Optimize your car insurance: strategies to protect yourself while saving money
Insurance companies often advise you to purchase auto coverage at “as high a limit as you can afford”. This is singularly unhelpful.
For one thing, how do you decide what you can afford? Not to mention that their motivations are suspect.
Between the complex choices, the obscure jargon, and the lack of unbiased information, many people are wasting money on insurance they don’t need, and skimping on the kinds that are critical. So here’s my attempt to lay it out straight and as simply as possible, so that you can both protect yourself and save money.
Understand the real purpose of insurance
Before I get into the nitty-gritty details of auto insurance, I want to make an important point about insurance in general.
All insurance is a way of transferring risk. Insurance companies have billions of dollars; they can absorb any cost. You don’t and cannot.
But you can absorb some cost, and you should. Insurance companies price their premiums — the fees they charge for taking on your risk — so that all but the most disastrously unlucky persons pay a great deal more in premiums over the long term than they receive in benefits. That’s how companies manage to both absorb the big costs and turn a good profit.
If you transfer all your risk to insurance companies, you’re going to lose a lot of money. It makes about as much sense as installing a permanent IV to drain blood by the pint … just so that the next time you cut your finger it doesn’t bleed at all.
You should only buy insurance against catastrophe. For mere hardship, you should simply prepare yourself.
What’s the difference? An auto accident that results in hundreds of thousands of dollars of damage and injuries would be, for all but the very wealthy, a catastrophe. A broken windshield, however, costs a couple hundred dollars to replace. That may be hardship — even severe hardship if you’re very poor — but it’s not financial ruin.
So the smart thing to do is to buy insurance against the catastrophic accident, and prepare for the possibility of a broken windshield by making sure you have enough savings to cover a new one.
As you get better at preparing yourself — as you build up your financial cushion — you can increase the level of risk that you can handle on your own, thereby keeping more money in your pocket instead of the insurance company’s. Today the windshield, tomorrow the whole car.
How much car insurance should you buy?
There is no one-size-fits-all answer to that question, because the best choices are dependent upon related variables — like how much your car is worth, and whether you have a car loan, and where you live, and what kind of health insurance you have. Optimizing your auto insurance requires making specific decisions in all of those areas.
Here are the related decisions that we’ve made:
- We own our cars outright — no auto loans, ever. We buy used from private parties and pay cash.
- We choose models for their fuel efficiency and low repair needs, not for showing off.
- We have an emergency fund that is larger than the current value of our car.
- We have high-deductible health insurance (and health savings in excess of our annual out-of-pocket limit).
This is the auto coverage we currently carry (for definitions, see my previous post):
* (If the insurer offers the option — not all do — I eliminate the property damage portion.)
This strategy saves the most money over time while not exposing us to any catastrophic risk. If you can follow a similar strategy, you should. In the five sections below, I’ll explain the reasons for each decision, and describe the scenarios in which you might need to make different choices.
This is the core insurance, the one that will protect you against the worst calamities. Every state requires a minimum amount of liability coverage, but they’re all different. The lowest is Florida, with 10/20/10; the highest are Alaska and Maine, which require 50/100/25. You don’t even need to know your own state’s law, because all the minimums are inadequate.
I think about the property damage component (the third number) this way: There are a lot of cars out on the road that are worth more than $10K. $50K is better, but still pretty risky — about one in every 7 or 8 cars is less than two years old, and browsing any dealer web site turns up a lot of luxury sedans and SUVs priced in the $50-$80K range. But the number of cars on the road worth over $100K? Tiny. $100K of property coverage would go quite a ways even if your car ended up careening around like a pinball in a crowded intersection.
Bodily injury is trickier; I personally have no reliable way to estimate likely post-collision medical care costs. For this, I rely on sources like Consumer Reports, which — unlike an insurance company — has no financial stake in the amount of insurance you buy or don’t. CR recommends coverage at the 100/300 level unless you have a high net worth, in which case they suggest 250/500.
