in an accident and your car is totaled, your insurance company will calculate your payout based on the replacement cost of your car. It is critical to understand that the replacement cost of your car is not the same as the price you paid for it. However, if you have collision coverage, you will only be reimbursed for the cost of a new car. If you downgrade, you will be responsible for purchasing a new vehicle if your current one is totaled.

How to downgrade your insurance

Simply contact your current car insurance provider and explain your situation to them to downgrade your insurance. The representative may argue with you, but in the end, it is your decision. You'll be able to reduce your insurance and annual premium costs as long as you know you've made the right decision.

Remember that lowering your car insurance will almost certainly raise your deductible, so make sure you have enough savings to cover the new deductible as well as any additional repair costs if you get into an accident without comprehensive or collision insurance.

After you have downgraded your car insurance, it is a good idea to review the next insurance statement to ensure that the downgrade was completed correctly and that everything appears to be in order.