Is Good Umbrella Insurance a Useful Way to Manage Risk?

Have you ever considered if the inconvenience of carrying an umbrella is worth it and decided to take one just to get Murphy’s Law to prevent rain?

I know I have, more than once…

The minor inconvenience is a small price to pay to avoid getting soaked.

What’s Umbrella Insurance? What Does It Cover and What Doesn’t It Cover?

Umbrella insurance is like that, except that instead of protecting your clothes and hair from getting wet, it protects your assets and/or future income against catastrophic losses from lawsuits.

Umbrellas add coverage above and beyond the limits of your homeowner, auto, and other policies; it also adds certain other coverages those underlying policies may not include, such as defamation.

For things already covered by your other policies, the umbrella “kicks in” once your primary coverage is exhausted. For these, the umbrella policy has very high deductibles that set the minimum primary coverage you need. For example, it may require at least $300k liability coverage on your auto insurance.

Umbrella policies typically cover you and members of your household against judgments, settlements, legal fees, and court costs, due to claims resulting from e.g.:

• Accidentally injuring or killing someone (including medical costs, pain and suffering, and loss of income).
• Accidentally damaging or destroying someone’s property (e.g., car, house, business, boats in some cases, etc.).
• Making a verbal or written statement damaging someone’s reputation (slander, libel, and/or defamation of character) or invasion of privacy.
• False arrest, detention, or imprisonment.
• Mental suffering.
• Someone is injured or killed in your home or rental property or suffers property damage there.
• Some umbrellas cover you for volunteer work as a member of a board of directors or trustees (some boards provide Directors and Officers coverage for board members, so you may not need your umbrella for that).

Some things typical umbrella policies don’t cover:

• Your own injuries and/or property damage and/or business losses.
• Intentional and/or criminal acts.
• Infecting someone with a disease.
• Claims against your business (you may want a business umbrella or a professional “errors and omissions” policy for this).
• Liability for breaching contracts.

How Big a Risk Can Come of Forgoing an Umbrella Policy?

When considering insurance, think of three things:

• How badly can things get without insurance?
• How likely is it for something like that to happen?
• How expensive is the insurance relative to potential losses?

How Bad Can Things Get?

In cases of personal injury, you’d definitely have to pay an attorney (or several), which is already expensive.

According to All Law, “…a more complex case anywhere could cost upwards of $30,000… a large case, which could involve multiple attorneys or hundreds of attorney hours, [could] cost $100,000 or more.”

And how expensive is it to settle a personal injury case?

Forbes reports some statistics, including:

• The median settlement for all cases was $31k.
• The median settlement for homeowner or landlord liability was $90k.
• The average settlement for medical malpractice cases was nearly $700k.

Another situation where an umbrella policy can help is defamation lawsuits. Even if without merit, it can be very costly to defend against these.

According to the Institute for Free Speech, defeating even a meritless claim can cost $21k to $55k, but it often exceeds $100k or even $1 million!

How Likely Are You to Face Such a Situation?

The Law Dictionary reports that 95% of lawsuits end up settling. Thus, in 19 out of 20 cases, the defendant pays at least enough to get the plaintiff to drop the case.

And the remaining 5%?

A staggering 90% of those end up with the defendant winning!

All told, if you’re sued, you’re certain to pay attorney fees (unless you’re a fool), and combining the 95% of cases settling with 90% of those going to court ending in a win for the plaintiff, it’s a near-certainty (99.5%) you’ll pay the defendant to go away or pay even more after losing in court.

You may think that, despite the huge potential fallout, you’re very unlikely to ever face such a situation.

Perhaps.

However, here are some scenarios that could happen to almost anyone.

