The first line of defense in asset protection
Personal injury lawsuits are a sign of these litigious times. The cases range from serious accidents to frivolous grievances. And if you are sued, the truth matters less than your ability to buy the best defense and guard your wealth from an aggressive plaintiff.
When evaluating personal liability risk exposure, many people assume that their auto and homeowners insurance will provide more than enough protection. But the standard liability coverage in most policies is $300,000—not a large amount, considering the frequency of multimillion dollar settlements. If you are relying on a standard policy to protect your wealth, you may have more risk exposure than you know.
If you face a settlement or legal judgment that exceeds coverage, you will make up the difference. This could mean selling assets, pledging future income or consuming an expected inheritance. There go your dreams.
A layer of protection
Umbrella liability insurance can add a major layer of personal asset protection. This supplemental insurance guards against a catastrophic settlement or court judgment by increasing the amount and broadening the scope of your liability coverage. Umbrella insurance kicks in after your primary auto and homeowners liability insurance is exhausted.
For instance, suppose your neighbor is seriously injured on your property. He sues and is awarded $1 million. Your homeowners policy pays $300,000 for liability claims, minus your $1,000 deductible. That leaves a $700,000 balance owed to the plaintiff. The umbrella policy covers the difference. You pay only the initial $1,000 deductible in the settlement.(1)
Umbrella coverage is surprisingly affordable. Policy premiums range from $200 to $300 a year per $1 million of coverage.(2) The low premium reflects the actuarial truth about risk exposure. Primary policies are first in line to pay smaller but more frequent claims, while an umbrella functions as a backup or spillover policy.
Primary policies address the risks of bodily injury and property damage, while the umbrella structure broadens coverage to include personal injury. This category includes false claims, libel, slander, defamation, false arrest, wrongful entry, malicious prosecution, invasion of privacy, eviction, certain property damage, and liability incurred while acting as a volunteer officer or director for a nonprofit organization.(3) Most policies also pay for legal defense and court fees, up to a specified limit.(4)
Of course, you cannot eliminate exposure to every risk. Like all insurance, an umbrella has exclusions and limits. Most policies don’t cover liabilities arising from professional and business activity. Also take note of exclusions on separate assets, such as boats, recreational vehicles and other sports toys.
Furthermore, coverage is generally excluded on contracted liabilities, intentional damage, possession of non-owned property, punitive awards and home-based business operations. A policy may cover newly acquired assets (such as additional vehicles for a vacation home) or legal entities (such as trusts) only if these are itemized on the policy and titled accurately. If you plan to use an umbrella in an elaborate asset protection strategy, seek expert guidance.
Most people completely overlook supplemental protection—or assume that only the very rich need it. But anyone with accumulated wealth or high current income is a target for litigation. Assess your exposure to lawsuits by evaluating the assets you own and the life you lead.
For instance, do you have a swimming pool, trampoline, swing or other hazardous equipment on your property? Do you frequently entertain guests in your home? Do you have pets considered to be high risk? How much do you travel and by what means? Are your children driving? Do you have a visibly affluent lifestyle or pursue high-risk hobbies? Are you in a high-income profession? These factors (and others) suggest a need for enhanced coverage.
Determining how much umbrella coverage to buy is also crucial. Protection should well exceed your total net worth since there’s no guarantee that a court judgment will stay within the limit of your ability to pay. In fact, juries often award amounts far beyond a defendant’s paper wealth.
Finally, if you want to add coverage, compare the umbrella premium to the cost of raising liability limits on your primary policies. Most people can raise coverage without a sizable increase in premium—but only up to a certain point. Beyond this, an umbrella provides a higher measure of security for less.
(1) Umbrella insurance requires the policyholder to meet a large deductible before it starts paying. In this example, the deductible is $300,000, which equals the $300,000 minimum liability coverage in the homeowners policy. (The policyholder pays the first $1,000 as a deductible.) It’s crucial that no gap exists between your primary policy’s minimum liability coverage and the umbrella’s deductible. Otherwise, you will have to fund the difference.
(2) The premium costs of an umbrella policy may be lower if purchased from the same company offering your automobile and homeowner’s insurance. But prices depend on geographic area and the types of risks added to the policy. A policyholder is usually required to have at least $250,000 in base liability coverage under a homeowners policy. Minimum auto liability ranges from $100,000 to $250,000 per person, $300,000 to $500,000 per total occurrence for bodily injury, and $100,000 to $250,000 for property damage. Minimum coverage varies among insurance carriers.
(3) Umbrella policies don’t pay director’s liability if you are receiving compensation for the service. This requires directors and officers insurance.
(4) For instance, a $1 million umbrella liability policy might pay for legal and court fees up to $1 million more than standard policy coverage.