How Car Insurance Works: Premiums, Deductibles and Limits

Car insurance is a contract. You pay a company a regular fee, and in return the company agrees to pay for certain costs if something covered goes wrong, such as a crash, a theft or a lawsuit after an accident. The details of that agreement live in your policy, and understanding a handful of terms makes the whole thing far less confusing.

The four numbers and terms to know

Almost every auto policy is built from the same few parts. Once you can read these, a quote or a declarations page starts to make sense.

• Premium. The price of the policy. It is billed monthly, every six months or yearly, depending on the insurer and your payment choice.
• Deductible. The amount you agree to pay yourself on certain claims before the insurer pays the rest. It usually applies to damage to your own car, such as collision and comprehensive claims.
• Limits. The most an insurer will pay for a covered loss. Liability limits are often written as three numbers, such as 25/50/25 (an example of the format only, not a recommendation).
• Policy term. How long the policy lasts before it must be renewed, commonly six or twelve months.

What a policy is made of

A car insurance policy is a bundle of separate coverages. Some protect other people when you cause an accident. Others protect you and your vehicle. You choose which to carry, within whatever your state and your lender require.

Our guide to liability versus full coverage goes deeper on how these fit together.

How premiums and deductibles interact

Premium and deductible usually move in opposite directions. Choosing a higher deductible often lowers the premium for the same coverage, because you are agreeing to carry more of the cost of a small claim. The trade-off is that you need to be able to pay that larger amount if you do make a claim.

What happens when you make a claim

When something happens, you report it to your insurer, who opens a claim. An adjuster reviews what happened, checks it against your policy, and estimates the loss. If the claim is covered, the insurer pays according to your limits and deductible. If you were not at fault, the insurer may also pursue the other driver or their insurer to recover the cost.

The steps are covered in more detail in how to file an auto insurance claim.

Who sells car insurance

You can buy a policy several ways. Some companies sell directly to you online or by phone. Captive agents sell for a single company. Independent agents and brokers can offer policies from more than one company. None of these channels is automatically better for everyone; what matters is that the coverage fits your situation and that the seller is licensed in your state.

Why prices and rules differ

Insurance is regulated mostly at the state level, so the coverages you must carry, the way claims are handled and even which pricing factors are allowed can differ from one state to the next. Within a state, each insurer uses its own formulas, which is why two companies can quote different prices for the same driver. For more on what insurers look at, see what affects car insurance rates.

Keeping your policy in good standing

• Pay on time. A missed payment can lead to cancellation and a gap in coverage.
• Tell your insurer about changes such as a new address, a new vehicle, a new driver or a change in how you use the car.
• Review your policy at each renewal rather than letting it renew on autopilot.
• Keep proof of insurance available in your car or on your phone, as many states require.