Accidents happen all the time, regardless if they are your fault or not. You could be driving down the road and your car could lose control and seriously injure another driver or an electrical fire could burn down your and your neighbor’s houses, leading to millions of damages and even lawsuits.
When you’ve spent years building your financial freedom, the last thing you want is one unfortunate accident to wipe you out financially. Not having proper liability insurance is an unaffordable risk.
While you should have some liability coverage from your home/renter and car insurance, those base policies have limits. This is where an umbrella policy comes in.
Think of an umbrella policy, also called a Personal Umbrella Insurance Policy (or PUP), as additional protection for your hard-earned assets on top of what your standard insurance policies can cover.
When it comes to protecting your assets, if you have assets that are higher than your standard liability limits, an appropriately sized umbrella policy is a must-have. Buying an umbrella policy is good value for your money. You don’t want to risk your hard-earned wealth to a lawsuit in this litigious world.
“Never work for the same money twice.”
The Rich Henry
Even if a lawsuit is frivolous (happens all the time to high-profile people like doctors, lawyers, and businessmen), you would be on the hook to defend yourself. You could be responsible for tens of thousands of dollars in legal fees even if the other side has no shot of winning and only hoping you’d settle for some money.
Having an umbrella policy will fully cover all your legal bills and court costs if you’re sued. What’s even better is insurance companies have great lawyers to make sure you have the best chance of winning so they don’t have to pay out!
Umbrella Insurance Policy Basics
An umbrella policy typically has 2 parts:
Part 1: Excess liability insurance coverage (on top of your standard home/car insurance)
- Bodily injury: Covers the cost of medical care to other people if you or someone in your family is at fault for injuring them
- Property damage: Covers the cost of any damage caused by you or someone in your family to someone’s property (car, fence, home, etc.)
- Personal injury liability: this is not covered under your home/car policies. Personal injury can include any reputational damages from defamation, libel, or slander. If you say something bad about someone that causes them reputational damage, your umbrella policy will protect you if they sue you
- Pro Tip: When you are buying your umbrella policy ask your agent to size your minimum underlying liability limits to match your home/car insurance for their umbrella policy to be effective
This is the most important part of an umbrella policy: to protect you and your family in the event you or someone in your family hurts someone else. Umbrella excess liability coverage sits on top of your home/car policies and only kicks in after those liability limits are fully used.
Most umbrella policies usually require $250K/$500K/$100K of auto liability coverage per person/per accident/property damage and $300K liability coverage on a home/renter policy.
If your policies are with different insurance companies, ask your umbrella agent for the exact minimum underlying liability limits to make sure the umbrella you buy will actually kick in! You don’t want to be stuck paying the difference before your umbrella kicks in…
Even if you think you have a low-risk lifestyle, you can’t fully control everything that happens in life. An umbrella policy is even more important if you have a family, with children, since the risk of accidents increases with multiple people.
- Pro Tip: If you don’t own a car, keep in mind that having a non-owners car insurance policy will unlock the ability to get an umbrella policy since pretty much every insurance company requires you to have both home and car insurance
Example 1:
Let’s assume a couple, Henry and Henrietta, has rented a car in New York City when they run a red light and hit a pedestrian, seriously injuring her.
Turns out, the pedestrian is actually a renowned surgeon who sues them for $1.3 million due to her suffering and lost income because she could not work while recovering. She wins the lawsuit because of Henry’s negligent driving.
Henry however isn’t worried. He has a $1 million umbrella policy and $300K of bodily injury liability coverage on his car insurance.
The car insurance covers $300K of the lawsuit settlement and his umbrella policy kicks in to cover the remaining $1 million along with all legal fees.
His total out-of-pocket cost for a $1.3 million lawsuit is zero!
Since he checked with his insurance company beforehand, he knows a deductible doesn’t apply to his car insurance for liability claims to other people (bodily injury and property damage) and there is no deductible on his umbrella policy.