Similarly, Smart Money’s auto insurance guide says:
If you make $30,000 a year and rent your apartment, $50,000/$100,000 should suffice. But if you make more than $75,000 a year, own a house worth $150,000 and have $40,000 in mutual funds, you should consider at least $100,000/$300,000 of coverage.
I didn’t at first understand why net worth should matter — after all, expenses are expenses. But while that may be generally true for property damage, it’s not the way injury claims work. Bodily injury, if you recall the definition, compensates for ‘pain and suffering’ in addition to actual medical costs, lost wages, etc. There’s a lot of room for interpretation, there.
If you don’t have a lot of money or possessions, the old adage “You can’t get blood from a stone” applies. Suing you for something you don’t possess will just waste the plaintiff’s time and money. But the wealthier you are, the more compensation the other party is going to seek.
If you have few assets and your job doesn’t pay very much, and you’re finding insurance payments a hardship, you might be able to get away with just 50/100/50. If the sum of the value of all your vehicles, the equity in your home and other properties, and all savings and investment accounts (excluding retirement) is more than $300K, you might be better off with 250/500/100.
For everyone in between, 100/300/100 is the way to go.
2) Uninsured / Underinsured Motorist
The whole idea of Uninsured Motorist coverage is unfair, but it’s also the cold reality. Yes, every state has a law requiring liability coverage. And about one in every seven drivers on the road is ignoring that law and ‘driving naked’.
That’s the national average, but the variation from place to place is significant. In Maine and Massachusetts, the odds that you will run into (literally) an uninsured driver are just one in twenty-two. In Mississippi and New Mexico, the number is one in four.
On top of the completely uninsured, you have the many, many people who are either trying to save money by cutting back on their insurance, or who mistakenly assume that the legal minimum in their state provides adequate coverage. (Yes, you can try to sue them, but remember what we said earlier about blood and stones.)
Essentially, if you’re in an accident and the other person is adequately insured, you should count yourself lucky.
However, with UM/UIM you’re not insuring against a lawsuit — you’re insuring yourself against catastrophic injury. That means your general health insurance is also in play. For that reason, I think UM/UIM is a reasonable place to cut back on expenses if you’re feeling pinched … so long as you’re confident in your general health coverage.
A commonly cited rule of thumb is to keep your UM/UIM at the same level as your Bodily Injury Liability coverage. I did so for years, and only recently dropped our UM/UIM down to 50/100 as a cost-saving measure.
In making that decision, I considered the following numbers in addition to the premium savings: the deductible on our health insurance, the maximum annual out-of-pocket limits on our health plan, and the amounts in our Health Savings Accounts (which is how we would cover the deductible and copays up to the annual limits in case of major illness or injury). We’re both self-employed right now, and get money in freelance dribs and drabs, so there’s no lost wages to be recouped. (If you are employed full-time, consider also your disability insurance coverage and deductibles.)
I don’t care about the Property Damage component (if there is one — often UM/UIM covers Bodily Injury only), for the same reason that I don’t take Collision and Comprehensive coverage. Speaking of which …
3) Collision and Comprehensive
Ideally, you should never pay to insure your own vehicle.
Here’s why this is different from Liability: If I am in an accident, I have no control over how expensive the other person’s car is, or how serious their injuries are. If the collision is judged my fault, we could be wiped out financially.
However, the most we would ever need to pay for damage to our own car is $5000. That’s a number that we control completely, by our selection of vehicles.
That’s exactly what happened two years ago — my accident totaled our 1999 Honda Civic, which was at the time worth around $3500. We replaced the car out-of-pocket, paying $4000 cash from our emergency fund for a low-mileage 1999 Chevrolet Prizm.
The $4000 hit to our savings was painful, and (since the accident was my fault) I felt terrible about it. But remember: the point of insurance isn’t to avoid pain — it’s to avoid financial annihilation. If you have so much insurance that an accident wouldn’t hurt your wallet, you’re doing it wrong.
