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UPDATED: Apr 8, 2020
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With so much focus put on lowering car insurance costs, many people may inadvertently put themselves at risk with policies that do not cover the total cost of an accident. Most agents are very good about explaining coverage, but it’s always good to know in advance exactly what car insurance you need and what your premiums are paying for. Once you understand how the limits of your policy work, you can make informed decisions about changing your coverage without risk to your personal finances.
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In order to have full coverage, an auto insurance policy must have collision and liability coverage. Additional coverage is optional; you may wish to buy medical coverage, rental reimbursement or uninsured motorist coverage. Regardless, all insurance can be divided into first-party insurance and second-party liability insurance.
First-party insurance such as collision, comprehensive and uninsured motorist coverage pay for damage caused to an insured vehicle. If you are involved in an accident, you will be responsible to pay a portion of the repairs with your deductible; after that, the damage will be paid by your insurance. If you are not at fault for an accident, you should be able to recover your deductible from the other insurance company.
There is no limit to first-party coverage; the insurance company will pay up to the value of the vehicle for repairs, and if repairs cost more than the vehicle is worth, you will be compensated for the worth of the vehicle. In some cases, depreciation deteriorates the worth of a vehicle rapidly so that you cannot pay off your car loan with the settlement amount you receive from an accident. To counteract this problem, you may want to take out loan GAP insurance; gap insurance, usually purchased directly from the dealership or finance company, pays the difference between a car’s value and the outstanding value of your car loan.
Your policy may also include first-party medical coverage. This will usually come with a predetermined limit. If a situation arises where you develop more medical bills from an accident than your insurance can pay for, your insurance adjuster may be able to pull coverage from other vehicles you insure to help cover these costs. This varies from one policy to another and is also subject to state law, so you should be sure to ask your agent how those situations are handled.
Liability insurance pays for damage caused to another person’s property; it also pays for injuries a person sustains from an accident that you cause. If you are found to be at fault for an accident, your liability coverage will pay for the damage to the other person’s vehicle. There is no deductible on most liability policies: The damage is simply paid from your policy.
All policies have limits of liability. States set minimum car insurance requirements for these limits, but you are able to purchase substantially more than the required minimum. It’s important to carry enough liability insurance on your vehicle because if you cause more damage than your policy can cover, you will be held personally responsible for that damage.
For example, if you skid on a patch of ice and collide with two vehicles before spinning into a guard rail, you will be held liable for damage to both vehicles and the damaged guard rail. If both vehicles are new luxury vehicles or sports cars and you only have a $10,000 limit on your policy, you will very quickly max out your policy limits.
If you cause more damage than you are insured for, the remaining balance will be billed to you directly through a collections agency. You may also be taken to court and sued for damage, which can become extremely costly. Many people opt for policies with at least a $100,000 limit to prevent having any issues with their limits of liability coverage. If you have a lot of assets that could be seized in a lawsuit, you can protect your interests by taking out an umbrella policy or personal liability policy; this is usually purchased in addition to your other insurance and offers financial protection for any situation you are held liable for, such as people being injured in your home.
If you are concerned about your policy, you should discuss your options with your agent. He may be able to help you find discounts that can lower your premiums without making dangerous cuts on your insurance policy that could leave you without coverage you desperately need.