Understanding How Auto Insurance Works (2025)

Auto insurance can be surprisingly complicated. The industry is filled with jargon and confusing terms.

Many drivers have auto insurance yet don’t really understand how it works. That’s a problem: you might assume your car insurance policy covers theft, for example, when it really does not.

Today, we’re helping you understand auto insurance. Keep reading to discover the basics behind how auto insurance works, including:

• Why do I need car insurance? Is it legally required?
• What types of car insurance are available?
• How much coverage do I need?
• What are deductibles and what should my deductible be?
• How can I get cheap car insurance rates?

Why Do I Need Car Insurance?

In the early 1900s, cars were becoming increasingly popular in American cities. But cities noticed a problem: car accidents were creating significant costs for society.

Car accidents were injuring or killing people. They were damaging private and public property. They were inflicting huge costs for everyone.

Someone had to pay for these costs. That’s when governments decided to force drivers to have car insurance.

From that point forward, most states in America have required drivers to have some level of car insurance. This car insurance covers the cost of “making whole” any damages you inflict on other people and property, including medical bills and property damage repair costs.

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Is Car Insurance Legally Required?

The bare minimum car insurance required by law is called liability insurance. Every state except New Hampshire and Virginia requires drivers to have liability insurance. All states require you to have a specific level of liability insurance.

Drivers in California, for example, are required to have $15,000 of bodily injury liability coverage per person and $30,000 per accident. they’re also required to have $5,000 of property damage liability coverage. Some drivers buy bare minimum car insurance that just meets these requirements. Other drivers surpass these requirements.

Certain states – including California – also require you to have uninsured/underinsured motorist coverage, which covers certain expenses if you are involved in an accident with someone without car insurance (or with too little car insurance).

Other states – like Florida – require you to have medical payments coverage and other additional coverage options.

Drivers in New Hampshire and Virginia Are Not Required to Have Car Insurance

It’s true that some states don’t require drivers to have car insurance. New Hampshire and Virginia have no specific car insurance requirements.

However, drivers in New Hampshire and Virginia aren’t off the hook for car insurance entirely.

Drivers in New Hampshire, for example, are still responsible for damages resulting from a car accident. They must pay up to $50,000 for liability coverage and $25,000 for property damage coverage. Drivers who cannot pay these amounts can have their license and registration suspended. Because of this requirement, most drivers in New Hampshire buy car insurance anyway.

Drivers in Virginia, meanwhile, can avoid buying car insurance just by paying the state $500 per year. However, this doesn’t give the driver any accident coverage whatsoever, and the driver who caused the accident is still liable. This is why most drivers in Virginia carry car insurance.

Drivers in all other states in America, meanwhile, are legally required to have car insurance.

What Happens If I Don’t Have Car Insurance?

If you don’t have car insurance, then you’re exposing yourself to significant risk.

First, driving without car insurance is illegal in most states. If you are pulled over by a police officer and cannot provide proof of insurance, then you could face serious consequences. Your car could be impounded. You might receive a fine. You could even go to jail.

Second, driving without car insurance exposes you to significant liability. If you drive without car insurance and cause an accident, you are personally liable for all damages. That means you have to pay the lost wages, medical bills, car repair costs, and all other expenses incurred as a result of your actions. For bad accidents with multiple serious injuries, your liability can easily exceed $1 million. Normally, a car insurance policy or umbrella policy would cover these costs. Without car insurance, however, you will need to pay for these costs out of pocket.

Driving without car insurance is generally a bad idea. Despite the risk, approximately 1 in 7 drivers in America drive without car insurance.

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What Types of Car Insurance Are Available?

We touched on the types of car insurance above. Generally, however, car insurance is separated into three specific coverage types:

Liability Car Insurance

Liability car insurance coverage is required in every state except New Hampshire and Virginia. Liability coverage includes bodily injury liability coverage (which covers medical bills, lost wages, and other personal expenses incurred as a result of your actions) and property damage liability coverage (which covers car repair costs and other property damage repair or replacement costs).

