Umbrella Insurance Reduces Your Risk

Umbrella insurance provides broader coverage and more limits than your auto and homeowners policy for liability claims made against you. In this post, I’ll provide:

  • An explanation of what liability is.
  • A description of what is covered under an umbrella policy.
  • An illustration of how the limits work.
  • Some examples that compare the cost of an umbrella policy to the cost of buying higher limits of liability on your auto and homeowners policies.
  • A few suggestions for deciding whether an umbrella policy might be a good purchase for you.

What is Liability

According to the Cambridge English Dictionary, liability is “the responsibility of a person, business, or organization to pay or give up something of value.” In the context of insurance, it is something for which you are responsible to repair, replace or pay related to a third party (i.e., not you or your immediate family). That is, if you injure someone or damage their property, you are liable for their medical costs and lost wages and the repair or replacement cost of their property.

The most commonly considered forms of personal liability relate to your car and your residence. One component of your automobile policy is liability coverage. That coverage defends you and pays the cost (up to your limit of liability) of any injuries to other people or damage to other people’s property from accidents you cause. Similarly, your homeowners (or renters or condo-owners) policy defends you and pays the cost of any injuries to other people or damage to their property related to owning your home.   For example, if someone trips over an uneven spot in your front walk and gets injured or is injured or killed in fire in your home, the costs will be covered by your Homeowners policy.

What is Covered by an Umbrella

There are two ways in which an umbrella policy provides coverage for you:

  • It provides additional liability limits above those on your Homeowners and Auto policies.
  • It provides protection from other sources of personal liability.

Home and Auto

One of the choices you have when purchasing home and auto policies is the liability limit. Most insurers offer limits as high as $500,000 and some have limits has high as $1 million. There are many types of injuries, such a brain trauma, burns and quadriplegia, which can cost well in excess of $500,000 or even $1 million. One source estimates that the average lifetime medical cost for a 25-year-old paraplegic is $2.5 million; for a quadriplegic, $3.6 million to $5 million depending on the location of the injury. In addition, the person causing the injury could be liable for lost wages.

If you injure someone in a car accident or they are injured in your home, you are liable for the total cost of their injuries. If that total is more than the limit of liability on your policy, you are responsible for the excess. That doesn’t mean everyone will make a claim against you for the excess, but they generally have the legal right to make a claim on and, if successful, take your assets.

To reduce the likelihood that your insurance won’t be enough to cover the costs in these situations, you can purchase an umbrella policy that, in essence, increases the limits on your home and auto policies by the limit on the umbrella policy. For example, if you have a $500,000 liability limit on your auto insurance policy and purchase an umbrella policy with a $2 million limit, your insurer will pay $2.5 million to people you injure in auto accidents you cause. It is much less likely that their costs will exceed $2.5 million than $500,000 or $1 million.

Other Sources of Personal Liability

There are many sources of personal liability other than your home and cars. These include injuries or damages from:

  • pets
  • boats
  • ATVs or other “toys”
  • libel
  • slander
  • volunteer activities
  • participation in sports in which you might injure someone else
  • vacant land you own, especially if you lease it out for activities such as hunting

Generally, these sources of personal liability are covered under an umbrella policy though there are exclusions that you’ll want to check.

For example, there are exclusions that limit the coverage for motorized boats and toys and large boats, such as requiring them to be listed on the declaration page and paying a higher premium, buying an underlying policy to provide insurance for liability related to them or limiting the locations at which they are insured. If you have any of these “toys,” you’ll want to make sure that the umbrella policy you purchase is going to provide the coverage you seek.

Limits of Liability

Personal umbrella policies are generally offered with limits ranging from $1 million to $10 million. I’ve read that most people who purchase umbrella policies select a $1 million limit. Our umbrella policy has a $2 million limit, though I don’t have an analytical reason why we chose $2 million.

How Limits Work

The limits on an umbrella policy apply differently for the two types of coverage, as illustrated in the graphic below for an umbrella policy with a $2 million limit and the required liability limits of $300,000 on homeowners and $500,000 on auto.

Your homeowners and auto policies will pay the first $300,000 and $500,000, respectively, of any covered claim. The $2 million of umbrella limit applies on top of these limits, for a total of $2.3 million of liability coverage for homeowners claims and $2.5 million for auto claims. For all other types of personal liability claims, the umbrella policy starts paying immediately (after any deductible on the umbrella policy) and provides $2 million of total coverage for these claims.

I note that many umbrella policies have a small deductible. For example, ours has a $250 deductible. In the graphic above, there should be a very small layer just below the orange box that represents the deductible. In our case, we will pay the first $250 of every claim before our umbrella policy starts paying.

A Clarification about Insurance

As indicated above, if you cause an injury to someone and don’t have enough liability limit on your insurance policies, they can make a claim against your assets. An important point to understand is that insurance policies don’t “protect” or shelter any of your assets. That is, if you buy an umbrella policy with a $1 million limit, it doesn’t mean that claimants won’t be able to take some or all of that $1 million in assets. Rather, it means that claimants can only take your assets if their claims are larger than the total coverage provided by your insurance (e.g., $1 million for personal liability claims and $1 million plus the liability limit on your auto and homeowners policies for those types of claims).

