Selecting the right coverage amounts requires balancing protection against potential losses against the premium costs of that protection. Neither minimum coverage nor maximum coverage is universally correct. The optimal level depends on your specific financial situation, assets, and risk tolerance.
Understanding Coverage Limits
Auto insurance coverage limits define the maximum your insurer will pay for covered losses. Liability limits protect against claims from others. Uninsured motorist limits protect you when at-fault parties cannot pay. Medical payments cover your own injury costs regardless of fault.
Higher limits cost more in premium but provide greater protection. The relationship between limits and premium is not linear: doubling your limits typically costs far less than double the premium because most claims fall well below maximum limits.
Liability Coverage Optimization
Liability coverage protects your assets when you cause accidents. The stakes are highest here because liability claims can exceed policy limits, exposing your personal assets.
Asset-Based Analysis
A fundamental principle suggests carrying liability limits at least equal to your net worth. If you have $500,000 in assets, you should consider $500,000 in liability coverage. Claims exceeding your limits can result in judgments against your personal assets.
Beyond current assets, consider future earnings. A large judgment can garnish future wages for years. Young professionals with high earning potential may need higher limits than their current assets alone suggest.
The Cost of Higher Limits
Increasing liability limits from state minimums to $100,000 per person and $300,000 per accident typically costs $100 to $200 annually. Further increases to $250,000 per person and $500,000 per accident add another $50 to $100. The marginal cost of additional protection decreases as limits increase.
Umbrella Policy Consideration
Personal umbrella policies provide additional liability coverage above your auto and home policy limits. A $1 million umbrella typically costs $150 to $300 annually. Umbrellas require underlying auto liability limits of at least $250,000 per person and $500,000 per accident.
For significant asset protection, combining reasonably high auto limits with an umbrella policy often provides more coverage per dollar than maximizing auto limits alone.
Uninsured and Underinsured Motorist Coverage
Uninsured motorist coverage pays for your injuries and damages when an at-fault driver has no insurance. Underinsured motorist coverage pays when the at-fault driver's limits are insufficient to cover your damages.
The Risk Reality
Approximately 13% of drivers nationally are uninsured, with some states exceeding 25%. Many insured drivers carry only minimum limits, which may be grossly inadequate for serious injuries. The risk of encountering uninsured or underinsured drivers is substantial.
Matching Liability Limits
Financial logic suggests carrying uninsured and underinsured motorist limits equal to your liability limits. If you value $300,000 of protection when you injure others, you should equally value $300,000 of protection when others injure you.
Medical Payments Coverage
Medical payments coverage pays for your medical expenses regardless of fault. It supplements health insurance and covers deductibles and copays your health coverage does not pay.
Health Insurance Considerations
If you have comprehensive health insurance with low deductibles, medical payments coverage provides less marginal value. If your health coverage has high deductibles or significant gaps, medical payments coverage provides more value.
Typical Levels
Medical payments limits typically range from $1,000 to $10,000. Premium differences between low and high limits are often modest. Given low incremental costs, higher limits usually make sense unless you have no exposure to the covered risks.
Physical Damage Coverage Amounts
Collision and comprehensive coverage protect your vehicle. Coverage amounts equal your vehicle's actual cash value; you do not select limits as you do with liability. However, deductible choices significantly affect your net protection.
Value-Based Decisions
As your vehicle depreciates, the maximum possible payout decreases while premiums decline more slowly. Periodically recalculate your premium-to-value ratio and consider dropping coverage when it becomes unfavorable.
Rental Reimbursement
Rental reimbursement coverage pays for a rental car while yours is being repaired. This optional coverage typically costs $20 to $50 annually. If you would otherwise pay for rentals out of pocket, this coverage often provides value. If you have access to alternative transportation, you might skip it.
The Optimization Framework
To optimize your coverage amounts, apply a systematic framework.
Step 1: Inventory Your Assets
List your home equity, investments, savings, and other assets. Estimate your future earning potential. This represents your exposure in liability claims.
Step 2: Assess Your Risks
Consider your driving environment, miles driven, and local uninsured driver rates. Higher risk factors suggest higher coverage needs.
Step 3: Get Tiered Quotes
Request quotes at multiple coverage levels to understand the marginal cost of each increase. The cost differences often surprise people with how affordable higher limits can be.
Step 4: Apply the Marginal Analysis
For each coverage increase, ask whether the additional protection is worth the additional premium. When marginal value exceeds marginal cost, increase coverage. When marginal cost exceeds marginal value, you have reached your optimal level.
Step 5: Consider Package Effects
Umbrella policies and multi-policy discounts can change the optimal mix. A cheaper umbrella might substitute for expensive increases in auto limits. Bundle discounts might make higher coverage affordable.
Common Optimization Mistakes
Several mistakes lead to suboptimal coverage amounts.
Minimum Limits Default
Choosing state minimum limits without analysis exposes significant assets to judgments. Minimum limits rarely provide adequate protection for anyone with meaningful assets.
Uniform Increases
Increasing all coverages by the same percentage ignores their different economics. Some coverages provide better value at higher levels than others. Optimize each separately.
Ignoring Changing Circumstances
Coverage appropriate when you were young with few assets may be inadequate after accumulating wealth. Review coverage amounts when major life changes occur.
Documentation and Review
Document your coverage optimization reasoning. Record your asset values, risk assessments, and the logic behind your choices. This record helps during annual reviews and ensures you reconsider decisions as circumstances change.
Review coverage amounts at least annually and after major life events like home purchases, inheritances, or significant income changes. The optimal coverage today may not be optimal tomorrow.