There is plenty of basic advice on the web for reducing auto insurance costs. One of the recurring recommendations is to reduce your auto insurance premium on collision and comprehensive coverage by raising your deductible. Others suggest dropping collision and comprehensive coverage after five years to reduce the auto insurance premium further. I like both pieces of advice, and they are certainly practical steps in the frugal living direction. But I recommend taking a leap further. How? By dropping both of these first-party insurance coverages outright as soon as you reasonably can and, in all cases, by the third year of ownership.
You will see the wisdom of my recommendation once you realize how little insurance benefit your first-party premium dollar buys.
How first-party auto insurance works
Both collision and comprehensive insurance is considered “first-party” coverage because it protects you, the insured, as opposed to third-parties whom you might damage. Both are subject to deductibles.
Assuming you follow the conventional frugal rule of carrying a $1,000.00 deductible, the insurance company will not pay for any repair up to that amount. You will. Furthermore, most drivers will either pay out of pocket, or forego having, repairs costing anywhere close to that amount. Why? Because they figure it is not worth the increased premium and hassle of making a claim just to net three or four hundred dollars of insurance pay out. Depending on the driver’s personal threshold, this means the insurance company, for all practical purposes, enjoys a floor of $1,300.00, to perhaps as much as $2,000.00, before it will pay anything on a first party claim.
The insurer enjoys a ceiling on its responsibility as well. Contrary to popular belief, that ceiling is not what you paid for the car, nor is it the cost of buying a new, replacement car. It is instead the fair market value of the car at the time of the accident. This means that the insurer gets to depreciate the value of your car according to its age and related factors.
Depreciation thus provides another substantial discount for the insurer. According to Edmunds, cars with average driving depreciate 20 percent after one year, 31 percent after two years, 42 percent after three, and on and on it goes.
The net effect is that the insurer only pays for damages that your vehicle suffers within a relatively small price range, and that range narrows each year. When you run the numbers, you see that the insurance protection is just not worth the high premiums that you must pay to continue carrying that collision and comprehensive coverage after the first three years.
Edmunds provides the useful example of a car bought new for $29,873.00. After three years, and assuming average driving of 15,000 miles per year, that car is worth $17,406.00. Consequently, the most your insurer would pay on damage to the car would be $17,406.00, less your deductible.
The final point to remember is that collision coverage generally comes into play only if you have an accident that is your fault. If the accident is the other driver’s fault, his or her liability insurance pays for your damage and your insurer pays nothing. (This assumes the at-fault driver is identifiable and insured, as the law requires.)
Putting it together in your case
You have to ask yourself whether it is worth paying several hundred dollars or more a year for this limited insurance benefit. In making the decision, consider three major factors: your accident risk profile, your financial ability to replace the vehicle without insurance, and the cost/value of your vehicle.
Taking these in order, if you are accident prone, perhaps it is worth the cost. If you routinely do stupid things like text while driving, it certainly is. On the other hand, if you are a good, mature driver who has had no major accidents in 15+ years, it probably is not. I would also factor climate into this consideration because frequent ice and snow is a risk factor that even good drivers cannot fully control.
Next, consider your ability to replace the vehicle if you do have a serious accident that is your fault. If you are a veteran of frugal living and you have amassed substantial savings, I strongly recommend that you drop this coverage early in the vehicle’s life. If, for example, you have $100,000.00 or more in non-retirement assets, you can, if you must, but a new or used replacement vehicle in cash if you like. At this point, some of you are probably asking what I am smoking if I believe folks have such savings. Many people do, and if you follow this blog, you will be there faster than you think. But no worries if you are well south of this figure. Why? Because even with substantially less saved, you could still replace the vehicle using your savings, vehicle financing, or some combination of the two. Either way, you are essentially self-insuring the current vehicle, as opposed to paying an insurance company substantial premium dollars that most likely will never bring you a benefit.
Finally, consider the value of your vehicle when making the decision. A truly frugal person buys economically priced and fuel efficient cars, which typically fall at or below our hypothetical $29,873.00 vehicle example. If, however, you own a luxury vehicle, an SUV, or some other vehicle that still holds a value well north of this figure, you would be gambling with more of an out-of-pocket loss by dropping the insurance, which probably weighs in favor of keeping the first-party coverages a bit longer.
The bottom line is this: if you are a responsible, safe driver with a reasonably priced vehicle that you can, if necessary, replace on your own, you should lose the collision and comprehensive coverages after the first year or two. If you are particularly well situated financially, such that buying a replacement vehicle will hardly dent your net worth, just forego these coverages from day one.
Auto insurance companies are not our friends. They are not good neighbors, and they are not good hands. They are in business to maximize profit at your expense. Be wise and minimize those premium windfalls.