- Pro Tip: As a rule of thumb, a deductible is usually due for coverage of your own injuries or property damage (i.e. property insurance to replace damaged furniture, collision insurance to repair damages to your own car in a crash, or PIP to cover your own injuries)
Part 2: Excess Uninsured/Underinsured Motorist (UM/UIM) coverage:
- UM/UIM bodily injury: Covers you and your passenger’s medical bills if you are hurt by someone else without any or enough liability insurance. This can also cover hit-and-run accidents (where the driver can’t be found) and most importantly even when you are walking, biking, or riding a bus
- UM/UIM property damage: Covers you and your passenger’s property if damaged by someone else without any or enough liability insurance
- Pro Tip: When you buy an umbrella policy, the excess UM/UIM coverage is NOT an automatic add-on. You have to ask your insurance agent to add it to your umbrella policy, for a minimal increase in premium
- If your umbrella insurance provider does not offer excess UM/UIM coverage, your best bet is to increase your liability limits on your car/non-owner policy since that also increases the UM/UIM limits
Excess UM/UIM coverage is the second most important part of an umbrella policy. This protects you and your passengers when someone else hurts you and can’t afford to pay for the damages (this coverage also extends to your family members as well, even if they’re not with you). While you might be a careful person, you can’t control if someone else hits you while you’re driving, walking, or biking!
The most unfortunate scenario is when someone gets in a serious accident caused by another person who has minimum insurance and can’t collect enough to pay for the damages. You can protect yourself from this scenario.
UM/UMI coverage protects you if there is an accident that hurts you or damages your property and the person at fault can’t cover the damages.
It’s estimated that roughly 1 in every 8 drivers on the road has no car insurance, despite every single state (except New Hampshire) legally requiring all drivers to have an active policy. Out of the others that do have insurance, some may have just the state minimum requirements.
For example, in New York state the minimum bodily injury liability coverage is $25K/50K per person/per accident and $10k for property damage. That’s not nearly enough to cover a major accident! A trip to the emergency room and a wrecked car can easily exceed those limits.
Remember, if you’re walking around the city, UM/UIM coverage can also cover you for hit-and-run accidents where the driver can’t be found. You can’t count on the other person’s insurance policy to pay you if you can’t find who hit you!
For these reasons, having UM/UIM coverage is more useful in urban areas where you walk or bike around a lot, in addition to driving.
Getting the maximum UM/UIM coverage on your base car insurance policy will give you peace of mind that no matter what, your insurance company will have you covered at some level. However, you may want to consider getting excess UM/UIM coverage under your umbrella policy as well.
Example 2:
Let’s assume that instead Henry and Henrietta are driving in New York City when they are hit by another driver who runs a red light, landing them both in the emergency room with severe injuries that put them both out of work for 3 months.
They find out that the other driver was driving illegally with no insurance, but they have a non-owner car insurance policy with $300K per person/$500K per accident of UM/UIM bodily injury coverage.
They can claim up to $300K per person or $500K in total from their own insurance company for their injuries and lost wages, despite the other driver not having insurance.
If the driver speeds off, never to be found again, they can still claim up to $300K per person or $500K in total for their injuries and other damages.
If the driver had minimum insurance limits and no assets, they would only be able to collect up to $25K (NY minimum) from the other driver’s insurance company and then claim up to $300K per person or $500K in total from their own insurance company under their UM/UIM coverage.
Example 3:
Let’s take this one step further with excess UM/UIM insurance provided by Henry’s umbrella policy
Henry and Henrietta are unfortunately both permanently disabled from the accident. They are limited to recovering $25K from the other driver’s insurance plus a maximum of $500K from their non-owner car insurance policy, for a total of $525K.
Since they are both high-income earners, $525K doesn’t even come close to covering their lifetime of lost earnings and treatment for their pain and suffering
However, if Henry had a $5M umbrella policy with excess UM/UIM coverage, that would kick in above the $525K for a maximum claim of $5.525 million.
Additionally, if they had individual long-term disability insurance, they could also claim benefits from that policy as long as they remain disabled!
