When your vehicle is totaled in an accident, your insurance company pays you for the value of the totaled car—or, more accurately, it pays you what it claims the value to be.
Nearly everyone who has been through this process can attest that the most frustrating part is accepting the auto insurance company’s assessment of your car’s value. Almost invariably, the estimate comes in lower than you anticipated, and the amount you receive is not enough to purchase an apples-to-apples replacement. Sometimes, it is not even enough to cover what they still owe on the car.
Confounding the issue is the fact that most customers are unfamiliar with the methodology used by insurance companies to value cars. The valuation methods of car insurers are esoteric, relying on abstract data, the specifics of which they are careful not to reveal. That makes it difficult for a consumer to challenge a low-ball offer from a car insurance company.
Knowing the basics of how insurance companies value cars and the terminology they use can bring you to a stronger position from which to negotiate.
- A car insurance payout is determined by the value of the vehicle you were driving before the accident that wrecked it.
- A standard insurance policy does not pay you the cost of an equivalent new model.
- Nor does it guarantee a payment equal to the amount you may still owe on the car.
- Replacement insurance and gap insurance can eliminate those hazards but are costly additions.
Understanding Car Insurance Claims Valuations
When you report a car accident to your insurance company, the company sends an adjuster to assess the damage. The adjuster’s first order of business is deciding whether to classify the vehicle as totaled.
An insurance company may consider the car to be totaled even if it can be fixed. Generally speaking, the company decides to total a car if the cost to repair it exceeds a certain percentage of its value, anywhere from 51% to 80%, according to Insure.com. Some states mandate or provide guidelines for this percentage: Alabama, for example, sets it at 75%.
Assuming the vehicle is totaled, the adjuster then conducts an appraisal and assigns a value to the vehicle. The damage from the accident is not considered in the appraisal. What the adjuster seeks to estimate is what a reasonable cash offer for the vehicle would have been immediately before the accident took place.
Next, the insurance company enlists a third-party appraiser to issue its own estimate on the vehicle. This is done to minimize any appearance of impropriety or underhandedness and to subject the vehicle to a different valuation methodology. The company considers its own appraisal and that of the third party when making its offer to you.
It may be possible to hire your own appraiser if you disagree with your insurance company's valuation, though you may need your insurer's approval to do so.
Actual Cash Value vs. Replacement Cost
There's a big distinction between the insurance value of your car as determined by the insurance company and the amount it actually costs to purchase a suitable replacement. The insurance company bases its offer on actual cash value (ACV). This is the amount that the company determines someone would reasonably pay for the car, assuming the accident had not happened.
Actual cash value usually takes into consideration factors including depreciation, wear and tear, mechanical problems, cosmetic blemishes, and supply and demand in your local area. For example, State Farm explicitly references its insurance value car calculator: “We base your vehicle’s value on its year, make, model, mileage, overall condition, and major options—minus your deductible and applicable state taxes and fees.”
Before purchasing gap insurance, take time to compare premiums and costs from the best car insurance companies to ensure that you get a reasonable deal.
The Depreciation Problem
Even if you purchased a car new and only drove it for a year before the accident, its ACV will be significantly lower than what you paid for it. Simply driving a new car off the lot depreciates it by as much as 10%, and depreciation accelerates to 20% by the end of the first year, according to Edmunds.com.
Indeed, the insurance company dings you for everything from the miles on the odometer to the soda stains on the upholstery accumulated during that year.
The amount of the ACV offer is inevitably going to be less than the replacement cost—the amount it costs you to purchase a new vehicle similar to the one that was wrecked. Unless you are willing to supplement the insurance payment with your own funds, your next car is going to be a step down from your old one.
Replacement Cost Insurance
A solution to this problem is to purchase car insurance that pays the replacement cost.
This type of policy uses the same methodology to total a vehicle but, after that, it pays you the current market rate for a new car in the same class as your wrecked car.
The monthly premiums for replacement cost insurance can be significantly higher than for traditional car insurance.
If you total your car shortly after buying it, you could wind up with negative equity in the car, depending on your financing deal. That is, the insurance payment could be less than you owe on the vehicle.
When Valuation Falls Short
The situation can get worse if the car is relatively new. The amount the insurance company offers for the totaled car may not be sufficient even to cover what is owed on the wrecked car.
This may occur if you wreck a new car shortly after buying it. A new car takes its biggest valuation hit when its new owner drives it off the lot. If an accident occurs within a year or so, it's likely that the payoff for the totaled car will be less than the owner owes on it.
This becomes more likely if the buyer has taken advantage of a special financing offer that minimized or eliminated the down payment. While these programs certainly keep you from having to part with a large chunk of cash to buy a car, they almost guarantee that you drive off the lot with negative equity.
When your insurance check cannot pay off your car loan in full, the amount that remains is known as a deficiency balance. Because this is considered unsecured debt—the collateral that secured it is now destroyed—the lender can be aggressive about collecting it. This can include seeking a civil judgment against you to compel you to pay what's owed.
If a lender is able to obtain a court judgment they can then pursue means to collect the deficiency balance, including wage or bank account garnishment.
The Gap Insurance Solution
Like the replacement cost issue, this problem has a solution. You can add gap insurance to your policy to ensure that you never have to deal with a remaining balance on a totaled car.
This coverage pays for the cash value of your car as determined by the insurance company and pays for any deficiency balance left over after you apply the proceeds to your loan.