Cost Comparison

I asked my insurance agent, Billy Wagner, Personal Insurance Sales Executive at PayneWest Insurance in Helena, MT, for some examples of the pricing of umbrella policies. He created three different insurance buyers to use as illustrations.

Buyer 1 Single male 1 car Renter No kids No toys or high-risk activities (e.g., dogs that might attack, bungee jumping, local politics)
Buyer 2 Family 3 cars A primary home, rental property and lake cabin 4 teenage drivers Trampoline, pit bull, fast boat, snowmobiles, etc.
Buyer 3 Empty nesters with solid credit 4 cars 1 house No kids at home Two canoes, volunteer work, medium risk overall

Just Auto and Home

The table below shows rough estimates of what each buyer will pay for the liability portion of their auto coverage and the total cost of their homeowners coverage all with $1 million limits.

Buyer Auto Liability Primary Home Total at $1 million limits
1 $800 $1,450 $2,250
2 4,000 2,500 6,500
3 1,500 3,250 4,750

Add Umbrella

If, instead, each buyer purchased the minimum limits required by the umbrella policy ($500,000 for auto liability and $300,000 for homeowners) and bought an umbrella policy with a $1 million limit, the rough costs would be those shown in the table below.

Buyer Auto Liability ($500,000) Home ($300,000) Umbrella ($1 million) Total
1 $650 $1,300 $325 $2,275
2 3,800 2,250 1,250 7,300
3 1,250 3,000 625 4,875

How Much More for the Umbrella?

The total costs of the two options are shown in the table below.

Buyer

$1 million/ No umbrella

Umbrella Additional Cost
1 $2,250 $2,275 $25
2 6,500 7,300 800
3 4,750 4,875 125

If you are already buying $1 million limits on your auto and home policies and aren’t considered high risk, the additional cost of purchasing umbrella coverage is very small ($25 for Buyer 1 and $125 for Buyer 3). Not surprisingly, if you have high-risk drivers, lots of risky toys and participate in risky activities, the additional cost increases, as is the case for Buyer 2.

If you are buying somewhat lower limits, such as $500,000 on your auto and $300,000 on your home, your total insurance bill will increase by the cost of the umbrella coverage – in these examples ranging from about $325 for the single, low-risk insured to $1,250 for the riskier family for $1 million of coverage.   And, if you are buying low limits (such as $100,000 or less), your premium would increase by the cost of raising the limits on your underlying policies to $500,000 and $300,000 for auto and home, respectively, in addition to the cost of the umbrella itself.

How to Decide Whether to Buy

Umbrella policies aren’t for everyone. Generally, people who are the best candidates for purchasing umbrella policies are those who both:

  • Participate in activities that can lead to personal liability claims (such as those listed above), are high-risk drivers or have high-risk characteristics at their residences
  • Have assets that they want to protect

If there isn’t much risk in your life, either in your cars, residence or activities, you might decide to not buy an umbrella policy because you don’t think you will ever have any claims that would be covered by the policy.  Similarly, if you don’t have any assets someone you injure could take, it might not be worth purchasing an umbrella. However, as shown in the tables above, it might not cost much more to purchase an umbrella policy so it is something to consider as it may not have a large impact on your budget.

Higher Deductibles vs. High Limits

One way to offset the additional cost of increasing your liability limits and/or buying an umbrella is to increase your deductibles. I don’t have any specifics on the premium reduction from increasing your deductibles, but one source cited a difference between a $100 deductible and a $1,000 deductible ofvery roughly $200 per year per car. If you have one car and are low-to-medium risk, you could cover a significant portion of the cost of an umbrella policy if you carry the required auto and home limits or the full cost of the changing from a $1 million policy limit to an umbrella policy.

The Risk-Reward Trade-off

The choice of a higher deductible versus more coverage and a high limit is one of risk and reward. If you increase your deductible, you are increasing the maximum amount you will pay on each claim by a fixed amount – say the $900 difference between a $100 deductible and a $1,000 deductible. Using the $200 premium savings estimate above, the additional $200 saves you up to $900 in repair costs each time you have an accident. Even if you have 5 accidents of more than $1,000 each, the total repair cost savings would be less than $5,000. Using the $5,000 as the repair cost savings, the ratio of the premium savings to the repair cost savings is 4% (=$200/$5,000).

On the other hand, spending $325 on an umbrella policy provides you with an additional $1 million of protection if someone is seriously injured either physically or economically by something you own or your actions. If someone is awarded damages that includes the full $1 million coverage under your umbrella policy, the ratio of premium savings to liability savings is 0.03% ($325/$1 million). Of course, it is much less likely that you will cause a loss that goes through the full $1 million coverage of your umbrella and, if you didn’t have the coverage, the amount of damages for which you are sued might be lower.

The trade-off between the much smaller additional cost of repairs with the higher deductible and the potentially much higher cost of a large liability claim is something to consider, especially if you can afford to pay for the repairs to your car from accidents you cause from your budget or emergency savings.