When most people consider their insurance needs, only certain types of coverage usually come to mind. Health insurance and life (or sometimes disability) insurance protect you and your loved ones; car and homeowner’s or renter’s insurance protects your large tangible assets.
Personal liability insurance, often called an “umbrella” policy, rarely makes this list. But when a rainy day – or an expensive lawsuit – turns up, sometimes nothing but an umbrella will do.
As the name suggests, personal liability coverage primarily exists to protect against liability claims. In most cases, this means finding yourself, and your property, the target of a civil lawsuit. A personal liability policy may seem excessive to those who already hold three or four insurance policies. It is true that not everyone needs these protections. But an umbrella policy effectively defends your assets and future income against damage claims that can arise from a wide variety of scenarios. Like flood insurance for beach properties, liability insurance is a product you hope you never need to use, but one that can create great peace of mind in the meantime.
Who needs liability insurance?
Some level of personal liability coverage is built into homeowner’s (or renter’s) insurance and auto insurance. For many, this may be enough. In part, this is because some types of property are protected by state and federal law. For example, a court cannot force you to use qualified retirement accounts, such as 401(k)s, to pay a legal judgment, and most states have laws that protect traditional IRAs. Some states also protect Roth IRAs and other retirement accounts. Many states also protect your primary residence, though the exact rules vary; Florida, for example, offers very strong protection in this area, while other states can only protect a certain level of home equity.
You can also protect certain assets from lawsuits through estate planning tools, such as structured assets and funded irrevocable trusts. However, be careful about establishing such a bond directly after an incident that you fear could trigger a lawsuit. If it seems that you are simply trying to avoid future creditors, the courts could determine that the asset transfer is fraudulent, making these assets available to pay a judgment.
If you don’t have many assets outside of your retirement savings and your primary residence, then your existing liability coverage may be sufficient. But second homes and non-retiree investment accounts are vulnerable. High income earners, and their spouses, may also want to consider protection options, as courts have been known to garnish wages to satisfy judgments.
While amounts vary by geography and policy, homeowner’s insurance typically includes up to $300,000 in personal liability coverage. Auto insurance typically covers up to $250,000 per person and $500,000 per accident involving bodily injury, and less for incidents involving property damage only. But serious injury lawsuits can sometimes result in judgments or settlements for millions of dollars. This is where the umbrella policy kicks in.
Most people think of car accidents as the main trigger for these lawsuits, and with good reason, since car accidents are relatively common and can cause a lot of damage. But there are a wide variety of situations where you can find yourself liable for an accident. You may host a party at your home where one of the guests is seriously injured. Your dog may bite a stranger or a friend. If you employ household staff, such as a nanny or home health aide, the employee can sue not only for physical harm, but also for wrongful termination or harassment.
There are other liability risks that may not spring to mind so easily. For example, the hyper-connected world of social media creates many more opportunities to defame or slander someone, even without intentionally doing so. Your teenage or pre-teen children can also create these problems; in a worst-case scenario, they could end up participating in a cyberbullying or harassment incident that takes a tragic turn. Teens also increase your responsibility when they get behind the wheel. Even adult children can trigger “vicarious liability” laws that can leave you personally liable in certain circumstances, such as if they borrow your car and are involved in an accident.
Another area that some people overlook is the risk of sitting on a board for a nonprofit organization. Many nonprofit organizations are too small to offer much, if any, protection for board members’ personal assets in the event that the organization and its board of directors are sued. Board members may wish to consider directors and officers insurance specifically, as well as or in lieu of an umbrella policy. People whose charitable work – or whose professional activities – put them in the public eye may also want to consider increased liability insurance coverage because of the potential damage a lawsuit could do to their reputation as well as their financial health.
When considering the need for personal liability insurance, it is also worth considering the common law concept of “joint and several” liability. In many jurisdictions, a plaintiff can recover all damages from any one of several defendants, regardless of fault. In other words, if all four defendants are found equally liable, the plaintiff can recover 100 percent of the damages from one of them and nothing from the other three. Many lawyers thus focus on the defendant with the highest net worth in these cases, according to the theory that this method is more likely to secure the largest payment for their clients.
How Much Liability Insurance Should You Carry?
As you can see, people with a high net worth, high income potential or both have reason to worry about their liability exposure. Once you have decided to buy an umbrella policy, the next logical question is how much insurance you should buy.
Unfortunately, there is no specific formula to determine the correct amount of coverage. A good rule of thumb is to carry at least enough insurance to cover your net worth and the present value of your future income stream. A Certified Financial Planner™ or insurance agent can help you with these calculations, and there are also a variety of online tools designed to help you calculate a figure. Keep in mind that tools and advice from insurance companies will tend to want to sell you more insurance than you may need, but it can still be useful to see what factors will affect your coverage. Some of these are intuitive, such as your current net worth and assets you own. Others are more immediately concerned with the potential for injury; for example, you might want more insurance if you own a trampoline or a swimming pool, and you can expect slightly higher premiums as well.
As with any insurance decision, shopping around is a good idea. But there are real benefits to buying the majority or the entirety of your insurance products from one provider. Consolidating your insurance coverage will not only ease the administrative burden, but it will also make it easier to identify gaps. For example, if your homeowner’s insurance covers $300,000 in personal liability insurance but your umbrella policy doesn’t cover up to $500,000, you’ll be responsible for the $200,000 in between. To avoid this, most companies that sell umbrella insurance ask customers to increase the basic liability coverage to eliminate such holes. Sticking with one company can also make the process simpler in the case of a lawsuit, because you won’t have two separate companies handling two portions of your insurance coverage. And bundling can get discounts on premiums for your various policies.
The good news is that, in most cases, umbrella policies offer good value. Since catastrophic lawsuits are relatively rare, companies can afford to spread the risk widely among their customer pool. While the exact rates vary, $300 to $500 per year can often guarantee $1 million in coverage. This figure can go up or down depending on the number of houses, cars and drivers in the insured’s household, as well as the part of the country where he lives. However, almost always what you pay for the first $1 million in coverage, the second million will cost less. If $1 million in coverage costs $500 per year, $5 million will almost certainly be less than $2,500.
For these relatively low premiums, personal liability insurance offers a lot of peace of mind. In addition to the basic function of the product, some policies go above and beyond. Extras you may encounter include not counting legal defense costs against the insurance coverage limit or offering reimbursement for public relations firms’ fees to handle the fallout from the incident. Depending on your needs and lifestyle, it may be worth comparing features, as well as prices, when choosing a policy.
We in the United States live in a very litigious society. Some of these lawsuits are frivolous; many are not. The reality is that civil lawsuits can, and often do, result in judgments or settlements that reach into the millions of dollars, and judges and juries are under no obligation to limit the damages awarded to an amount that the party being sued can comfortably afford. . Personal liability insurance protects you in the worst cases, even if the court finds you fully responsible.
So while adding another insurance policy may seem unnecessary at first, for those whose assets are vulnerable to creditor claims, an umbrella policy is an economically sensible way to protect against a rainy day in court.