Start investigating the subject of “umbrella” liability insurance and it won’t be long before you hear this phrase: “It’s only a couple hundred dollars per year for $1 million of coverage.”
While it may sound like you get a lot for little cost, you first need to understand exactly what umbrella insurance is — and whether you even need it — before concluding such insurance is “a bargain.”
What does it shield you from?
Auto and homeowner’s insurance policies typically contain multiple coverages. First, both provide damage protection. If you wreck your car or your house burns down, such insurance will pay to fix the damage. Assuming the underwriting process was done correctly, auto and homeowner’s policies should cover the full value of those respective assets.
Second, such policies provide a degree of liability coverage. However, unlike insuring against damages where value is relatively easy to ascertain, liability risks are more difficult to measure—and can potentially be much greater. Often, liability protection offered by auto and homeowner policies proves to be insufficient.
That’s where an umbrella liability insurance policy, also known as an “excess-liability” policy, comes in. It kicks in at whatever point the liability coverage of your auto or homeowner’s (or renter’s) policy ends.
Here’s a simple illustration of how an umbrella liability policy helps supplement your existing coverage. Joe has a $300,000 limit on bodily injury liability in his auto insurance. He is at fault in an accident which results in total medical bills of $500,000 for the person he hit. His auto policy will cover the first $300,000. Without the umbrella policy, Joe would likely be sued for the remaining $200,000. Instead, his umbrella liability policy covers those bills.
First, understand your current coverage
Vehicle owners are required by law to carry insurance that provides two forms of liability coverage. If you are found to be at fault in an accident, property damage liability coverage will help pay to repair the other person’s property. If the other person is injured, bodily injury liability will help pay his or her medical bills.
While both types of liability coverage are required in most states, mandatory coverage amounts vary by state, and can be fairly low. In Kentucky, for example, the law requires property damage liability coverage of only $10,000 and bodily injury liability coverage of just $25,000 per person and $50,000 per accident. Many drivers opt for higher coverage amounts, but there are limits as to how much coverage is available. Even at higher coverage levels, you run the risk of being sued for more, and that’s when umbrella coverage can be helpful.
Homeowner’s insurance policies provide two types of liability coverage as well. Personal liability covers claims or lawsuits related to any injuries or property damage someone may experience because of an accident on your property, or because of an accident elsewhere caused by you (or a family member who lives with you). Protection levels typically range from $100,000 to $300,000. Medical payments to others covers medical costs for someone injured on your property. Medical payments coverage can provide as little as $1,000 to $5,000 of protection per person. An umbrella policy can provide additional payments in such cases.
Inclusions and exclusions
Here are some added risks to weigh. If you have teenage drivers or you regularly give rides to other adults or other people’s children, you have increased risks that may warrant increased insurance protection.
When it comes to your home, stairways and slippery sidewalks are common sources of injury. Add a swimming pool, trampoline, swing set, or a pet that could hurt someone (e.g., Pete the pit bull could be a problem; Georgie the goldfish, not so much), and your risk levels go up quite a bit.
If you own rental property, an umbrella policy will typically help pay for injuries or property damage sustained by a tenant. Such insurance also protects you in case you’re sued for libel, slander, and more.
As for what umbrella policies do not cover, typical exclusions are: damage you caused intentionally, issues arising from business pursuits, and anything related to aircraft, jet skis, and other types of recreational vehicles.
Umbrella policies typically are sold only by companies that already provide your auto or homeowner’s insurance, and most such companies require you to carry certain levels of liability coverage on those policies before they’ll sell you an excess-liability policy.
Umbrella policy math
A starting point for evaluating whether you need an umbrella liability policy is to estimate the value of your assets and compare it to the liability coverage you have through your auto and homeowner’s policies. The greater the gap, the more an umbrella policy probably makes sense. It’s worth noting that some settlements and judgments in liability cases can go after your future earnings as well as your current assets.
Money magazine suggests basing the amount of umbrella coverage on your assets because in a liability lawsuit, attorneys tend to aim for the amount of your available assets but often will settle for a comparable insurance amount. That line of thinking is the reason why some financial planners recommend insuring for roughly the amount of your net worth, though many of those will recommend adding an extra $1 million of coverage for peace of mind, given the relatively low incremental cost of additional coverage.
That said, some of your assets may already be protected from lawsuits. Workplace retirement plan and IRA assets would most likely be protected. Your state’s homestead exemption may protect your home, or at least some of its value. Another measure you could take to protect your home is to title it, “tenancy by the entirety” if that’s an option in your state. That means your home couldn’t be sold unless both you and your spouse agree to the sale.
For many people, relying on words and phrases such as “may,” “most likely,” and “some” doesn’t seem like a good plan. If you have significant assets that could be at risk if you were to be sued for some sort of liability issue, an umbrella policy is likely worth the relatively small premiums. As with insurance generally, you hope you’ll never use the policy. But even if you never make a claim, an umbrella policy is likely to yield a benefit nonetheless: the peace of mind that comes from knowing these types of unforeseen liability situations are covered.