Collision Car Insurance

Collision car insurance coverage is not required in any state. Collision coverage covers the cost of repairing your own vehicle after a collision. If you’re at-fault for a collision and only have liability coverage, then your car repair or replacement costs will not be covered. To have these costs covered, you need collision coverage. With collision coverage, you’ll only pay your deductible, while your insurer will cover the remaining costs of repairing or replacing your vehicle.

Comprehensive Car Insurance

Comprehensive coverage protects your vehicle from all non-accident-related types of damage, including theft, vandalism, fallen trees, water damage, fire damage, and other events.

Car Insurance Policy Options

The three broad types of car insurance policies include liability, collision, and comprehensive coverage. However, you can add additional terms to your car insurance policy, including:

Uninsured and Underinsured Motorist Coverage: Certain states require you to have uninsured/underinsured motorist coverage. This coverage protects you if you get into an accident with an uninsured motorist or a motorist with too little car insurance.

Medical Payments Coverage: Certain states also require you to have medical payments coverage, which functions similar to health insurance. Medical payments coverage covers your own medical bills after an accident, regardless of fault.

Personal Injury Protection: Some states require you to have personal injury protection insurance, which covers certain medical expenses and loss of income resulting from a covered accident.

Gap Insurance: Gap insurance is optional in every state, although some insurers require it when leasing or financing a vehicle. It covers the ‘gap’ between the price you paid for the vehicle and what the vehicle is currently worth.

Read more:

• What is gap insurance and do I need it when filing an auto insurance claim?
• Does my auto insurance cover my medical expenses after an accident?
• Does my auto insurance cover damage caused by a driver who is uninsured or underinsured?
• Do I have too much auto insurance coverage?
• Cheap Hampshire Auto Insurance
• How does the auto insurance company determine my premium?
• What is the difference between a deductible and a premium in auto insurance?
• Self-Insured Auto Insurance: An Affordable Alternative

Rental Reimbursement Insurance: Many car insurance policies have rental reimbursement insurance, which covers the cost of renting a vehicle if your primary vehicle is being repaired after a covered incident.

Classic Car Insurance: Classic cars have different types of auto insurance coverage than ordinary cars. Many insurance companies offer classic car insurance specifically for this reason.

Towing and Labor Coverage: Towing and labor insurance covers the cost of towing your vehicle to the nearest service station – say, if it breaks down on the side of the road. It may also cover the labor costs of anyone fixing your vehicle.

How Much Coverage Do I Need?

Every state in America has different rules governing car insurance.

Check Wikipedia to see your state’s current minimum insurance requirements.

Minimum insurance requirements are expressed as three numbers like 25/50/25. These numbers refer to $25,000 of bodily injury liability coverage per person, $50,000 of bodily injury liability coverage per accident, and $25,000 of property damage liability coverage.

Certain states have additional requirements – like medical payments coverage.

You don’t have to worry about these minimum requirements when shopping for car insurance. If you buy car insurance from any company serving your state, then that insurance policy will at least meet your state’s minimum insurance requirements.

Drivers who want the cheapest possible car insurance can meet their state’s minimum insurance requirements. Drivers willing to pay more for added peace of mind may want to exceed the minimum requirements.

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What Are Deductibles and What Should My Deductible Be?

A deductible is what the insured party must pay before the insurance company covers the remainder.

Let’s say you have a $500 deductible on your collision coverage policy. You back your car into a wall and cause $5,000 in damage. You pay your $500 deductible, then your insurance company covers the remaining $4,500 in repair costs.

You can lower insurance premiums with a higher deductible. You’ll pay more (say, $1,000 or $2,000) if you’re in an accident, but you’ll pay less per month for car insurance.

The typical car insurance deductible is between $500 and $1,000. Based on your aversion to risk, you can raise or lower your deductible however you like.

How Can I Get Cheap Car Insurance?

Finding cheap car insurance is easier today than ever before. Today, millions of drivers use insurance comparison websites – including our own website – to compare quotes from insurance companies.

Just enter your ZIP code to get started. You will see a range of offers from companies serving your area.

Scan through the offers, then pick a few you like. Complete a customized quote with each insurance company, then decide which insurance company best fits your needs and budget.

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