Dump the insurance on your clunker

By Liz Pulliam Weston

If you're paying for collision and comprehensive insurance coverage on an older car, you're probably wasting your money.

Yet many people I talk to are reluctant to drop this coverage, which pays for:

• The damage you do to your own vehicle when you cause an accident.
• The loss you suffer when your car is stolen or damaged by something other than a crash (such as a falling tree squashing it flat).

Collision and comprehensive coverage are two of the three major components of car insurance. The third is liability coverage, which pays for the damage you do to other vehicles and people.

Though you always need liability coverage, and probably a lot more than the minimum, dropping collision and comprehensive insurance is often a smart way to save money.

Not a snap decision

Deciding when to let go of this coverage, though, can be a challenge. The old rule of thumb, that you should ditch it after five years, no longer works for many people because:

• Many cars retain their value better than in the past. In the old days, vehicles were less expensive, and values often dropped sharply over the years. Now, cars tend to cost more upfront and hold their values better, meaning you'll get a bigger payoff from the insurance company if your car is totaled or stolen.
• Many folks are "upside down," owing more on their vehicles than they're worth. Accidents or theft in these situations can be a financial disaster; you'd need to come up with money for another car while still owing on the old one. (Read "The real reason you're broke" and "Will the loan outlive the car?" for more details.)
• Many people live paycheck to paycheck. Without savings to tap to buy another car, they face higher financing costs and years of being underwater on their loans if they have to replace their vehicles.

To see where you stand, you should first look up the value of your car so you have some idea what your collision and comprehensive coverage would actually pay. MSN Autos offers Kelley Blue Book values, and Edmunds.com offers additional used-car pricing information. You might want to check more than one source because the prices they quote can vary.

• Video: Insuring your car

Although you can't predict exactly how much your insurer would send you if your car was totaled or stolen, you can probably expect a check for an amount between the car's average trade-in value and what a dealer would charge. The "private-party sale" value is often a good proxy for what you'd get.

Now dig out your last insurance-premium statement. If the annual cost for collision and comprehensive insurance on your car is more than 10% of what you'd get from your insurer, then it's time to consider dropping them.

Say you have a 10-year-old Honda that's worth $4,000 in a private-party sale and have a $500 deductible. Your risk is $3,500. If your premiums for collision and comprehensive are more than $350 a year, it may be wiser to bank that money toward a newer car.

Many people could realize big savings by getting rid of these coverages. You might save 20% to 50% of your annual premium.

When to keep full coverage

But you probably shouldn't do that if:

• You're upside down. If you owe thousands more on your car than you'd get from your insurer, you'd be smart to hang on to comprehensive and collision coverage and buy gap insurance (read "Close the gap in your car insurance" for details). You're probably required to keep collision and comprehensive on the car as a condition of financing, anyway.
• Your finances are running on the rims. If you have no savings, your credit cards are tapped out and your credit scores are in the tank -- in other words, if even a small insurance payment could make the difference between a crisis and a manageable pain in the butt -- then consider keeping comprehensive and collision coverage. The insurance payment would serve as your down payment on the next car, which might help you get a better interest rate and reduce the time you're under water on the loan.

What if you're otherwise in OK financial shape but still balking about giving up comprehensive and collision coverage? You're probably thinking about insurance the wrong way. You're hoping the coverage will some day "pay off" and prevent you from having to dig into your own pocket to cover your losses.

The better way to think about insurance is as protection against catastrophic loss -- something that you couldn't easily pay for out of pocket. Reserving insurance for disastrous events, rather than using it for everyday costs, will save you serious bucks over time. You'll not only save on premiums, but you won't be tempted to make claims that could cause your insurance costs to skyrocket.

If you can't quite bring yourself to get rid of the coverage you don't need, at least boost your deductibles to $500 or $1,000. Keep that much cash in the bank to tap in case you need it, and you'll be miles ahead.

Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.

Published March 1, 2007