Umbrella Insurance Reduces Your Risk

Umbrella insurance provides broader coverage and more limits than your auto and homeowners policy for liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More claims made against you. In this post, I’ll provide:

• An explanation of what liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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, liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More relate to your car and your residence. One component of your automobile policy is liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More coverage. That coverage defends you and pays the cost (up to your limit of liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More) 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More limits above those on your Homeowners and Auto policies.
• It provides protection from other sources of personal liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More.

Home and Auto

One of the choices you have when purchasing home and auto policies is the liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 assetsThe value of things the company owns and amounts it is owed More.

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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More other than your home and cars. These include injuries or damages from:

• pets
• boats
• ATVs or other “toys”
• libelWriting something false about someone that causes them economic loss. Social media is becoming an increasing platform about which people sue for libel. More
• slanderSaying something false about someone that causes them economic loss. More
• 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More coverage for homeowners claims and $2.5 million for auto claims. For all other types of personal liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More claims, the umbrella policy starts paying immediately (after any deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More on the umbrella policy) and provides $2 million of total coverage for these claims.

I note that many umbrella policies have a small deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More. For example, ours has a $250 deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More. In the graphic above, there should be a very small layer just below the orange box that represents the deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More. 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More limit on your insurance policies, they can make a claim against your assetsThe value of things the company owns and amounts it is owed More. An important point to understand is that insurance policies don’t “protect” or shelter any of your assetsThe value of things the company owns and amounts it is owed More. 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 assetsThe value of things the company owns and amounts it is owed More. Rather, it means that claimants can only take your assetsThe value of things the company owns and amounts it is owed More if their claims are larger than the total coverage provided by your insurance (e.g., $1 million for personal liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More claims and $1 million plus the liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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.

Just Home and Auto

The table below shows rough estimates of what each buyer will pay for the liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More portion of their auto coverage and the total cost of their homeowners coverage all with $1 million limits.

Add Umbrella

If, instead, each buyer purchased the minimum limits required by the umbrella policy ($500,000 for auto liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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.

How Much More for the Umbrella?

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

If you are already buying $1 million limits on your auto and home policies and aren’t considered high riskThe possibility that something bad will happen. More, 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More claims (such as those listed above), are high-risk drivers or have high-risk characteristics at their residences
• Have assetsThe value of things the company owns and amounts it is owed More that they want to protect

If there isn’t much riskThe possibility that something bad will happen. More 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 assetsThe value of things the company owns and amounts it is owed More 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 budgetA plan showing targets for income and expenses over a fixed time period, such as a month or a year. More.

Higher Deductibles vs. High Limits

One way to offset the additional cost of increasing your liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More limits and/or buying an umbrella is to increase your deductiblesThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More. I don’t have any specifics on the premium reduction from increasing your deductiblesThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More, but one source cited a difference between a $100 deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More and a $1,000 deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More of very roughly $200 per year per car. If you have one car and are low-to-medium riskThe possibility that something bad will happen. More, 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 deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More versus more coverage and a high limit is one of risk and reward. If you increase your deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More, you are increasing the maximum amount you will pay on each claim by a fixed amount – say the $900 difference between a $100 deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More and a $1,000 deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More. 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 liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More 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 deductibleThe amount that you pay before the insurer starts reimbursing you either in part (see coinsurance) or in full. Deductibles can apply per claim (as is usually the case for auto collision and homeowners... More and the potentially much higher cost of a large liabilityWhen used as a noun, the amount you owe to someone else.  When used as an adjective, an insurance coverage that protects you when you cause damage or injury to someone else or their property. More claim is something to consider, especially if you can afford to pay for the repairs to your car from accidents you cause from your budgetA plan showing targets for income and expenses over a fixed time period, such as a month or a year. More or emergency savings.

Susie Q

Susie Q is a retired property-casualty actuaryA professional who assesses and manages the risks of financial investments, insurance policies and other potentially risky ventures. Source: www.investopedia.com/terms/a/actuary.asp More and mother of two adult children.  As her children were moving from their teens into their 20s, she found she was frequently a resource on many, many financial decisions and she had insights and information she could provide to them.  She spent a significant portion of my career building statistical models of all of the financial risks of an insurance company and interpreting their findings to help senior management make better financial decisions.  She is the primary author at Financial IQ by Susie Q and volunteers with other organizations related to financial education.