How Much Umbrella Insurance Do I Need?

Most mortgage lenders require homeowner’s insurance. Most states require car insurance. No one requires umbrella insurance. Insurance agents don’t make much commission on an umbrella policy. It must be packaged with your home and car insurance, and you have to call to purchase it.

Umbrella insurance covers you for liability that goes above and beyond your auto and homeowners insurance. Coverage starts where other policy coverage ends and extends the coverage by millions of dollars. This protects you against other’s claims of bodily injury and property damage. Umbrella insurance also covers you for lawsuits where you are being sued for slander, libel, false arrest, malicious prosecution, or mental anguish. Umbrella insurance doesn’t cover intentional acts or punitive damages.

It is the insurance for if your teenage driver is at fault and young people in both cars are seriously injured. If your dog bites a child. If you chaperon a class trip and are judged negligent when one of the students tragically dies. If you cause an accident on the freeway and a truck filled with expensive cargo is involved. If a neighbor slips on your steps and sues you.

Even with a legitimate cause for a lawsuit, most potential plaintiffs won’t go to court for massive damages unless the defendant has significant assets. Suing someone without assets is pointless. However, when the defendant is wealthy, the chances of litigation are higher even when the cause is frivolous.

Personal umbrella liability insurance covers only nonbusiness activities. Umbrella policies are also available for businesses and may be well worth the money.

Families who are worth millions of dollars use umbrella insurance to defend them from large lawsuits. We live in a litigious society. Anyone can sue you for any reason.

Some states have adopted Rule 11 of the Federal Rules of Civil Procedure. This rule discourages use of the court system to harass or purposefully increase the cost of litigation. However, tort reform advocates believe that even these rules don’t protect innocent citizens from bearing the cost of bogus lawsuits.

Even if the lawsuit is frivolous, you don’t want to represent yourself. Requests for documents or admissions must be filed while papers filed by the other side must be quickly answered. You must understand legal discovery tools and rights. Interrogation under oath must be done before trial. Depositions must be taken. Third parties should be subpoenaed. A coherent strategy should be devised. And then a motion for summary judgment should be filed.

You don’t want to represent yourself.

With lawsuits costing upwards of $300,000, having an insurance company with an obligation to defend you in court is the primary benefit of umbrella insurance. For those with assets sufficient to make them a target for lawsuits, umbrella insurance is the answer.

To insure up to $1 million of additional liability costs between $150 and $300 annually. Each additional $1 million of umbrella coverage might cost between $100 and $125 annually.

We recommend umbrella insurance for anyone with over $300,000 of savings.

You need more coverage than you have assets. Having as much coverage as you have assets is not a good rule of thumb. If you have $1 million in assets and $1 million in coverage a $2 million judgment will still wipe you out.

According to one study, “13% of personal injury and liability awards and settlements are $1 million or more.”

The first $1 million coverage will cover all of the nuisance lawsuits. This coverage is important. However, we recommend having at least $2 million in coverage of umbrella insurance.

The next $1 million of coverage will cover completely the unlikely event that a judgment or settlement is reached in court for more than $1 million but less than $2 million.

We are not usually fans of insurance. If you can afford to self-insure you probably should since insurance companies, on average, make money. But you don’t want a single accident to wipe out your life savings. Umbrella insurance helps protect you against that possibility.

Totaling your car or losing your house leaves you with the option of taking the loss and downsizing. However, if you receive a judgment for more than your net worth, you will likely 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 as well as any current or future inheritance you receive outright.

Umbrella insurance is designed to cover these very unlikely but very costly events at a reasonable price. This is exactly what insurance is supposed to do.

In review courses for the certified financial planner (CFP) exam, prospective advisors are told to remember, “Umbrella insurance is always the right answer.”

While there is a possibility of a judgment or settlement over $1 million, each subsequent million becomes more remote. For most people, umbrella insurance over $5 million is remote enough to not be needed.

About 12% of homeowners purchase umbrella insurance. For the wealthy, that number grows to about 50%. For those with assets over $5 million, 79% have an umbrella policy.

Having more assets also increases the amount of coverage they are likely to have. Somewhere between $2 million and $5 million is a good amount of coverage. Beyond $10 million might be excessive. While the likelihood of needing that much coverage is remote, it is not zero. Families who choose that much insurance are often those at risk for large judgments. Because of this self-selection, the cost is often higher for amounts greater than $10 million.

Insurance companies will only write an umbrella policy if they also provide both your home and auto insurance. They don’t trust another insurance company to defend their interests.

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. If you own a Rottweiler or have a recent reckless driving charge, 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. If you have a driver younger than age 25 or have a very poor driving record, coverage may cost an extra $100 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.

In summary, we recommend $2 to $5 million of umbrella coverage for typical families with assets over $300,000.

Photo used here under Flickr Creative Commons.

About the author

David John Marotta, CFP®, AIF®

David John Marotta, CFP®, AIF®, is President of Marotta Wealth Management, Inc. of Charlottesville providing fee-only financial planning and wealth management at www.emarotta.com and blogging at www.marottaonmoney.com.

11 Comments

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  • Lets say I have underlying policy covering me 1M. Now I got an umbrelly (or excess) policy covering me for 5M. My question is, am I covered for a total of 6M or 5M?

  • If you have $3 in assets and purchase an umbrella coverage for $4 or even $20 million if you are sued for $40 million or more. Nowadays, people get sued for ridiculous amounts of money for ridiculous reasons. During my divorce, my lawyer was working on a case worth 8 figures. Since I can’t afford this level of coverage, why bother having an umbrella policy at all?

  • Frankly, yes these assets should be considered. They’re protected while sheltered in the tax-qualified retirement accounts, but eventually the common goal is withdrawal. This is when the funds would be exposed. As the author has stated, when it comes to the umbrella policy, over insure a safe amount. The cost pencils and the peace of mind is invaluable.

  • Frankly, yes these assets should be considered. They’re protected while sheltered in the tax-qualifies retirement accounts, but eventually the common goal is withdrawal. This is when the funds would be exposed. As the author has stated, when it comes to the umbrella policy, over insure a safe amount. The cost pencils and the peace of mind is invaluable.

  • Are retirement assets such as IRAs and 401Ks protected in a liabilaity lawsuit. In other words should those assets be included in net worth for determing how much umbrella insurance you need?

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