Umbrella Insurance Could Be the Right Answer

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Mouse Under ToadstoolIf you have a personal umbrella insurance policy, congratulations. If you don’t, you must not have a lot to lose. This important insurance can extend your liability coverage beyond your home and auto insurance by millions of dollars.

We live in a litigious society. Anyone can sue you for any reason. Those with money are targets simply because suing someone without assets is pointless.

Car and home insurance are required, but even $300,000 liability coverage won’t protect you in the event of a catastrophe. Your teenage driver is at fault and young people in both cars are seriously injured. Your dog bites a child. You chaperon a class trip and are judged negligent when one of the students tragically dies. You cause an accident on the freeway and a truck filled with expensive cargo is involved. A neighbor slips on your steps and sues you. You write something reckless and unwarranted on the Internet about a certain financial columnist, and he sues you for slander and libel.

The good news is that these events are relatively unlikely. The bad news is that any one of them could result in a judgment well in excess of your liability limits. Your insurance company will just pay their $300,000 share and leave you to defend yourself in court for the remainder. If the judgment doesn’t ruin your finances, the legal fees will.

If you receive a judgment for more than your net worth, you could lose everything. Your taxable investments and savings may be subject to the claim. The equity in your house may be at risk. A large judgment can also garnish 2.5% of your wages for the next 10 years and/or any current or future inheritance you receive. Any inheritance left in a generation-skipping trust offers protection against creditors and failed marriages, but many families leave an inheritance outright instead.

You don’t want a single accident to wipe out your life savings. Umbrella insurance helps protect you against that possibility.

Personal umbrella insurance sits on top of your auto and homeowners insurance. To get umbrella coverage you must first increase your home and auto insurance liability coverage to where the umbrella policy begins, usually $300,000. Only then can you get additional coverage of $1 million or more. If you get sued for $1.3 million, you would first pay your $1,000 deductible. Your home or auto insurance would pay $299,000 to reach the $300,000 liability on the policy. The umbrella insurance would pay the final $1 million. You would pay nothing more than the initial $1,000.

Being sued for more than $300,000 is not a remote possibility. For example, with today’s more effective air bags, surviving an auto accident even with serious injuries is much more likely. As a result, the cost of life insurance policies is decreasing while medical expenses continue to accelerate. We’ve made cars safer and more people survive the accident. They survive, and then they sue for damages.

Anyone with assets they don’t want to lose will benefit from umbrella insurance. Many accidents are the fault of someone with no assets to lose. Unfortunately they can simply not pay or at worst declare bankruptcy and lose nothing. If you are saving and investing, you have something to lose. It isn’t clear at what level of assets you should get protective umbrella coverage, but financial pundit Dave Ramsey recommends it for families who have more than $200,000. It certainly isn’t just for the ultra rich.

Consider buying more than $1 million in coverage. Getting the same amount of coverage as you have assets won’t protect the assets you have. For example, if you have $1 million in assets and you purchase $1 million of coverage, you will lose all of your savings in a $2 million judgment. Thus you need to have enough coverage to satisfy the worst judgment you might receive. Coverage of $2 to $4 million will suffice for most of today’s lawsuits.

I am usually not an advocate of insurance products. Umbrella insurance is the exception. It is designed to cover very unlikely but very costly events, exactly what insurance is supposed to do, at a reasonable price. In review courses for the certified financial planner (CFP) exam, prospective advisors are told, “Umbrella insurance is always the right answer.”

About 12% of homeowners purchase umbrella insurance. For the wealthy, that number grows to about 50%. The tragedy is that half of wealthy homeowners are betting their entire net worth against the odds of a freak accident, which unfortunately do happen.

Insurance companies will only write an umbrella policy if they also provide your home and auto insurance. They want to know if the underlying coverage gets cancelled for any reason, and they don’t trust another insurance company to defend their interests.

Another excellent feature of an umbrella policy is that the insurance company is obligated to provide your legal defense, and the legal costs are paid in addition to your coverage.

The first million dollars of coverage usually costs the most. A typical annual premium might be $150. Subsequent costs are about 65% of the first million for each subsequent million. So $2 million of coverage would cost about $248, and $4 million would cost $443.

Premium costs vary and are subject to a host of issues. When you apply for an umbrella policy, your answers to a number of questions may raise your rates or even disqualify you. Own a Rottweiler or a have been recently convicted of reckless driving and you may not be able to get umbrella coverage. If you serve on a board, you may not be able to get coverage for more than the board’s coverage. And if you have a driver younger than age 25 or have a very poor driving record, coverage may cost a $100 more per million. Even if you don’t plan on getting umbrella insurance, you might want to apply just so you know what behaviors may limit your likelihood of being sued.

Remember, personal umbrella liability insurance covers only nonbusiness activities. Umbrella policies are also available for businesses and well worth the money. Any umbrella insurance won’t cover intentional acts or punitive damages.

For the cost of a splurge on a not particularly memorable restaurant meal, you can enjoy the protection of a $1 million umbrella policy. Insurance agents don’t make much commission on an umbrella policy. So you have to call them. Just do it.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818...)