There are lots of bad rental car agencies in Iceland.
There are also a few very good ones.
Yes, you should fully document the condition of the vehicle, inside and outside, when you pick it up. Video or lots of photos. And if you can do it again when you drop it off, do so.
We get some of the insurances, but we definitely don't get them all, and we've done 4 driving vacations covering 29 days in Iceland with zero issues. But we drive cautiously on dirt and gravel roads keeping a substantial distance away from other cars so rocks don't fly up and hit us. And we are VERY careful opening car doors on windy days as we've seen doors fly off of other people's cars.