When most people consider their insurance needs, usually only certain types of coverage come to mind. Health insurance and life (or sometimes disability) insurance protect you and your loved ones; Auto and homeowners/renters insurance protects your major tangible assets.
Personal liability insurance, often called an “umbrella” policy, rarely makes this list. But when a rainy day strikes, or an expensive lawsuit strikes, sometimes nothing more than an umbrella is enough.
As the name suggests, personal liability coverage exists primarily to protect against liability claims. In most cases, that means you and your property are the subject of a civil lawsuit. A personal liability policy may seem like overkill to people who already have three or four insurance policies. It is true that not everyone needs such protection. 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 waterfront property, liability insurance is a product you hope you never have to use, but can provide great peace of mind in the meantime.
Who needs liability insurance?
Some level of personal liability coverage is built into homeowners (or renters) insurance and auto insurance. For many people, this may be enough. In part, this is because some types of assets are protected by state and federal laws. For example, a court cannot force you to use qualified retirement accounts, such as 401(k), to pay a court 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, although the precise rules vary; Florida, for example, offers very strong protections in this area, while other states may only protect a certain level of home equity.
You can also protect certain assets from lawsuits through estate planning tools, such as properly structured and funded irrevocable trusts. However, be careful about establishing such trusts directly after an incident that you fear may trigger a lawsuit. If it appears that you are simply trying to evade future creditors, the courts could find the transfer of assets to be fraudulent and leave these assets available to pay a judgment.
If you don’t have many assets outside of your retirement savings and primary residence, then your existing liability coverage may suffice. But second homes and non-retirement investment accounts are vulnerable. High earners and their spouses may also want to consider their coverage options, as courts have been known to garnish wages to satisfy judgments.
While amounts vary by geography and insurance policy, homeowners insurance typically includes up to $300,000 of personal liability coverage. Auto insurance generally covers up to $250,000 per person and $500,000 per accident involving bodily injury, and less for incidents involving property damage alone. However, serious accident lawsuits can sometimes result in millions of dollars in judgments or settlements. This is where general policies come into play.
Most people think of car accidents as the main trigger for these types of lawsuits, and with good reason, as car accidents are relatively common and can cause a lot of damage. But there are a wide variety of situations where you may be liable for an accident. You may throw a party at your house where one of the guests is seriously injured. Your dog can bite a stranger or acquaintance. If you employ domestic staff, such as a nanny or home health aide, the employee could sue not only for bodily harm, but also for wrongful termination or harassment.
There are other liability risks that may not come to mind so easily. For example, the hyper-connected world of social media creates many more opportunities to slander or defame someone, even without knowingly intending to. Your teens or tweens could also create these kinds of problems; At worst, they could end up involved in a cyberbullying or stalking incident that takes a tragic turn. Teens also increase their responsibility when they get behind the wheel. Even adult children can trigger “victim liability” statutes that can leave you personally liable in certain circumstances, such as if they borrow your car and are later involved in an accident.
Another area that some people overlook is the risk of serving on a nonprofit board of directors. Many nonprofit organizations are too small to offer much, if any, protection for board members’ personal assets in cases where the organization and its board of directors are sued. Board members may consider directors and officers insurance specifically, as well as or instead of a blanket policy. People whose charitable work, or whose professional activities, bring them into the public eye may also want to consider more liability coverage because of the potential damage a lawsuit could do to their reputations 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 multiple defendants, regardless of fault. In other words, if four defendants are found to be equally liable, the plaintiff may recover 100 percent of damages from one of them and nothing from the other three. Therefore, many attorneys focus on the highest net worth defendant in such cases, on the theory that this method is the most likely to secure the highest payout for their client.
How much liability insurance should you have?
As you can see, people with high net worth, high earning potential, or both have reason to be concerned about their exposure to liability. Once you’ve decided to buy an umbrella policy, the next logical question is how much insurance to buy.
Unfortunately, there is no specific formula for determining the correct amount of coverage. A good rule of thumb is to have 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 number. Keep in mind that insurance companies’ tools and advice will tend to want to sell you more insurance than you need, but it can still be helpful to see what factors will affect your coverage. Some of these are intuitive, like your current net worth and the assets you own. Others are more concerned about the possibility of accidents; For example, you may want more insurance if you own a trampoline or a swimming pool, and you can also expect slightly higher premiums.
As with any insurance decision, shopping around is a good idea. But there are real benefits to buying most or all of your insurance products from a single provider. Consolidating your coverage will not only ease the administrative burden, but also make it easier to spot potential gaps. For example, if your homeowners insurance covers $300,000 in personal liability insurance, but your umbrella policy doesn’t kick in until $500,000, you’ll be responsible for the $200,000 in the middle. To avoid this, most companies that sell general insurance require customers to increase their basic liability coverage to fill in such gaps. Sticking with one company can also simplify the process in the event of a lawsuit, since you won’t have two separate companies handling two parts of your coverage. And the combination can guarantee discounts on the premiums of your various policies.
The good news is that, in most cases, umbrella policies offer good value. Since catastrophically large claims are relatively rare, companies can afford to spread risk widely across their client pool. While exact rates vary, $300 to $500 a year can often secure $1 million in coverage. This figure can go up or down depending on the number of homes, cars, and drivers in the policyholder’s household, as well as the part of the country in which he lives. However, it is almost always the case that no matter what you pay for the first million dollars of 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 such relatively low premiums, personal liability insurance offers great peace of mind. In addition to the basic function of the product, some policies go further. Extras you may find include not counting legal defense costs against the coverage limit or offering reimbursement for public relations firm fees to handle the aftermath of the incident. Depending on your needs and lifestyle, it may be worth comparing features, as well as cost, when choosing a policy.
We in the United States live in a highly 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 amounting to millions of dollars, and judges and juries are under no obligation to limit damages awarded to an amount the defendant can comfortably pay. . Personal liability insurance protects you in worst-case scenarios, even if the court finds you fully liable.
So while adding one more insurance policy may seem unnecessary at first, for people with assets vulnerable to creditor claims, an umbrella policy is a financially sensible way to protect against a rainy day in court.