Umbrella Insurance: What is Covered and When Does it Make Sense?
When you purchase home and auto insurance, you have to choose how much liability insurance coverage you want.
You may be wondering why people need such high limits.
Unfortunately, lawsuits happen.
In severe cases, $500,000 may not be enough coverage.
Let’s say someone slips and falls on your property and gets severely injured. They end up in the hospital for a month and physical therapy for a few months.
Chances are, that’s going to cost more than $500,000. By the time you add in lost wages, pain and suffering as well as lawyer costs, the lawsuit could easily top $1,000,000.
So how do you protect yourself from these rare cases? That’s where umbrella insurance comes in.
What Is Umbrella Insurance?
Umbrella insurance covers you for liability above and beyond what your standard insurance policies offer.
It does not replace your regular insurance.
Higher coverage limits
The limits on umbrella insurance policies are typically high. Most often, the coverage limits start at $1,000,000.
You can normally purchase extra coverage in $1,000,000 increments.
You’d think a $1,000,000 liability limit policy would be expensive. That isn’t the case, though.
The policies are usually reasonably affordable since it is rare for them to be used.
It’s incredibly beneficial if you find yourself in an unfortunate position where you need to use it.
It’s also important to note that umbrella insurance is not the same as excess liability insurance.
How Umbrella Insurance Works
Umbrella insurance doesn’t work the same way regular insurance works.
It’s the second line of defense for your assets.
First, you have to exhaust any coverage on your underlying policies, such as renters, auto, or homeowners insurance.
These underlying policies often have deductibles, so you’ll have to pay for that part of the claim yourself.
Once you exceed those limits, your umbrella insurance policy kicks in. It covers any extra costs above your other policy’s limits that fall below your umbrella insurance policy limits.
Unlike your underlying policies, umbrella insurance generally does not require you to pay a deductible.
It won’t reimburse you for the deductibles you paid on your underlying policies, though.
What is usually covered
It’s important to know that umbrella insurance doesn’t cover the same things your underlying policies might.
Instead, umbrella insurance covers liability claims.
Common types of liability claims that may be covered include:
- Property damage to others
- Bodily injuries to others, including medical bills
- Personal injuries to others
- Liability claims from being a landlord
- Lawsuits from libel, slander, and more
- Defense costs for lawyers to defend you
Of course, you need to read your policy to see what is specifically covered.
The good news:
Umbrella insurance covers other members of your household, too.
It may even cover liability that doesn’t occur within your home or your car, depending on your circumstances.
What typically isn't covered
Umbrella insurance isn’t the ultimate type of insurance protection. While it does cover many types of liability, it doesn’t cover every potential loss you may have.
In particular, umbrella insurance doesn’t cover things like:
- Loss of personal property
- Business-related losses
- Contractual losses
- Losses due to crime
- Losses due to intentional acts
How Much Does Umbrella Insurance Cost?
The Insurance Information Insititute estimates the first $1,000,000 in coverage will set you back about $150 to $300 per year.
Additional coverage in $1,000,000 increments adds about $75 for the first $1,000,000 and $50 for each $1,000,000 beyond that.
Naturally, the cost of your policy depends on your circumstances. People with more potential liabilities will likely have higher prices.
A landlord with ten rental properties, a lavish home of their own, three cars, a spouse and five children would likely cost more to insurance than a single person living in a humble home with a single vehicle.
The cost for peace of mind may be well worth it for people with a high net worth.
Umbrella insurance coverage provides many potential benefits to policyholders including those listed below.
Umbrella insurance is relatively inexpensive compared to most major types of insurance.
Coverage may cost you less than your auto or homeowners insurance policies, depending on where you live.
Can protect you from financial ruin in some instances
If you get sued for $1,000,000 but only have $300,000 of coverage through your homeowners or car insurance policies, you’d be on the hook for the other $700,000.
Most people can’t afford to pay this amount of money.
Instead, they’d have to drain their retirement accounts or file for bankruptcy.
An umbrella insurance policy could help avoid this fate.
Covers some things regular insurance doesn’t
Homeowners and auto insurance cover many things. They don’t cover everything an umbrella insurance policy does, though.
For instance, many umbrella insurance policies cover libel and slander. These coverages don’t generally apply to other policies you’d normally carry.
Covers your whole family in most places
Umbrella insurance covers your whole household, including children and your spouse.
The coverage applies in most places around the world, although certain exceptions do apply.
Unfortunately, umbrella insurance isn’t perfect. The downsides include the following.
While umbrella insurance is there to protect you, it isn’t used as often as homeowners or auto insurance.
Even though the cost is low, it adds up if you pay the premiums over decades and never use the coverage.
Must keep underlying insurance policy limits at certain levels
Companies that offer umbrella insurance need to make sure their policies are profitable.
To do this, they try to minimize the number of claims.
One way they do this is by requiring you to have specific insurance limits on underlying policies. You may have to carry $300,000 or $500,000 of liability coverage on your auto or homeowners insurance policies.
If you don’t already carry these limits, this could increase the cost of those policies. Then, adding in umbrella insurance adds yet another cost.
When Does Umbrella Insurance Make Sense?
Umbrella insurance makes sense when you have a decent net worth you want to protect.
Commonly, people say you should get umbrella insurance when your net worth exceeds your homeowners or auto insurance policy limits. This is a flawed recommendation, though.
Let’s say you have $500,000 in coverage and a $300,000 net worth. Someone slips and gets injured. They sue you for $1,000,000 and win. You now have to liquidate your net worth to pay the amount.
If you had umbrella insurance, it would have covered the extra $500,000 that was awarded. Instead, you’re starting your back at zero.
When it doesn't make sense
Umbrella insurance doesn’t always make sense.
Let’s say you’re starting your financial journey and have a relatively small net worth.
In this case, paying a couple of hundred dollars per year for umbrella insurance may not be a smart decision.
Tips to Save Money on Umbrella Insurance
When you buy umbrella insurance, you can try to save money in a few ways.
Each insurance carrier offers policies with different exceptions and coverage. Rates vary, too.
A broker can do the shopping for you. Alternatively, you can get quotes from companies directly on your own.
While many insurers require you to have at least one policy with them to get umbrella insurance, not all do. Make sure to ask when getting quotes.
It’s essential to pick a limit you’re comfortable with.
However, getting more insurance because it’s cheap doesn’t mean it’s a smart purchase.
Look at what policy limits your umbrella insurance requires you to have on your underlying policies, as well.
You may currently carry more than the required amounts. If you do, you can lower your limits on your underlying policies, saving money in the process.
Consult an Insurance or Financial Professional
If you’re considering umbrella insurance to limit your personal liability in high-dollar claim situations, it makes sense to consult a professional.
Insurance professionals should know the ins and outs of their policies. They can help explain what is covered and what isn’t in the policies you’re considering.
They can also help highlight gaps in coverage you may need to cover in other ways.
An insurance broker would likely have access to umbrella insurance options from several companies. A salesperson may be limited to a single company’s policies.
For this reason, consulting a broker is usually a better idea.
You don’t pay insurance professionals directly. Instead, insurance companies pay the salespeople commissions.
This can cause a conflict of interest, so make sure to use common sense when discussing your options.
If you want a truly objective opinion, consider consulting a fiduciary fee-only financial advisor for advice.