• You visit a restaurant and have a horrible experience, so you leave a nasty online review. The restaurant sues you for libel, claiming they lost $500k in revenue because of your review. After paying $50k in legal fees, you settle for $100k. Your homeowner’s insurance happens to not cover this sort of claim, so you’re out $150k.
• You host a party at your house and a guest slips and falls. She sues you for $500k in medical costs, pain and suffering, and loss of earnings. Your homeowner’s insurance covers $300k but you’re responsible for the remaining $200k.
• Your teenage kid texts while driving and runs a red light. She hits another car, injuring several people. The other car is totaled, costing $50k. The people in the other car sue for medical costs and pain and suffering to the tune of $1.5 million. Worse yet, one of the injured passengers is a surgeon who can’t work for a couple of months and sues you for $400k in lost earnings. Total liability reaches $1.95 million. Even though your auto policy covers far above the state minimum — $500k per accident —you have to cover $1.45 million out of pocket!
• You’re driving on the highway at 55 mph. One of your passengers distracts you momentarily, so you fail to notice traffic is stopped ahead of you. You hit the car in front of you at high speed, causing a chain reaction affecting five other cars. Including your two passengers, 12 people are involved. Tragically, one dies and three others suffer severe injuries. Since you caused the accident, you pay $1.5 million for the fatality, an average of $550k in medical bills, pain and suffering, and loss of earnings for each of the three severely injured people, plus an average of $100k for each of the other eight. Property damage to the five vehicles adds $150k. Your auto policy covers $500k, leaving you on the hook for $3.6 million.

Such scenarios can happen to anyone and can cost hundreds of thousands or even millions of dollars, potentially wiping you out financially.

An umbrella policy pays the difference between your primary coverage (auto, homeowner’s, etc.) and the full cost of the incident, including legal costs, up to the full umbrella coverage.

Better yet, the umbrella policy incentivizes your insurer to mount an aggressive defense and get you the least-expensive outcome.

Say your liability is $2.5 million and you have $500k in primary coverage. Your insurer may decide to cut their losses by paying $500k, leaving you to deal with the remaining $2 million plus legal fees.

With an umbrella policy, they’ll have another $2-million incentive to fight the lawsuit, and they pick up all the legal costs.

When Should You Get an Umbrella Policy?

Settlements and judgments are often affected by how much you have and/or earn. It may not seem fair, but it’s understandable.

As they say, “You can’t squeeze blood out of a stone.”

Thus, you’re more likely to need an umbrella policy if you own property or a business, and/or have a high net worth and/or high income (judgments can garnish future income).

You’re also more likely to need umbrella coverage if your exposure is higher than most. E.g., you:

• Own rental property
• Have a swimming pool
• Own an aggressive dog or a horse
• Have young drivers on your auto policy
• Frequently host parties and/or houseguests
• Volunteer as a board member without Directors and Officers insurance
• Employ household staff
• Play higher-risk sports (e.g., surfing, hunting, shooting, skiing, etc.)
• Are highly visible (e.g., politician, prominent business owner, etc.)
• Often travel overseas where your primary coverage may not apply but an umbrella likely does.

How Much Umbrella Insurance Do You Need?

The usual guidance is to have enough insurance, between your primary and umbrella policies, to cover the exposed portion of your net worth.

If your current and/or expected income is higher than average, consider insuring more than your current net worth.

A couple of caveats, though.

First, employer-sponsored retirement accounts such as 401(k) and amounts rolled over from such plans are protected from lawsuits by the Employee Retirement Income Security Act of 1974 (ERISA). However, ERISA doesn’t protect non-rollover IRAs or solo 401(k) plans.

State laws may protect some of your other assets (e.g., primary residence equity up to a certain amount), so check your state laws before choosing a coverage amount.

Second, many ultra high-net-worth individuals don’t buy over $10 million in coverage, since getting successfully sued for more than that is very rare.

