If you don’t pay close attention to your auto insurance premiums, deductibles and the replacement value of your car, there is a good chance you could be getting ripped off by your insurance company.
A longtime reader of my personal finance blog recently posed this example which highlights what can happen when you’re still paying for “collision insurance” on a car with a very low replacement value.
Ben, I wonder if you would consider doing an article on insuring an old car. I recently had a fender bender with my BMW which still looks and drives well. The problem is the book value is $1300 and my deductible is $1,000. It would cost $2,000 to get the car fixed, so the insurance company has totaled it. The annual premium I paid is more than I would get back.
Unfortunately, this is an all too common scenario and one that is very profitable for insurance companies.
When buying a new car, most people pay for both “liability” insurance (which protects the driver from damage to other people’s property) and collision insurance (which covers the repair of the driver’s vehicle).
In the event your vehicle is damaged in some sort of accident where you were at fault, your insurance company would pay to have the car fixed or replaced minus your policy’s deductible.
As years go by, the insurance premiums for liability and collision insurance stay relatively the same (or go up in some cases) but the value of your car rapidly depreciates. You may of bought your car for $15,000 three years ago, but there’s a good chance its worth less than $2,500 today.
This depreciation in your car’s value is important because it can make the “collision” component of your insurance policy obsolete. In other words, your car is worth less than the combination of your policy’s deductible and monthly premiums.
In the case of the reader above, she was still paying her monthly premiums for both liability and collision insurance. Ironically, the amount she paid annually for her “collision” insurance was more than what her car was worth.
Ideally she should have dropped collision insurance from her automobile policy and saved the difference in her emergency fund or car replacement fund.
This lack of parity between what you’re paying in premiums and the coverage you receive is one of the biggest profit components in an insurance company’s business model. Don’t count on them to tell you when their opinion of your car’s value is less than what your deductible would be (let alone your annual premiums).
Things to Consider Before Dropping Collision Insurance on Your Car Insurance
Before you drop collision or comprehensive insurance coverage from your automobile policy, there are a few things you need to consider.
First, you need to research what your car’s realistic replacement value is; not what the insurance company says your car’s worth, but what a fair replacement value is for your car in your area.
Second, you need to look at how much extra you’re paying per year on your automobile insurance policy for “collision” or “comprehensive” insurance. Depending on your car, this may account for 50% or more of your total car insurance bill.
Third, you need to look at what you’re insurance deductible is for an at-fault collision claim. Most car insurance deductibles are $1,000 but many people opt for the $500 deductible option.
Rule of Thumb on When to Drop Collision Coverage
If your car’s replacement value is less than 3X the combined total of your insurance deductible and annual premium (collision component only) then you should really consider dropping collision insurance on your automobile.
Example: Let’s say your car’s replacement value is $5,000. If you’re deductible for an at-fault “collision” claim is $1,000, and you’re paying $1,000 extra per year for “collision” coverage, I recommend your drop collision insurance, IF, and this is a big if, you have an adequate amount of money saved in an emergency fund. ($1,000 + $1,000) X 3 = $6,000 = more than replacement value.
Caution: If your car is financed through a bank or other financial institution, there is a good chance you’re actually required to keep “collision” insurance on the car. This is weird I know, especially when you’re paying for something that has ABSOLUTELY no value for you.
For additional help on your specific situation, feel free to ask a question in the comment blocks below. I’ll tell you what I would do if I were in your situation.