Insurance is always a game of what-ifs. The more what-ifs you can protect now, hopefully, the better off you will be if they appear in the future. Umbrella insurance helps protect against some of the worst-case scenarios, and many people don’t even realize it. While umbrella insurance is less talked about than other insurance policies, it is designed to protect you if something bad enough happens that your current policies cannot cover.
Key Takeaways
- Umbrella insurance is a backup liability policy that only covers catastrophic events above and beyond your base property and casualty insurance limits.
- Experts recommend umbrella insurance for people who could max out their current liability coverage. Examples include teenage drivers, people with pools or trampolines, and people who participate in sports like skiing or hunting.
- Obtaining liability coverage equal to your net worth is a good rule of thumb when shopping for umbrella insurance. Policies generally start at $1 million.
What is Umbrella Insurance?
For example, let’s say your teenage son gets in a serious car wreck and badly injures a group of people in the other car. While your auto insurance policy is designed to cover car damage, it may not have enough liability insurance to cover the injuries and/or potential lawsuits from the victims. If your liability limit per accident is $300,000 and you are liable for $500,000 or $1,000,000 in damages, you could be on the hook.
This is where Umbrella Insurance comes in as a backup liability policy meant to cover only catastrophic events. The original auto policy would still provide the first $300,000 of liability protection (or any other policy with liability protection). If a $1,000,000 claim were to occur, the umbrella policy would help cover the difference between your existing insurance and the claim.
I find it interesting that these policies are not talked about enough. There is little public data on the frequency of these rare events, but that does not mean they do not happen or that they should not be insured. More interestingly, according to Gen Re, a major Property & Casualty reinsurance company, umbrella policies make up “less than 1% of the roughly $1 trillion of P&C direct premium written in 2024”. In other words, insurance companies are not making a lot of money on these policies and, therefore, are not encouraged to market and sell these insurance policies. In my opinion, how much money the big insurance companies make should be nearly irrelevant to whether individuals need protection to cover these risks.
Who Needs Umbrella Insurance?
Extra liability is generally recommended for people who could potentially max out their current liability coverage. Teenage drivers are an easy example, but this could apply to any situation where you are hosting or interacting with others in a potentially dangerous environment. A dog bite, a pool party, and a trampoline, among others, are other common examples. Sports like skiing or hunting are another good example, where the potential for very expensive accidents is above zero.
A common rule of thumb is usually to obtain liability coverage equal to your net worth, which I generally agree with. In our example above, it would be life-altering to need to sell a business or a property just to come out of pocket for any liability your current policies could not cover. I would say most owners would prefer a cheap umbrella policy to cover the difference instead of their business.
There are commercial versions of umbrella insurance as well, to protect against many of the same risks. Legal costs, medical bills, and lawsuits all arising from your business and/or employees could potentially put you on the hook. If something were to happen and damages exceeded the current business liability protection you have, a commercial umbrella policy would step in to hopefully cover the excess.
How Much Should I Get?
The first step is to calculate a rough net worth, or the value of all your assets minus your debts. Add up all your investment accounts, property values, a rough guess on your business values, as well as your mortgages, student loans, and other debts. Rounding is more than fine here. If your net worth exceeds $500,000 or $1,000,000, it may be worth starting with that much coverage.
Umbrella policies generally start at $1 million, but they could always range upwards. $2 or $5 million is another common policy as well. Remember to offset your potential umbrella policy relative to your other liability policies. If the net worth is closer to $1.5 million, but you have $500,000 in liability coverage through your homeowner’s or $300,000 through your auto policy, a $1 million umbrella policy may be enough for your situation.
The cost for umbrella insurance has historically been relatively inexpensive. According to Mercury Insurance, the average annual cost of a $1 million umbrella policy is between $300 and $600. Not too dissimilar from the typical cost of term life insurance for healthy working-age adults. This is part of the reason why insurance companies are not pushing these policies. Access to $1 million for a few hundred dollars each year is much more reasonable than a few thousand, in my opinion.
Do You Need An Umbrella Policy?
At the end of the day, an umbrella policy is designed to protect you against catastrophic events. Chances are you may never use this policy, and each year throwing away money in the name of insurance. But by design, that is the goal: to cover yourself from the major risks in your life. Having a pool, being a coach, or going hunting by design adds greater risk than those who don’t do that. Is paying a couple of hundred dollars each year worth making sure your wealth, that you spent decades working on, doesn’t go away in one accident? That is for you to decide.
