A Car Insurance Lesson Learned the Hard Way

Sherrill St. Germain, CFP®

By Sherrill St. Germain, CFP®
Sherrill St. Germain is a CFP® professional turned freelance writer. She writes financial content with style and substance for a wide variety of clients and readers. Her work and ideas have been featured in books, online, and in magazines including Kiplinger Personal Finance, The Wall Street Journal and Financial Planning Magazine. When she puts down the pen, she can be found travel hacking her way to her bucket list destinations or hanging out with family friends, and cats (hers and others).
Posted on 04/02/2018

Everybody knows how car insurance works. You nod only half-comprehending as you accept the agent's policy recommendations. Then you grumble each year as you pay an ever-increasing premium as you hope to avoid having an accident and making a claim. But sometimes, you experience the sort of Grownup moment that brings with it a new level of (unwelcome) clarity.

A Rude Awakening

I remember waking up at the crack of dawn back in 1986 to the incessant ringing of the telephone. I was half asleep until I processed the words my brother said on the other end of the phone. “Your car was stolen.” Cue the panicking.

He explained that my apartment in Massachusetts had been burglarized. The thieves grabbed my keys off the dresser and drove away with my 10-month-old Dodge Charger. All while my roommate enjoyed a flick at the Somerville Theatre.

At the time, I was on vacation in Florida. The cops were already on the case, albeit not very encouraging about the car's safe return. It seems I'd taken up residence in The Stolen Car Capital of the World, and my car—a popular model—was a frequent target of chop shop proprietors.

In my foggy state, I reasoned there was nothing to be done right away. I wasn't exactly going to track down the perps myself. Besides, I had all the car insurance required by Massachusetts law, and then some.

But I was in for a rude awakening.

Class Is In Session

After my trip, I flew north to face the music. The news wasn't good: the car was found stripped for parts. I never did recover my cherished cassette tape of Bruce Springsteen's Born to Run. But that was a drop in the bucket compared to the other losses I experienced as a result of the chop shop's entrepreneurialism. Cue Grownup moment…

The insurance company declared the car a total loss, and cheerily informed me: “We'll send a check for what it's worth directly to the lender. You'll be responsible for paying off the rest of the loan.” The implications took a moment to sink in.

“Wait, what? You mean, I'm going to come out of this thing several thousand dollars poorer because some nefarious character not only broke the law, but profited from it?!”

Precisely, and here's why:

  • I hadn't had the car long enough to make a dent in the loan.
  • It had already lost 1/3 of its value, as new cars are wont to do.
  • My insurance policy specified “actual cash value” as the insured amount.

I, the insured, was responsible for the gap between what was owed on the loan and the car's fair market value, a significantly smaller sum. I would have to continue payments on a car that no longer existed.

Adding insult to injury, I needed a new set of wheels, which meant I had to come up with a down payment and make monthly payments on that in parallel. If memory serves, this went on for more than a year. It was a bitter pill even most Grownups would have found hard to swallow.

Course Correction

So now you know better than to invest in a bumper sticker that says “Hit me. I need the money.” But besides being lucky and not moving to The Stolen Car Capital of the World, what can you do to protect yourself from a similar fate?

Less than you might imagine, as I later learned through years of adulting and a decade as a financial planner. The process worked precisely as it was supposed to. When you think about it, it all makes perfect sense. But you have to think about it.

Contrary to popular belief, the purpose of insurance is not necessarily to make you whole, i.e. compensate you for 100% of your loss. Rather, it is to mitigate the impact of loss, up to the extent that the insurance company is willing to cover it and you are willing to pay for that protection.

So the only thing off was my expectations, which had been mis-set by a combination of cultural myth, industry jargon, and inattention to detail. In my mind, I was “covered,” which meant I would be “compensated for my loss.” And I was, up to the “actual cash value,” just like it said in the policy.

Perhaps I was offered a policy that covered “replacement cost,” which would have matched my expectations. But I'm sure the distinction between the two would've been lost on me. And I would have balked at paying the higher premium for what was seemed a minuscule risk. I still would today.

So what can be done to reduce the impact of such misfortune? In reality, the main thing you have control over is the size of the potential loss and your ability to absorb it gracefully.

One way to keep the potential loss down is to buy a used car that holds its value. That way, the original owner has already paid the premium for the new car smell, and the decline in value over time is much slower. Then if bad luck happens, your out-of-pocket is less, making it easier to recover financially. Ditto having a cash emergency fund with a healthy balance.