Umbrella Insurance: How Does it Work?
We all know unexpected things can happen from time to time. While we of course hope these are of the good variety, it’s also important to prepare for the curveballs life is known to throw at you.
In all likelihood, you’ve probably already prepared for the unexpected by taking out various insurance policies; but in some cases, these are not enough. While not everyone needs umbrella insurance, this option can offer an additional layer of security to the long-term financial stability of those who do.
In this post, we’ll run through everything you need to know about this type of insurance: including what it is, how it works, advantages and disadvantages, and how to determine if it’s right for you. Ready? Let’s jump in.
What is umbrella insurance?
Liability limits for your home, car, and other insurance policies will protect you—but only up to a point. If you’re involved in an incident on the road or someone falls while on your property, for example, you might get sued for a sum exceeding your insurance policy coverage and thus be responsible for the rest.
Umbrella insurance exists to cover that gap, providing the additional liability coverage you need when your base insurance fails to do so on its own. In other words, just as an umbrella keeps you dry during a rainstorm, umbrella insurance protects your money and assets if your foundational liability coverage does not cover the entire amount.
Many people don’t need umbrella insurance, as it’s not considered essential for everyone in the same way that car and home insurance are. Yet, it is essential for some individuals—such as those with ample wealth/assets or individuals with an increased risk of being sued.
How does umbrella insurance work, exactly?
Now that we’re familiar with umbrella insurance, let’s consider how it works in practice by discussing an example of the same.
Let’s say you’re involved in an accident on the road and are ultimately at fault. The person you’ve hit has sustained $125,000 worth of injuries, and car repair costs total $15,000; and because that person is unable to work for six months, he’s suing you for $250,000 in lost earnings. That amounts to a grand total of $390,000. Unfortunately, your current liability coverage falls well below that at only $250,000.
So, where does the other $140,000 come from? That’s right: your pocket. That is unless you have umbrella insurance, which provides an additional level of coverage beyond your primary insurance policy and will pay the difference between this and the amount you’re responsible for.
What umbrella insurance covers
Most unexpected events in your life don’t pose a risk to your wealth; but some do, which is why umbrella insurance policies are there to protect you with respect to the following:
Legal fees
It’s not just the outcome of a lawsuit that can crucify your wealth; the process of defending yourself can be pretty costly, too. With umbrella insurance, you’ll enjoy peace of mind of knowing that lawsuit defense costs are covered.
Bodily injury
There are a million ways to be found at fault for someone else’s injury. Let’s say, for example, a child attending your son’s birthday party falls awkwardly in the bounce house you rented and breaks her arm. Because this unfortunate event occurred on your property, you’re responsible for her medical bills—and could even face a sterner lawsuit if her parents are sufficiently aggrieved. Thankfully, umbrella insurance exists to pay costs not covered by your primary insurance.
Umbrella insurance also protects you if you’re held responsible for someone else’s injury in other ways (e.g., if you injure someone while operating your vehicle or your dog bites a neighbor).
Reputational damage
In today’s digital society, it’s easier than ever to share your thoughts online—a fun convenience that does come with its own risks. If a person or company you comment on decides to sue you for defamation, for example, the financial fallout could be significant: especially if that party has a point to prove.
Thankfully, most people don’t need to worry about getting sued for libel or defamation; but if you’re a prominent person other people pay attention to, you don’t fall into that category and instead face increased risk. Umbrella insurance covers costs related to a libel, slander, or defamation lawsuit along with self-defense legal fees, allowing you to lean on this should you find yourself in a similar position.
Property damage
Inadvertently cause damage to someone else’s vehicle or property? Corresponding costs can add up quickly and often exceed the amount of coverage offered by standard insurance policies. Not to worry: umbrella insurance will cover the difference, even with respect to accidental property damage caused by your child or rental equipment incidents.
What umbrella insurance doesn’t cover
Umbrella insurance is often highly useful for specific situations, but it’s not a catch-all solution. If you assumed it serves as a watertight seal to protect all of your money and assets in any scenario, think again. For example, the following are excluded from this coverage:
Personal property
Keep in mind that umbrella insurance is a liability policy, meaning it won’t protect your own items and will instead only cover costs that may arise due to outside forces. If you have an incident on your property, for example, another policy will assume those costs.
Intentional acts
As with all insurance policies, umbrella insurance will only protect you in the event of an accident. If you intentionally damage someone else’s property, for example, don’t expect umbrella insurance to come to your rescue—because it won’t.
Contract workers
Umbrella insurance won’t cover any costs if a contract worker injures him or herself on your property. With this in mind, be sure these workers have their own insurance whenever you hire them—and always read the fine print so you know which costs you’re responsible for before signing anything.
Business-centric costs
Umbrella insurance covers personal liability matters; to protect your business, you’ll need to obtain commercial insurance.
Umbrella insurance costs
The value of umbrella insurance is immeasurable, but the actual cost of the policy itself is highly affordable. As for specific costs, policies in the $1 million range cost around $100–300 a year (with $2 million in coverage usually only an additional $75). You can buy as much coverage as you want, and in general, the corresponding cost will only increase by around $50 per year for every additional $1 million.
Note that you can’t buy umbrella insurance on its own and must instead add this to your existing policies—purchasing from the same company that provides your foundational coverage. Keep in mind your existing policies must reflect a specific level of liability coverage (usually between $250,000 and $350,000), and if you fall below this, you’ll need to increase your policy and pay the corresponding costs.
Umbrella insurance pros and cons
No insurance is perfect, meaning umbrella insurance policies come with both advantages and disadvantages. The vast majority of high-net-worth individuals, however, will find that the benefits greatly outweigh any downsides.
Pros
Primary umbrella insurance benefits include:
Extra coverage: You’ll receive a wide breadth of coverage for a relatively low cost, with policies starting at $1 million and costing $100–$300 on an annual basis.
Asset protection: Umbrella insurance can safeguard your assets (such as your home) in the event you’re found liable for any injuries or damage.
Extensive coverage scope: With umbrella insurance, you’re covered for circumstances most insurance policies do not cover—such as libel and slander.
Add-on convenience: If you currently have $250,000 in liability coverage and add a $1 million umbrella policy, you’ll enjoy $1,250,000 in coverage—offering significant protection against lawsuits.
Cons
On the flip side, umbrella insurance downsides include:
Stringent prerequisites: You typically can’t obtain umbrella insurance unless your existing policies provide the highest level of coverage. If you need to boost your foundational insurance accordingly, you’ll need to pay more overall.
Holes in coverage: An umbrella policy doesn’t cover everything, as personal property, business losses, and acts of war/terrorism fall outside the scope of these policies (for example).
In sum: is umbrella insurance worth having?
If you’re a high-net-worth individual, pursuing umbrella insurance is likely worthwhile.
You can determine if this is right for you with a simple calculation; simply tally up the cost of all your assets—including savings, home equity, college funds, retirement accounts, and more—and if their value exceeds that of the coverage provided by your insurance policies, umbrella insurance is most definitely recommended to avoid putting your financial future at risk.
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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.
Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.