Here’s what financial pros say about how much coverage makes sense:

• Kevin Estes, Founder & Financial Planner, Scaled Finance: “I generally advise clients to purchase umbrella insurance roughly equal to their net worth, rounded up to the next million. Umbrella insurance is relatively inexpensive and helps protect the nest egg they’ve worked hard to build.”
• Zack Swad, CFP®, CWS®, BFA™, AWMA®, AAMS®, President & Wealth Manager, Swad Wealth Management: “I advise almost all my clients to purchase umbrella insurance. I base the coverage amount on their assets. E.g., if their home is worth $1 million and their brokerage and IRA accounts are $3 million, I advise $4 million coverage. I’d much rather err on the side of having too much because it’s such great protection at a very small cost.”
• Scott Custis, Scott R Custis, CFP, Lead Planner at Money Scientific: “The only time I advise against getting umbrella insurance is if nearly all of the client’s net worth is in a 401(k) plan that isn’t a solo 401(k).”
• Kevin M. Arquette, CFP®, Wealth Manager, Managing Partner, Wealthpoint Financial Planning: “Having umbrella insurance is wise, especially if you have substantial nonexempt assets, as governed by state and federal laws. The appropriate coverage amount is based on the value of your nonexempt assets.”
• Angela Dorsey, CFP®, MBA, Financial Planner, Dorsey Wealth Management: “I recommend umbrella insurance to my clients if their auto/homeowner liability coverage is less than 1–2 times their net worth.”
• Jorey Bernstein, Executive Director, Wealth Manager, and Founder, Bernstein Investment Consultants: “Assess your assets, risk exposure, and affordability to determine your umbrella coverage. E.g., if you have $1 million in assets, consider at least $2 million coverage.”
• Joe Petry, PhD, CFP®, Founder and Financial Planner, Mayfair Financial: “Umbrella coverage, which I recommend to most clients, is insurance in its purest form — transferring to the insurer the risk of a low-probability, high-impact event. It’s so inexpensive to take that risk off the table, that for most people it’s worth a few hundred bucks a year. As for coverage amount, once they buy $1 million of coverage, they have a staff of lawyers to fight on their behalf at no additional cost. Coverage beyond that isn’t a bad idea but is less critical. I leave that to my clients and their insurance agents.”
•  Paul Doak, CFP®, I.D. Financial: “All it takes is one lawsuit or major accident to ruin a financial plan! Here’s a true story about a guy who was three years from a nice retirement. He thought insurance was a waste of money, so he repeatedly declined to buy umbrella coverage and bought only the minimum required auto coverage. His wife drove their Mercedes to the dealership for servicing. Her foot struck the accelerator instead of the brake, damaging 12 new high-end cars and causing $750,000 worth of damage. They were insured for $50,000. Had he bought umbrella coverage, it would have protected them.”

Since your net worth will likely grow over time, review your coverage level periodically.

How Much Does Umbrella Coverage Cost?

Umbrella policies usually come in million-dollar increments and are very inexpensive relative to the coverage. You may get $1 million coverage for $300/year. Subsequent million-dollar increments cost less, so $5 million coverage may cost as little as $600.

If your liability exposure is higher, your premium will be higher. Factors affecting premiums include living where homes and autos are more expensive, and incomes are higher, having poor credit, having drivers in your household with poor driving records, etc.

Some carriers will only sell an umbrella policy if they write the underlying auto and homeowner’s policies. Others will sell an umbrella on top of other carriers’ primary coverages but will give a discount for bundling policies with them.

If your existing auto and homeowner’s policies have high liability coverages, say $500k, you may be able to reduce those to $250k-$300k once you buy an umbrella, lowering those premiums and partially offseting your umbrella cost.

On the flip side, if your current primary coverages are lower than the umbrella deductibles, you’ll need to increase them, increasing those premiums.

The Bottom Line

The likelihood of a lawsuit costing more than your primary policies cover is low, so you’re unlikely to ever file a claim against an umbrella policy, which is why it’s so inexpensive.

However, as the above-mentioned scenarios show, it could happen and an umbrella policy can then save a lifetime’s worth of wealth and income.

Given how little umbrella insurance costs for a great deal of coverage, and the peace of mind knowing you have a big corporation and its legal resources on your side if needed, it’s a good idea to at least consider buying such coverage.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.