Littlejohn: Umbrella insurance: Are you covered?

If you don’t have umbrella insurance, it may be time to get it. This is especially true for high-net-worth individuals, wealthy families and inheritors.

That’s because umbrella insurance can provide extra liability protection above and beyond your existing coverage. And, as your net worth grows, creditors and predators are more likely to go after your assets.

Unfortunately, the wealthy are largely under-insured, despite being attractive targets for lawsuits. Of those with at least $5 million in assets, one in five doesn’t have an umbrella policy, according to an ACE Private Risk Services report. And, of those who do, nearly 25% report having less coverage than their net worth.

If you don’t have umbrella insurance or aren’t sure if your coverage is complete, here’s a look at what it covers, how it works and when to buy it.

What is umbrella insurance?

Umbrella insurance is liability insurance that offers protection above and beyond existing coverage. It becomes more valuable the wealthier you are, as you’re more likely to be a target of expensive lawsuits.

Your homeowner’s insurance policy will provide liability coverage up to a certain amount. However, umbrella insurance extends that coverage to much higher limits.

Say a visitor injures themselves on your property, for example, and sues you for an amount that exceeds your homeowner’s liability coverage. Umbrella insurance would then protect your personal assets in full, assuming you’re fully insured.

What it covers

Umbrella insurance covers you and your family against liability claims that exceed the limits of your other insurance policies. This generally includes:

  • Injuries to others.
  • Damage to property owned by other people.
  • Certain lawsuits involving libel, defamation of character and slander.
  • Personal liability situations.

For example, let’s say you’re hosting a party at your home. One of your guests accidentally falls down the stairs and gets hurt, so they sue you to cover their medical bills. Once your homeowner’s liability policy is exhausted, your umbrella insurance kicks in to cover the rest.

Alternatively, imagine your teenage son is at fault in an auto accident that results in a five-car pileup. Some of the other drivers suffer serious injuries, resulting in high medical costs and lost wages. If your auto insurance isn’t sufficient to cover the extent of the damage, your umbrella policy would cover the additional amounts up to your policy limit.

Umbrella coverage often applies anywhere in the world. In some cases, it may even extend to certain rental items like boats, RVs or cars.

What it doesn’t cover

There are certain things umbrella insurance won’t cover. Examples:

  • Intentional acts. If you intentionally cause damage, harm or injure another person or their property, umbrella insurance won’t cover you.
  • Business losses. Umbrella coverage doesn’t extend to your business, even if you operate it from home.
  • Your injuries or damage to your property. While umbrella insurance covers others’ injuries and damage to others’ property if you’re liable, it generally won’t cover your injuries and damage to your own property.

How does it work?

Once you’ve purchased umbrella insurance, your protection is in place. If you’re involved in an accident or lawsuit and found liable, your umbrella policy will cover you above your existing liability coverage.  

Consider the following worst-case scenario:

You run a stop sign, hitting another car and totaling it. In addition, some of the passengers suffer injuries as a result.

The other car has $50,000 in damage, and the medical bills total $400,000. Meanwhile, the other vehicle’s driver is a cardiologist who’ll be unable to work for four months due to a broken hand. She sues you for $300,000 in lost earnings.

In total, you’re liable for $750,000. Unfortunately, your auto insurance only covers up to $250,000. With sufficient coverage, your umbrella policy will cover the additional $500,000. Otherwise, you’d be responsible for paying the difference.

When to consider purchase

Generally, you should consider purchasing umbrella insurance when your assets exceed your existing liability coverage. For most, this is when their personal assets exceed roughly $250,000 — the average liability limit for auto and homeowner’s insurance.

Your personal risk tolerance and exposure to risk may also determine whether you need umbrella coverage. For example, if you like to host and entertain guests, you’re at a higher risk of someone experiencing injuries at your home, which may result in a costly lawsuit. In addition, if you have teenage drivers, umbrella insurance can help protect your nest egg in the event of an accident.

You may also want to consider purchasing an umbrella policy if:

  • You coach youth sports,
  • You’re a landlord or public figure,
  • You serve on the board of a non-profit, and/or
  • You own property, pools, trampolines, guns or dogs.

How much?

According to the Insurance Information Institute, coverage costs about $150 to $300 per year for each $1 million in coverage.

Most insurance providers will require you to have the maximum coverage amounts on your auto and homeowner’s policies before they will allow you to purchase umbrella coverage. Depending on your existing coverage, this could increase your current insurance rates, thus increasing the total cost of adding umbrella coverage.

How much do you need?

Policies are usually sold in $1 million increments, and coverage limits start at $1 million. While each situation is unique and coverage needs will vary, a good rule of thumb to is to purchase enough umbrella insurance to cover your current assets less your current liability coverage.

Brian Littlejohn, MBA, CFP®, CFA is the founder of Sherwood Wealth Management, an independent registered investment advisor firm. He lives in Woody Creek and works with clients in the Roaring Fork Valley and beyond.