Don’t Get Caught In A Storm Without An Umbrella
Umbrella liability insurance isn’t needed for someone who doesn’t have assets to protect but is a no-brainer for those who have spent time and effort building their financial freedom and have things in their lives that increase the chance they will be sued.
Here are some risk factors to consider in your life:
- You have significant assets
- If you own a house or rental property
- Live a high-risk lifestyle (drive fast cars, host parties, etc.)
- Have hobbies that have a high risk of injuring other people (rock climbing, snowboarding, hunting, surfing, etc.)
- Have teenage children learning to drive
- Own pets that can harm visitors
- Are well known in your community
Umbrella policies usually start at $1 million of additional coverage on top of your home and car insurance. You can buy more in increments of $1 million up to $5 million max for most standard insurance companies. To get an even larger policy would require you to work with a specialty insurance provider like Chubb.
According to ACE Private Risk Services, the average $1 million umbrella costs $383 a year for a couple with a home and two cars.
While $1 million in liability coverage may seem like a lot, imagine you cause a fire that burns down your neighbor’s house or crash into a luxury car with a high earner resulting in lost income and injuries. Or if you are well-known in your community, you could become a bigger target for lawsuits because people think you have money (even if you are actually living paycheck to paycheck)!
If you do successfully defend against a lawsuit, legal bills can still rack up very quickly and you’d be on the hook to pay them. Having an umbrella policy will fully cover all your legal bills regardless of the final decision and you can sleep well knowing your insurance company has great lawyers to give you the best shot of winning so they don’t have to pay out!
As you see below, each incremental $1 million dollars of umbrella coverage costs between ~$70-90 a year and costs less the larger your policy so make sure you buy enough for your risk profile.
Remember your umbrella policy protects you and your family members for each individual incident. If you have a $1 million umbrella policy and you, your spouse, and your teenager all get sued at the same time (hypothetically), you will each be protected up to $1 million for a total of $3 million in coverage.
I also checked these prices with Liberty Mutual. The cost of their $1 million umbrella policy is ~$350 a year with the option to add excess UM/UMI coverage. That’s a very good value for peace of mind.
The agent also said I could qualify for multi-product discounts if I have other policies with them (home and non-owner car insurance). So try to keep all your insurance policies with one company if you want to save money.
Bigger Is Not Always Better
How much liability protection do you need? The short answer is at a minimum enough to cover your entire net worth (1.0x coverage).
I would recommend that you add an extra 50% buffer (1.5x total coverage) to cover your growing income and net worth. I even met an insurance agent who recommends 3.0x your net worth!
However, a bigger umbrella (or one that’s too big for you) isn’t always better for 2 reasons:
One, injury lawyers are very good at figuring out your insurance coverage based on public records. If you have a big umbrella policy, you will become a bigger target for lawsuits. Injury lawyers are more motivated to go after bigger umbrella policies with the chance of paying out more for the same amount of work.
Two, insurance companies want to limit their risk since they are legally obligated to pay in case you lose a lawsuit so they usually have a maximum of $5 million for a standard umbrella policy. If you have assets that are more than that limit, you will have to work with a specialty insurer like Chubb and pay a hefty premium to get more coverage.
- Pro Tip: When looking at your net worth, keep in mind that employer-sponsored retirement accounts like 401Ks are federally protected in a lawsuit. However, individual retirement accounts (IRAs) are not federally protected and rely on state laws. It may be worthwhile to keep 401Ks from old jobs with this legal protection or have enough umbrella coverage to cover your IRAs if you choose to roll the 401Ks over.
At the end of the day you will have to analyze your lifestyle, riskiness, and assets to determine how much coverage you need. If you have a risky lifestyle, it may be worth buying as much umbrella insurance as you possibly can, even if it costs you a premium.
However, if you have a low-risk lifestyle and substantial assets, you could also choose to insure a certain amount (i.e. 5 million) and take the remaining risk by betting on the odds of a lawsuit that results in more than $5 million of damages being extremely low.
While there will always be risks in life that you have to take, think very carefully about the ones that are unaffordable to you.