When to drop collision coverage on your car

Photo: ZapTheDingbat

A few years back, I got a tidy little lesson in exactly what collision coverage is. We'd had a car damaged in an accident, damaged pretty badly. So, it wasn't a surprise when the insurance company called and said they were going to total the car. Fortunately, we checked over the paperwork they sent.

It turned out that the appraiser had made an error--he thought the car was two years older than it actually was. Not only did that make a difference in how big of a check we had coming, it actually changed their decision: the book value of a car two years newer was high enough that it was cheaper to fix the car, and that's what they did. We've been driving it ever since--something like ten years now.

That's what collision insurance is: a promise to pay a very specific amount of money, and the ceiling for that amount is the book value of your car, minus the deductible. (The amount of the premium is based on the assumption that your car is an average car of its type. If it is somehow better-than-average, the time to make that case is before your car is in an accident.) Every year it's a promise to pay less money (as your car depreciates). And, of course, its value drops to zero if you don't pay the premium.

The insurance company is out to make a profit, of course, and (aside from the interest they earn between when the premiums are paid in and the claims are paid out) there are only two ways to make a profit in the insurance business:

  1. they can charge premiums that are more than their customers losses
  2. they can pay out claims that are less than their customers losses

In the real world, of course, they do a little of both, but a combination of competition, regulation, and lawsuits means there are some limits. By and large, premiums are just a bit more than "fair" and payments on claims just a bit less. But that's the point: anytime you pay for more insurance than you need, you're handing the insurance company a bit of extra profit.

After the insurance company paid to fix our car, I took a hard look at what they might have paid if the car had been damaged just a little more, then dropped the collision coverage and started banking the difference that made in the premium. By now we've saved much more than the car is worth. And that'll always be true. Over time, what you pay in premiums will always be greater than you'll get back in claims. The only way you'll come close is to have claims that are either large or numerous--and in either of those cases, you can be sure that the insurance company will raise your premiums enough to put you right back where they want you.

The rule is, take the risks you can bear, and insure the ones you can't. Look up the book value of your car: that, minus the deductible, is the most the insurance company will pay. If you had to cough up that much money, would it break your finances? If not, then drop collision altogether. Otherwise, you need at least some collision coverage. (Of course, if your car isn't paid off, the bank will insist that you insure it. Another good reason to pay it off as quickly as possible--you not only get out from under the car payment, you can get out from under the collision premium as well.)

How much coverage do you need? Probably not enough to make you whole again--that would amount to carrying a zero deductible. Instead, you want the highest deductible you can safely afford. Think about what your options would actually be, if your car got totaled. Could you get by without replacing that car? Could you get by with a cheaper car? Figure out the rock-bottom you could make do with, and set your deductible appropriately.

Ask your insurance company or agent how much your premium will go down. Even in the first year you're not actually facing that "rock-bottom" scenario, because you've got the saved premium on top of that. Punch that amount into a financial calculator and see how quickly the saved premium, plus interest, adds up to the book value of your car. After a very few years, you'll be able to raise the deductible again. Very soon after that, you won't need collision coverage at all.

Take the risks you can bear and insure the rest. That's the rule.

And, as a bonus: if you self-insure, you don't have to worry about getting cheated and you won't have to hire an attorney to sue yourself for trying to low-ball you on the estimate.

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Guest's picture
karen w

I have just recently begun getting my financial house in order, in part due to the wonderful information I find here. It's been a long hard road, but the rewards of frugality are beginning to reap benefits.
I still have collision insurance on my paid-off car, but have considered dropping it. (As soon as I reach my break-even point in my emergency fund.)
I have a question about your analysis though. How would you factor in the situation (at least in my area) that body shops have a higher "cash" price for labor? The insurance companies negotiate them down so far that the labor rate is only marginally profitable for the repair shop. Without collision insurance, you are now subjected to a repair bill 25-40% higher because you don't have that insurance company negotiated lower labor rate. I know this to be true, because I am working in this industry. I've never seen a customer successfully get the cheaper labor rate on a cash deal. At this point, I wouldn't particularly worry about it because my employee discount would offset the insurance price vs. the cash price. In the future, if I wasn't working here, it could be an issue. Any insight?

Guest's picture

thanks for the lesson in logic on this one. I have been trying to wrap my mind around this topic for a while. This will certainly help me make a decision!

Philip Brewer's picture

I don't know about negotiating with the body shops. It's hard to win on that sort of negotiation, because the consumer not only doesn't have the necessary information (or the time to get it), but he's negotiating a single instance, so there's not much incentive for the body shop to give a good deal--unless he's a very unlucky guy, he won't be back for 10 years, so there's not much customer good-will to be gained. It might well only be possible for someone with inside information (such as when one particular body shop had idle workers).