That said, there are a variety of less-than-ideal situations in which you will need to take Collision and/or Comprehensive coverage.
One is if you owe money on your vehicle. Your lender will almost certainly require you to take both Collision and Comprehensive coverage. The only choice you will have in that case is the amount of deductible. Take the highest deductible offered (usually at least $1000, and possibly $2500 or more). Then work like crazy to pay off the car loan ahead of schedule (hopefully you have a loan with no prepayment penalties). This will save you money twice: once on the interest of the loan itself, and once on the insurance you are no longer required to carry.
Another case is if you own your car outright, but you don’t have enough cash in your emergency fund to cover replacement. The third situation is if the value of the car is so high that replacing it would be, if not catastrophic, at least desperately dire. Of course both of these are more likely to be true with newer cars and luxury models.
Honestly, it’s a mistake to put yourself into that situation in the first place, and your best move at this point would probably be to sell that car and buy a cheaper one. (A longer explanation will have to wait for a different post.)
But failing that, go ahead and buy both Collision and Comprehensive. Again, take the very highest deductible offered, and expect to tap your emergency fund for any repairs up to the deductible amount. Then start increasing your savings until you can cover the entire cost of a replacement vehicle (preferably a cheaper one) in cash.
4) MedPay / PIP
If you live in one of the fifteen states* that require Medical Payments (MedPay) or Personal Injury Protection (PIP), purchase the legal minimum. In all other states, you should decline this coverage.
If you have separate health insurance coverage, additional medical coverage on your auto insurance is unnecessary and a waste of money. If you don’t have health insurance, then that should be your first priority — get a catastrophic plan as soon as possible. (In January 2014, this should become both easier and cheaper for many people.) General health insurance will cover you against everything from a car accident to cancer; getting specific coverage for auto accidents is not cost-effective. The same holds true for lost wages — if your temporary incapacity could be catastrophic for your family, you should have broad-based disability insurance that covers not just auto accidents but any other injury as well.
* The states that currently require PIP are Delaware, Florida, Hawaii, Kansas, Kentucky, Massachusetts, Michigan, Minnesota, New Jersey, New York, North Dakota, Oregon, Pennsylvania, and Utah. Maine requires MedPay.
5) Rental Reimbursement / Roadside Assistance
Never take either of these add-ons. As with all insurance, few people extract the value that they pay in. And the risk involved (or conversely, the benefit paid) is trivial — a few hundred dollars at most.
Create a general risk policy for your household
Without going into too much detail here, I want to explain that my method of choosing auto insurance is part of a broader policy that goes something like this: if the total risk — the worst-case scenario cost — is $10K or less, self-insure. We have the emergency savings to cover that level of loss. Practically speaking, this means taking deductibles in the thousands of dollars and foregoing any insurance where the maximum payout would be under five figures.
Applying this method across all our insurance decisions — auto, health, disability, home, even (ahem) extended warranties — helps what economists and statisticians refer to as the Law of Large Numbers to work in our favor. The money we save by foregoing minor insurance and taking high deductibles on catastrophic policies piles up. Once in a while — as with my accident two years ago — we have to pay out. I won’t kid you that it’s any fun when that happens. But over time it works out.
Companies like to advertise about the ‘peace of mind’ you’ll gain with insurance. And no wonder, because if you’re insuring at a level that gives you complete peace of mind, they’re raking in the profits.
Psychologist Daniel Kahneman, who won the Nobel Prize in Economics in 2002, writes about risk policies in his book Thinking, Fast and Slow. “You expect the occasional loss of the entire deductible, or the occasional failure of an uninsured product,” he explains. But you can offset the pain of loss with “the thought that the policy that left you exposed to it will almost certainly be financially advantageous over the long run.”
That’s where you’ll find the real peace of mind.