What is umbrella insurance, and how does it work?

Umbrella insurance is additional civil liability coverage. It is designed to ensure that you never have to pay more than the insurance amount if you lose a claim. Currently, the chances are slim, but if you ever find yourself in that situation, you could lose all your savings. Let’s look at this additional coverage: how umbrella insurance works, who needs it, how much it costs and what it doesn’t cover.

Key information:

  • Umbrella insurance is a type of personal liability insurance that covers claims that exceed the coverage of the average home, auto, or boat policy.
  • Umbrella insurance or umbrella insurance protects the policyholder and other family or household members.
  • The umbrella insurance coverage covers injuries to others or damage to their possessions; it does not protect the policyholder’s property.
  • Umbrella insurance is relatively cheap compared to other types of insurance.

What is umbrella insurance?

Umbrella insurance is personal liability insurance that can be essential when you have a more significant claim than your homeowners or auto insurance covers. If you own a boat, umbrella insurance will also cover you from the point where your boat’s liability insurance reaches.

Umbrella insurance even covers specific liability claims that some policies don’t cover, such as defamation, slander, and false imprisonment. And if you own a rental property, umbrella insurance provides liability coverage beyond what your rental policy covers.

How does umbrella insurance work?

Here are some examples of incidents that umbrella insurance might cover if homeowners or auto insurance weren’t enough:

  • The dog runs out of the house and viciously attacks a neighbor taking a walk. Your neighbor is suing you to cover his medical bills, lost wages, and pain and suffering.
  • Your daughter gets into a fight at school and hits another girl, breaking her nose. The girl’s parents sue you.
  • You cause a 10-car accident, and your auto insurance property damage coverage isn’t high enough to replace the vehicles of all ten accident victims. Nor is your liability coverage high enough to pay your medical bills.
  • You send sandwiches to your child’s school for a field trip lunch. Several students develop food poisoning, and their parents sue you.
  • Your teenage son throws a party at your house while you’re out of town. Someone brings alcohol to the party, and one of the guests is arrested for driving home under the influence. You are tired.

As you can tell from these examples, umbrella insurance covers not only the policyholder but also other members of your family or household. So, if your teen isn’t the best driver, you can sleep better at night knowing your umbrella policy will cover medical bills for injured parties if your teen is found liable in a severe accident. That said, make sure you understand how your policy defines each family member so you have the coverage you need.

You may also have noticed that while umbrella insurance acts as coverage beyond your home and auto insurance, the incident doesn’t have to involve your property or vehicle for your umbrella insurance to cover it. You are also covered worldwide, except for houses and cars that you own under the laws of other countries. 

Do you need umbrella insurance?

There is certainly a fear factor in the decision to purchase umbrella insurance. Many insurance companies say you need it because of the constant demands they face. They can sue you for anything and ruin you financially. In the news, you can find many horror stories about personal liability, where juries awarded multi-million dollar judgments to victims that defendants had to pay. But how likely are you to find yourself in that situation? Do you need umbrella insurance?

As a general rule of thumb, you may hear that you should buy comprehensive insurance if the total value of your assets, including regular checking and savings accounts, retirement and college savings and investment accounts, and home equity is greater than the liability limits of your car or home. The idea behind this advice is that you need enough liability insurance to cover your assets fully, so you don’t risk losing them in a lawsuit.

However, this recommendation doesn’t make much sense because jury penalties can easily exceed insurance policy limits. The real question you need to ask yourself is, am I at risk of being sued? Everyone is, so umbrella insurance is a good option for everyone in a sense. It’s a small price to pay for the peace of mind it provides.

But some people are more likely to need an umbrella policy than others. If you’re engaged in an activity that puts you at higher risk of incurring excess liability, you’re an even better candidate for an umbrella policy. Personal liability risk factors include:

  • Owning property.
  • Renting property.
  • Employing domestic staff.
  • Owning a trampoline or hot tub.
  • Hosting large parties.
  • Being a well-known public figure.

Having a teen driver in the family also increases risk, as does having a dog or a house with a pool. The more likely you are to be sued, the more you should consider purchasing umbrella insurance. In short, anyone will sleep better at night knowing that he is protected by umbrella insurance.

An example of how umbrella insurance works

Let’s say your homeowner’s insurance has a personal liability limit of $300,000. You throw a big party, and one of your guests slips and falls on your frozen steps. He ends up with a concussion and some astronomical medical bills and decides to sue you. The jury sides with your guest in court and awards her a million-dollar judgment. This judgment is $700,000 more than the liability limit on your home insurance.

Without personal liability umbrella insurance, you have to pay that $700,000 out of pocket. The money will have to come out of your retirement account, your primary source of savings. The loss is devastating and means you’ll have to work an extra ten years, find a better-paying job, or slash your expenses to replenish your retirement savings. But suppose you have a million dollars in umbrella insurance. In that case, your umbrella policy will cover the portion of the judgment not covered by your homeowner’s insurance, and your retirement savings will remain intact. The umbrella policy will also cover attorneys’ fees and other expenses related to the lawsuit that your homeowner’s policy does not cover. That coverage is in addition to the million dollars.

So if you have a $5,000 deductible on your homeowner’s insurance, you’ll pay that amount out of pocket. Then, your homeowner’s policy will spend the next $295,000, bringing you up to the $300,000 policy limit. Your general insurance does not have a separate deductible in this case because the homeowner’s policy covers part of the loss. Your umbrella policy pays the remaining $700,000 of the judgment plus legal fees. This way, you will only have to pay $5,000 for the $1 million reviews.

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