One option would be to go with a really high deductible at the insurance company--several thousand dollars, perhaps. That'd mean the insurance company was negotiating for you, but not really on the hook for much, so the premiums would be low. Probably, though, the premiums would still cost more than extra labor charges, unless you have a lot of accidents.

I would note that the body shops probably have it wrong. Car dealerships used to use the same logic: it'll be years before this guy buys another car, so there's no point in making a deal to get some customer good-will, because any payoff is so far into the future as to not matter. The fact is, though, that people looking to buy a car ask their friends and relations for suggestions, and a good buying experience plays into whether a dealership gets the nod or not. The same is very much true of bodyshops. Business owners can be just as short-sighted as the next guy, though, and things won't change until a very clever guy starts a bodyshop that competes for business on price. (Probably almost all competition between bodyshops is on quality of work, since most people have insurance paying the tab, almost like with medical care--which is how we get into the situation you describe.)

Guest's picture

I am in a foul temper against insurance companies at the moment, but glad I pay for the better service.

I hit a piece of concrete that fell of a bridge while driving at night in the pouring rain in the middle lane of a 400-series highway while doing the speed limit. This unfortunately places me in the category of "I hit something that wasn't moving" which is an at-fault collision. I pay the collision deductible, my rates go up, and I am now a bad driver.

Fortunately, they are covering the cost of my rental car for 2+ weeks and paid for the towing to the storage lot and then to the body shop.

I've been trying to recalculate the costs of redoing my plan, and this blog really helped. I'm going to go over things in a different way. Thanks!

Guest's picture

Great post! It's perfect timing as both mine and my husband's cars will be paid off in a few months and we were wondering when we should move them to liability only.

Guest's picture

I got in a car accident today. A trash truck slowed down and i slowed down, i thought it was turning. It started to back up, and i guess it didn't see me, so i stopped and blew my horn and it backed up into me. The state trooper came, and said it was my fault because my front(car)was under his bumper.Istopped and did not hit that truck in the back he hit me, but i'm at fault. what can or is their anything i can do to fight this, i've never been in a accident and have no tickets, never. I was given a ticket for driving to fast for conditions,what can i do?

Philip Brewer's picture

I not sure I can help much. I do know this: The state trooper doesn't decide who's at fault. That would be done in a court. (Plus the insurance companies have their own system to work these things out between themselves. And for this matter, your liability insurance would be involved, even if you don't have collision.)

If you were at a complete stop and the truck backed into you, then it's obviously not your fault. Making it legally not your fault may be difficult, but I suspect you've got a good chance, if you hire a good lawyer and follow his advice.

Guest's picture

nice summary of the trade-offs for keeping or dropping collision, especially the risks of getting the car totaled. Might benefit from adding sources for finding out what is the car value such as edmunds.com

Guest's picture

One issue I learned the hard way in the past couple of weeks.

My son's car was totaled while parked on a residential street. The at-fault drivers company took care of a rental car, gave me a very reasonable settlement, took care of all the paperwork and I just signed the car over to them.

My daughter was at-fault in a minor fender-bender. Our liability took care of the other party, but since I didn't have collision on the car, I'm stuck doing the leg work on getting estimates, and, having determined that the car is totaled, have to deal with getting rid of it myself.

I sure wish I'dve had collision on my daughter's car as it would have made the process much, much easier.


Guest's picture

Blue book value generally has nothing to do with what the insurance carriers will pay you if your car is totaled. Usually they find similar vehicles near you for sale, say 3-5 of them and average that cost. It's the average cost to replace the car you had, not blue book.

Guest's picture

Accident claims are generally paid on an actual cash value basis. That means, the insurance company takes the (local) market value less your deductible. They also factor any depreciation or appreciation on a case by case basis.

When it comes to claims, most insurance companies rarely use NADA, BLUE BOOK, or BLACK BOOKS. You get a better idea of your vehicle's value by going to an auto trader like website and getting the value for the same make and model in your area.

Guest's picture

I too had a recent lesson. In an effort to save, I dropped collision on my 8-yr old car. My car was totaled when I was hit by a well-insured driver. I was injured, but not hospitalized. My insurance company was not willing to help me get a settlement BECAUSE I had dropped collision. So I had to hire an attorney out of pocket to get a reasonable settlement. Would my insurance company attorneys have worked as hard to make me whole? I will never know. But the true cost of saving a buck on collision cost me a pretty penny in attorney's fees to properly replace a car equivalent to the one that was lost as well as appropriate compensation for my medical injuries. Just something to consider.