Car Insurance Policy Basics

Before shopping for auto insurance, you should understand the different components of coverage: liability, collision and comprehensive. Each of these components accounts for a part of the car insurance premium you pay. While it may be tempting to simply find cheap car insurance, it's a smarter choice to make sure you and your car are adequately protected.

Three Basic Types of Coverage

Liability: This is the part of a car insurance policy that you must have - it protects you in case you are at fault for an accident. You could be liable not only for damages to the other car, but also for medical expenses, lost wages, and pain and suffering for anyone injured. Liability limits are measured in tens of thousands (or sometimes hundreds of thousands) of dollars. For example, "50/100/25" means $50,000 bodily injury coverage for one person, $100,000 total coverage and $25,000 for property damage.

Collision: This coverage pays for repairs to your vehicle, or for the replacement of its market value if it's totaled when you collide with another car or hit something - regardless of who is at fault. If you own an older car, you may be better off without this coverage.

Comprehensive: This coverage pays for repairs or the replacement of your car if it is stolen or damaged in a fire, flood or high winds. Again, if you have an older car, you may not need this coverage.

The collision and comprehensive sections of your policy, which together account for 40 percent or more of your premium, each involve a deductible amount that you must pay before the insurance kicks in on each claim. For example, if you have a $500 deductible, and incur a loss of $1,000, you would pay the first $500 and your insurance company would pay the remaining $500.

Policies may also include medical payments coverage for you and your passengers (no matter who is at fault), and uninsured motorist protection in case your car is hit by an uninsured driver. Most policies also offer lower-cost add-ons such as rental reimbursement (in case your car is out of commission due to repairs after an accident), as well as towing insurance.

What's Required?

Nearly all states require drivers to carry liability insurance, but in some states the amount of coverage required is fairly low - somewhere between $15,000 to $25,000. No matter how much liability insurance your state requires, it's wise to get a policy with coverage limits of at least $100,000 per person injured and $300,000 per accident, because lower limits may not adequately protect you. In fact, according to the Insurance Information Institute, in recent years the average personal injury award in such cases has been about $323,000. You should also consider getting at least $50,000 in property damage liability coverage. Even though state limits may be much lower, repair bills can add up quickly on luxury cars and other expensive vehicles.

The quickest way to cut your car insurance premium is to increase the deductible on your collision and comprehensive coverage. Raising your deductible from the common $200 or $250 limit to $500 can cut 10 to 15 percent a year from your auto insurance bill. However, you should carefully weigh the potential savings against the higher out-of-pocket expenses. If you realistically can't afford to pay a higher out-of-pocket deductible, you should opt for the lower deductible.

If you drive an older car, you may be able to drop comprehensive and collision coverage entirely. In fact, if the car is more than five years old, you should consider this option. It just doesn't make sense to keep up expensive car insurance premiums if the car isn't worth that much. Remember that any payout will be on the market value only of that car. As a rule of thumb, don't keep up coverage if the premium for collision and comprehensive is more than 10 percent of the retail used value of the car.

Most states require uninsured/underinsured motorist coverage, which is often $20,000 to $40,000 in protection. If your vehicle is hit by a driver who doesn't have auto insurance or has insufficient insurance coverage, this will cover injuries to your passengers and other expenses that ordinary health insurance doesn't cover. It also protects you if an uninsured motorist hits you while you're riding a bicycle or walking. You can purchase $100,000 in coverage for about $50 each year, but it's usually worth the cost to increase this coverage a little more.

On the plus side, you may be able to save on medical payments coverage. Regardless of who is at fault in an accident, this coverage will pay doctor and hospital bills - and sometimes even funeral expenses - for you and your passengers. But before you decline the medical payments coverage, check to see if a combination of your life and health insurance would cover these items. If so, you can safely do without this option, which could save you as much as $100 a year.