Motor Vehicle Insurance Collision Coverage

The purpose of collision coverage in a motor vehicle insurance policy is to shift the financial cost of repairing or replacing a vehicle from the owner or lessee of a car to an insurance company. Like other forms of insurance, it is a method of shifting risk that would otherwise be on the owner or lessee.

Collision insurance coverage is “first-party” insurance. That means it covers the individual or entity that bought the insurance. The insurance policy purchased by the insured may cover multiple vehicles.
Collision coverage is, generally, an optional auto insurance coverage. That is, it is not mandated by law unlike other kinds of motor vehicle insurance. However, there are exceptions to this general rule, such as:

• When there is an outstanding loan on the car. In those cases, the lender may require that the vehicle owner maintain collision coverage on the vehicle. The reason is that the loan is secured by the value of the car. Therefore, if the car loses value because of a collision, the value of the security (the car) is reduced.
• When a car is leased. Since a leased car may be returned to the lessor at the end of a lease, the lessor wants to ensure that any damage to the car has been repaired so that the value of the car is maximized.

If the required collision coverage is not obtained and maintained by the borrower or lessee, the person or company that loaned money on the car or leased it, can buy “forced-placed” coverage. This is a kind of collision coverage that benefits the lender or lessor and protects his, her, or its security interest in the collateral (the vehicle). Typically, it is much more expensive than collision coverage that the individual could have obtained him/her/itself. The cost of the force-placed insurance is added to the amount owed by the borrower or lessee.

What Does Collision Coverage Pay?

In general, collision coverage pays the reasonable cost of repair of a vehicle resulting from a variety of causes, including:

• Damage resulting from impact with another vehicle
• Backing up into a telephone pole
• Hydroplaning on a wet road and colliding with a tree

The payment that an insurance company makes under the collision coverage of an automobile insurance policy is normally subject to a deductible. As discussed in articles on other kinds of insurance, a deductible is the amount of money that the insured pays toward a covered loss. In the case of car insurance, it is an amount of money that the insured pays toward the cost of repairing the car, and can range anywhere from $50-$500; different insurance companies offer different deductible choices. The amount of the deductible affects the premium for collision coverage in that in general, a higher deductible reduces the collision coverage premium. That is because the automobile insurer’s responsibility to pay is not triggered until the deductible has been met.

Sometimes individuals have collision insurance on an old car that does not have much remaining market value. More often, collision coverage is purchased when a car has significant value and the owner or lessee wants to ensure that he, she, or it does not have to be responsible for the cost of repair beyond the deductible.

When damage from a collision is great, the cost of repair may approach the “actual cash value” (ACV) of the vehicle such that the motor vehicle is a “total loss.” ACV can be defined as an amount equal to the replacement cost of the vehicle minus the depreciation that resulted from the damage. An edition of Claims Journal, a prominent and respected insurance publication, describes ACV and the determination of whether the vehicle is a total loss like this:

…insurance companies will calculate the total loss ratio (cost of repairs/actual cash value) and then compare this ratio to limits set either internally within the company and/or regulated and established by state law. It is also sometimes referred to simply as the damage ratio. Some states dictate how high this damage ratio needs to be in order to be able to declare a vehicle a “total loss” and be eligible for a salvage title or certificate.

This is referred to as the Total Loss Threshold (TLT). In order to total a vehicle, the total loss ratio must exceed the established percentage. If the TLT is not dictated by the state, an insurance company will usually default to something known as the Total Loss Formula (TLF) which is:

• Cost of Repair + Salvage Value > Actual Cash Value
• If the sum of the first two quantities is greater than the ACV, the car can be declared a total loss.

In Florida, the “total loss threshold” is 80%, so that if the threshold is reached, the insurance company must “total” the vehicle. The other States may have other thresholds and may use different formulas to determine what constitutes a “total loss.” Ratios and formulas from other States are shown in the cited Claims Journal article (be careful though-laws change and that article is a few years old).

If the insurer declares a vehicle to be a “total loss”, it will pay the ACV of the vehicle (what it was worth in undamaged condition), less the policy deductible. In return, the insurance company gets the salvage. If the insured keeps the salvage, its value will reduce the net amount paid to the insured.