When most people consider their insurance needs, only certain types of coverage typically come to mind. Health insurance and life (or sometimes disability) insurance protect you and your loved ones; car and homeowner's or renter's insurance protect your major tangible assets.
Personal liability insurance, frequently called an “umbrella” policy, seldom makes this list. But when a rainy day – or an expensive lawsuit – turns up, sometimes nothing but an umbrella will do.
As the name suggests, personal liability coverage mainly exists to protect against claims of liability. In most cases, that means finding yourself, and your assets, the target of a civil lawsuit. A personal liability policy may seem like overkill for individuals who already hold three or four insurance policies. It is true that not everyone needs such protection. But an umbrella policy effectively defends your assets and future income against damage claims that can arise from a wide variety of scenarios. Much like flood insurance for beachfront property, liability insurance is a product you hope you never need to use, but one which can create substantial peace of mind in the meantime.
Who Needs Liability Insurance?
Some level of personal liability coverage is built into homeowner's (or renter's) insurance and auto insurance. For many people, this may be sufficient. In part, this is because some types of assets are shielded by state and federal law. For instance, a court cannot force you to use qualified retirement accounts, such as 401(k)s, to pay a legal judgment, and most states have laws protecting traditional IRAs. Some states protect Roth IRAs and other retirement accounts, too. Many states also protect your primary residence, though the precise rules vary; Florida, for instance, offers very strong protections in this area, while other states may only shield a certain level of home equity.
You can also protect certain assets from lawsuits through estate planning tools, such as properly structured and funded irrevocable trusts. However, be wary of setting up such trusts directly after an incident you fear may trigger a lawsuit. If it looks as if you are simply trying to dodge future creditors, the courts could determine that the asset transfer is fraudulent, rendering these assets available to pay a judgment.
If you don't have many assets outside your retirement savings and your primary residence, then your existing liability coverage may be sufficient. But second homes and nonretirement investment accounts are vulnerable. High income earners, and their spouses, may also want to consider their coverage options, since courts have been known to garnish wages to satisfy judgments.
While the amounts vary by geography and insurance policy, homeowner's insurance usually includes up to $300,000 of personal liability coverage. Auto insurance typically covers up to $250,000 for each person and $500,000 per accident involving bodily harm, and less for incidents that involve property damage only. Yet lawsuits for serious accidents can sometimes result in judgments or settlements for millions of dollars. This is where umbrella policies kick in.
Most people think of car accidents as the main trigger for such lawsuits, and with good reason, since car accidents are relatively common and can cause a lot of damage. But there are a wide variety of situations in which you can find yourself liable for an accident. You may host a party at your home where one of the guests is seriously injured. Your dog may bite a stranger or acquaintance. If you employ household staff, such as a nanny or home health aide, the employee could sue not only because of physical harm, but also for wrongful termination or harassment.
There are other liability risks that may not spring to mind so easily. For instance, the hyperconnected world of social media creates many more opportunities to libel or defame someone, even without deliberately setting out to do so. Your teenage or preteen children could also create such problems; in a worst case scenario, they could end up involved with a cyberbullying incident or harassment that takes a tragic turn. Teenagers also increase your liability when they get behind the wheel. Even adult children can trigger “vicarious liability” statutes that may leave you personally liable in certain circumstances, such as if they borrow your car and are then involved in an accident.
Another area some people overlook is the risk of sitting on a board for a nonprofit organization. Many nonprofits are too small to offer much, if any, protection for board members' personal assets in cases where the organization and its board of directors are sued. Board members may wish to consider directors and officers insurance specifically, as well as or in lieu of an umbrella policy. People whose charitable work – or whose professional activities – put them in the public eye may also want to consider increased liability coverage due to the potential damage a lawsuit could do to their reputations as well as their financial health.
When considering the need for personal liability insurance, it is also worth considering the common law concept of “joint and several” liability. In many jurisdictions, a plaintiff can recover all the damages from any of multiple defendants, regardless of fault. In other words, if four defendants are all found equally liable, the plaintiff can recover 100 percent of damages from one of them and nothing from the other three. Many lawyers thus concentrate on the defendant with the highest net worth in such cases, under the theory that this method is the most likely to secure the largest payout for their client.
How Much Liability Insurance Should You Carry?
As you can see, individuals with a high net worth, high income potential or both have reason to worry about their liability exposure. Once you have decided to purchase an umbrella policy, the next logical question is how much insurance you should buy.
Unfortunately, there is no specific formula to determine the correct amount of coverage. A good rule of thumb is to carry at least enough insurance to cover your net worth and the present value of your future income stream. A Certified Financial Planner™ or an insurance agent can help you with such calculations, and there are also a variety of tools online designed to help you calculate a figure. Bear in mind that tools and advice from insurance companies will tend to want to sell you more insurance than you may need, but it can still be useful to see what factors will affect your coverage. Some of these are intuitive, such as your current net worth and assets you own. Others are more immediately concerned with the potential for accidents; for instance, you might want more insurance if you own a trampoline or a pool, and you can expect slightly higher premiums as well.
As with any insurance decision, shopping around is a good idea. But there are real benefits to purchasing the majority or the entirety of your insurance products with one provider. Consolidating your coverage will not only ease the administrative burden, but it will also make it easier to spot potential gaps. For instance, if your homeowner's insurance covers $300,000 in personal liability insurance but your umbrella policy does not kick in until $500,000, you will be responsible for the $200,000 in between. To avoid this, most companies that sell umbrella insurance require customers to increase their base liability coverage to eliminate such holes. Sticking to one company can also make the process simpler in the case of a lawsuit, since you will not have two separate companies handling two portions of your coverage. And bundling can secure discounts on premiums for your various policies.
The good news is that, in most cases, umbrella policies offer a good value. Since catastrophically large lawsuits are relatively rare, companies can afford to spread the risk widely among their customer pool. While the exact rates vary, $300 to $500 annually can often secure $1 million in coverage. This figure may rise or fall depending on the number of homes, cars and drivers in a policyholder's household, as well as the part of the country in which he or she lives. However, it is almost always the case that whatever you pay for the first $1 million of coverage, the second million will cost less. If $1 million in coverage costs $500 per year, $5 million will almost certainly be less than $2,500.
For such relatively low premiums, personal liability insurance offers substantial peace of mind. In addition to the product's basic function, some policies go above and beyond. Extras you may encounter include not counting legal defense costs against the coverage limit or offering reimbursement for public relations firm fees to manage the incident's fallout. Depending on your needs and your lifestyle, it may be worth comparing features, as well as cost, when choosing a policy.
We in the United States live in a highly litigious society. Some of these lawsuits are frivolous; many are not. The reality is that civil suits can, and often do, result in judgments or settlements that run into the millions of dollars, and judges and juries have no obligation to limit awarded damages to an amount the party being sued can comfortably afford. Personal liability insurance protects you in such worst-case scenarios, even if the court finds you entirely liable.
So while adding one more insurance policy may seem unnecessary at first, for people with assets vulnerable to creditors' claims, an umbrella policy is an economically sensible way to protect against a rainy day in court.