I have a confession to make: When I was 17, I took the family car one day to visit a friend who lived across town. I was a relatively new driver, having received my driver’s license – or maybe it was just a learner’s permit– only a few months prior. As I rounded a 30 mph curve at roughly double that speed, two children around the ages of 5 and 7 were walking their bicycles across an intersection. The light had turned green for them, red for me. I would have stopped, but I was busy searching the air waves for a Rock station and was completely oblivious to the traffic light. At one point I looked up and suddenly realized that my car was on target to collide with these kids, who by this time were only about 100 feet away. In a split second, and without applying the brakes, I yanked the wheel hard left and then again hard right. I missed them probably by only a foot or two – at 60 mph. After my heart stopped pounding, the rest of the trip was uneventful: I made it to my friend’s house, spent a few hours there and drove home (much more carefully this time!).
What if I hadn’t looked up? I will spare you the gory details about what might have happened to those children. Suffice it to say that my life would have been very different from then on, and so would my parents’ lives. Let alone the psychological guilt, the humiliating notoriety in the press, and the gut-wrenching change in our family dynamics – my parents would most likely have been ruined financially – they had no protection against a devastating event like this.
If I had been a financial planner then, I could have told them about “umbrella liability insurance.”
Umbrella Liability Insurance (“Umbrella” for short) provides personal liability coverage beyond that provided by your homeowners, boat, and auto insurance liability protection if you are sued by another party for injuries or property damage. Some policies will also protect you if you are sued while sitting on a non-profit board. And even if a judge or jury finds you not at fault, the policy will often pay for your legal defense.
Umbrella is a separate policy you buy, typically from your homeowners or auto insurance carrier. Coverage typically starts where your homeowners and auto personal liability coverages stop. For example, if you have $300,000 in personal liability protection on your auto policy, and you are successfully sued for $1 million due to a car accident, the auto policy would pick up the first $300,000, and an umbrella policy would cover you for the remaining $700,000.
Having teenage drivers is one example in which you may benefit from umbrella liability insurance. Other examples include:
- A neighbor’s child is severely injured while playing in your yard.
- A tenant in one of your rental properties is injured, or damages a neighbor’s property.
- An uninsured worker in your home has an accident while on the job.
- Your domestic employee sues you for wrongful termination.
- You host a social event at your home after which a drunk guest has a serious car accident.
- You injure someone with your car due to carelessness, poor night vision, or weather conditions.
- You are sued for libel after you post negative comments on social media about another person.
Let’s face it. We live in a litigious society, where anyone can sue you for almost any reason, even if it is frivolous. Higher net worth individuals and their families can be perceived to have deep pockets. According to TheLawDictionary.org, the most recently-available statistics suggest that about 95 of 100 pending liability lawsuits end in a pre-trial settlement. However, of those cases that do go to trial, over 90% end in victory for the plaintiff.1 Carrying extra protection in the form of umbrella liability insurance can protect your hard-earned savings and property from either a settlement or a trial.
So, how much coverage should you buy? There is no “correct” amount. Anyone could theoretically cause multiple bodily injuries or such massive property damage that no umbrella policy could cover the entire loss. The premium for a policy with unlimited coverage would be, well, unlimited. Most people, however, would be well served to purchase a policy that covers at least their financial net worth (defined as total assets minus total liabilities), plus the present value of future family earnings (if your state’s laws permit attaching earnings).
For example, suppose a married couple has $1 million in liquid or investable assets, and a $700,000 home with a mortgage of $500,000. One spouse earns $200,000 per year (adjusted for inflation) before taxes, and the other spouse doesn’t earn. The earning spouse is 50 years old and expects to work until age 65. The back-of-the-envelope calculation would be something like this:
Total Assets: $1,700,000 (addition of liquid assets and home’s fair market value)
Less Total Liabilities: $500,000 (mortgage)
Equals Net Worth: $1,200,000
Plus Present Value of Future Earnings: $2,800,000 ($200k per year for 15 years, with a real discount rate of 1%, rounded)
Equals Insurance Requirement: $4,000,000
When calculating your financial net worth, keep in mind that there may be assets (and related liabilities) worth considering in addition to your liquid assets and primary residence, such as a vacation home, rental property, a boat, or even expensive art work or jewelry. You should also include out-of-state property.
As insurance goes, umbrella is usually one of the simplest coverages to apply for, and the least expensive to purchase. You can buy it in increments of $1 million. The first $1 million typically costs around $150 to $200 per year, and as you increase coverage, the cost per million decreases. You can also offset the cost by increasing the deductible on your homeowners and auto policies. In other words, self-insure for losses you can easily absorb while insuring against the catastrophic losses.
While umbrella can be purchased up to extremely large coverage amounts for very high net worth individuals, most people who buy umbrella policies insure between $1 million and $10 million, depending on their financial position and earnings potential. (To obtain coverage, you need at least $250k of personal liability insurance on your auto policy and $300k on your homeowners policy.)
When purchasing an umbrella policy, read the contract carefully. Make sure that it adequately covers the risks for which you are most vulnerable, and that it coordinates well with your other property & casualty insurance across all of your homes, autos, and boats, as applicable. There shouldn’t be any gaps in coverage. Even rental cars and company cars should be covered (if you use your company car for personal travel). Also, your policy should cover legal defense costs, which can run into many tens of thousands of dollars whether you win or lose a lawsuit. Some policies also cover reputation defense, which can be quite valuable if a lawsuit becomes public knowledge.
As you might imagine, an umbrella liability insurance policy will generally not cover you if you injure someone or damage their property while committing a crime or an “intentional act” (unless perhaps it was an act of self defense). It also doesn’t cover professional liability; Malpractice or Errors & Omissions insurance would cover this type of risk. As part of the application process, your insurance broker or carrier will inquire about your assets, hobbies, and interests and will determine what coverages should be included and excluded.
You can also take proactive steps to protect yourself and your family financially beyond purchasing an umbrella policy:
- Have a safety expert evaluate your home(s) and rental properties for potential dangers.
- When hiring people to work in your home, verify that they are properly licensed and insured, and hire a professional firm to do a criminal and financial background check.
- For domestic help in particular, determine if your state requires you to carry worker’s compensation insurance. (The penalties can be stiff for not having this coverage if required.) Even if not required, you should strongly consider obtaining it anyway. Also, make sure you have a signed employment agreement with a clear job description, confidentiality expectations, and a process for evaluating performance. Consider doing a background check annually while they continue to work for you.
- If you are considering buying a car for an adult child, make sure the title and insurance policy are in their name, and remove your child from your own auto policy (and don’t let them drive your car).
- Post No Trespassing or other cautionary signage on your property if it contains hazards that you are not always able to monitor (e.g., swimming pool, trampoline, all-terrain vehicles, boat, tree house, swing set, etc.).
- When throwing a large party, hire a professional bartending service. Their staff can recognize when a guest has had too much to drink and stop serving them alcohol.
- Do not post potentially libelous or bullying content on Social Media, and educate your children to do the same.
You have spent your entire adult life accumulating assets that will serve you well during your retirement, or provide a bequest to your heirs. An umbrella liability insurance policy can help protect these hard-earned assets.