Umbrella Insurance: What is it and who needs it?

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You might think that your $250k accident insurance policy has you covered.

But does it?

What would happen if you were involved – heaven forbid – in a car crash with two families. You aren’t hurt that badly but the other family is.

Let’s go a little bit further and say that you are found to be the responsible party for the crash. Now you are not only on the hook for your car but the damages to the other family’s cars, their medical bills and wages lost to work.

All in all, the damages come to one million dollars. That means that you are on the hook for the $750k that remains after your insurance policy pays out the $250k.

That could be catastrophic. You could lose your house, your retirement as well as any assets you need to liquidate to pay the bill.

You could be ruined – unless you have an umbrella insurance policy.

This kind of insurance takes over when your other policies run up against their coverage limits. In our fictional example an umbrella policy would cover the extra $750k in damages and even pay your legal bills – saving you from having your assets wiped out and your retirement snatched away by a single accident.

How Umbrella Insurance Works

Most types of insurance provide only one specific kind of coverage.

For example, your auto insurance policy protects you in case of a car accident.  If you have homeowner’s insurance it covers your house, and the belongings in it, against theft or damage. If you are a nurse or physician then malpractice insurance protects yourself from lawsuits related to patient care.

Like its name implies, umbrella insurance is a single policy that covers most aspects of your financial life – just like a rain umbrella.

Any time you run over the liability limits on one of your other insurance policies, your umbrella policy kicks in to take care of the extras.

Umbrella insurance is a type of liability insurance. Its job is to protect you against lawsuits.

Most auto insurance policies have a maximum amount of liability coverage of either $300,000 or $500,000 per accident. Damages in a lawsuit can easily add up to millions of dollars.

If you have an umbrella policy this will keep a massive lawsuit from destroying your other assets. An umbrella policy also protects you against being sued for damage that other policies don’t cover, such as an accident you cause at work or on vacation.

What Umbrella Insurance Covers

Types of damage covered by an umbrella policy include

  • Bodily Injury – Umbrella insurance covers bodily damages not covered by other insurance. For instance, an umbrella policy picks up the tab if you injure someone in a car accident and the medical bills exceed the limits of your auto insurance. Likewise if someone you hire to do work in your house injuries herself, umbrella insurance will cover the damages not covered by your homeowner’s policy.
  • Property Damage – Like bodily damage above umbrella insurance covers property damage you are responsible for that other policies do not.
  •  Other Legal Damages – Umbrella insurance can protect you from other legal troubles like being sued for libel or slander. It can also protect you against suits for false arrest, malicious prosecution, violation of privacy, and a variety of other civil charges.
  • Legal Fees – Umbrella insurance will take care of legal fees and court costs in a lawsuit.

What Umbrella Insurance Doesn’t Cover

Although umbrella insurance protects against most types of lawsuits – there are certain kinds of legal situations that are excluded from umbrella insurance

  • Malpractice suits
  • Workers compensation claims against employers
  • Damage caused by any business-related activity or by a business itself
  • Damage that you caused intentionally both to people or properties

It’s important to understand that umbrella insurance only protects you from being sued for damage to other people.

If you’re the one who gets hurt and needs an expensive operation, it’s up to your health insurer to pay for it. Anything that health insurance doesn’t cover is your responsibility to pay – an umbrella insurance policy can’t help you with those expenses.

Who Should Get Umbrella Insurance

The whole point of umbrella insurance is to protect your assets from a lawsuit. Therefor if you have assets to protect you should get umbrella insurance.

Some insurance companies recommend buying an umbrella insurance policy if your net worth is at least $1 million. That's the minimum amount that is covered by most umbrella policies.

Other insurers have a broader standard. They say umbrella insurance is a good investment for anyone who has more in assets than they have in liability coverage from auto and homeowners insurance.

Another consideration in deciding on an umbrella insurance policy is how likely you are to be sued.

For example, if you travel a lot for work in your car, you are more likely to be in an auto accident. That means you’re more likely to be sued.

If you entertain al lot there can be a greater risk that one of them will be injured there. And having a swimming pool, a dog, or a gun in your house all increase the risk of accidents that could lead to a lawsuit.

If you decide an umbrella insurance policy is the right move for you, the next question logically is how much coverage you do you need?

To find out, follow these steps:

  1. Calculate your net worth – Add up the value of all your assets and subtract the value of your debts.
  2. Research how much liability coverage you already have. On your auto insurance policy look at, bodily damage per person and per accident, and property damage per accident. On your homeowner’s insurance policy look for personal liability per occurrence.
  3. Take the smallest of the numbers you found in step two and subtract it from the number you found in step one. That’s the amount you have unprotected and should be covered by umbrella insurance.

For most people, this means a basic policy of $1 million is enough.

However, you might consider bumping up your coverage to $1 million more than you think you will need.

The reasoning behind this is that you can’t go back and increase your coverage once you’re in the middle of a lawsuit. It’s better to have too much than too little if you can afford it.

Final Word

Umbrella insurance policy is something you don’t expect to use – but it’s a safety net in case you do.

For a minimal cost per year, you can guarantee your assets won’t be drained by an unexpected lawsuit. Don't resort to liquidating assets, such as your retirement fund or a college savings fund.

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