If you’re just stopping by for the first time, this is a class in a series of classes over the next few months which will culminate in the development of a complete financial plan. Stop by the orientation class HERE first for class orientation/overviews and HERE for more information about the website.
Class Objectives: To understand the fundamentals of disability insurance and how to calculate your short and long-term disability potential needs.
Prerequisites: PF102: Creating a Net Worth Statement (you will need to know your net worth for this class!)
Handout: Current Umbrella Policy Coverage
Assignment: Personal Umbrella Liability Insurance calculation in Excel| Google Docs (previews in lecture material)
If you’ve ever been curious about what exactly personal liability umbrella insurance covers and whether or not you need it, you’re in the right place!
Now that we’ve covered the basics of the other types of common insurance (auto, homeowner’s, medical, life and disability), we are going to talk about personal liability umbrella insurance. Unfortunately due to the litigious culture in the United States, this insurance is becoming more and more necessary not just for wealthy Americans but even for the middle class.
Personal liability umbrella insurance is designed to add extra liability insurance coverage to homeowners/renters, auto and watercraft policies, as well as provide some liability insurance for a few additional things that aren’t covered under those policies. It is an important part of a financial plan to protect the assets of those with a higher net worth than the maximum liability coverage provided by these other policies, as an unfavorable lawsuit could come after personal assets in excess of the liability coverage on that insurance. In addition to your home, cars, savings, and investments (even including retirement accounts), your future earnings can also be included as an asset for purposes of a lawsuit filed against you. This means that you can potentially pay damages for far more than even your current net worth if found liable in a legal battle. Umbrella insurance is a very cost-effective way to hedge against the possibility of significant loss from these types of liabilities.
MY EXPERIENCE WITH THIS INSURANCE
When we lived in China, my husband was involved in a biking accident where he accidentally ran a traffic light and hit an elderly Chinese woman who had crossed without looking. He was at fault for the accident, but we were far more concerned about the well-being of the lady, who spent a couple of weeks in the hospital, than the financial implications of the accident. My husband’s company covered us with a personal umbrella policy throughout the duration of our international assignments in Asia, and we ended up being fully reimbursed for the hospital bills we paid and the negotiated settlement (which as a side note was for sure hundreds of times less than what it would have been in the U.S.). Upon returning to the U.S., we immediately purchased our own personal umbrella policy for the peace of mind that it gave us. Hopefully, we’ve already had our one freak accident for life, but if anything else were to happen to us, we will be appreciative of our past selves that bought our future selves the peace of mind of having an umbrella policy in place. For me, the risk is just too great in the U.S. to not have an umbrella policy to protect our current assets and our current and future income.
WHAT DOES THIS INSURANCE COVER?
Personal liability insurance policies provide coverage for the insured, their spouse and family members living in the household.
In addition to the excess liability coverage of the auto, boat and homeowner’s policies, umbrella policies cover personal claims such as libel and slander (making written/spoken statements that damage a person’s reputation), false arrest, other personal liability situations and liability coverage on rental properties that aren’t covered by other policies.
Some example of situations that umbrella policies can cover include:
- Damage to other people’s property where you are found at fault (in excess to other insurance coverages)
- Bodily injury in an auto accident that you were responsible for (in addition to property damage caused over the auto limits)
- Injury caused to others due to your dog biting them (in excess of your homeowner’s insurance coverage)
- Injury caused to a guest in your home due to a fall or other accident (in excess of your homeowner’s insurance coverage)
- Someone getting injured in a rental property deemed to be your (the landlord’s) fault
- You post a negative online review and are sued for defamation
Some situations that personal umbrella policies do not cover include:
- Intentional and illegal acts
- Damage to your own property
- Written or oral contracts (you are deemed as assuming this liability by signing the contract)
- Business liability claims (you should have separate coverage for this)
In addition to the amount of the policy, the insurance company covers the cost of attorney fees, another huge benefit! Attorney fees alone could use up a significant portion of your assets in a long, drawn-out lawsuit. Also, many umbrella policies will cover your lost wages for time spent in court.
For example, assume that you are involved in an auto accident where the other person is injured and files a lawsuit against you. Your auto insurance has coverage of $250,000/$500,000/$100,000 (bodily injury for each person/bodily injury each occurrence/property damage). You have a $1 million umbrella policy.
- Scenario 1: Assume that the person is only mildly injured and incurs $10,000 of medical costs as well as $5,000 in damage to their car. They file a lawsuit for injury, pain and suffering and receive a total judgment of $50,000. Your auto insurance will completely cover this amount minus the deductible (as long as the accident isn’t due to an intentional act or other excluded act) as well as help cover legal fees.
- Scenario 2: Assume that the accident is more severe and the person takes you to court and receives a judgment of $400,000. The first $250,000 will be covered under the auto insurance policy and the remaining $150,000 will be covered by your personal umbrella policy. If you did not have the umbrella policy, you would personally be responsible for the extra $150,000.
- Scenario 3: Assume that the person involved in the accident is severely disabled for life and receives a judgment in court of $1.5 million. The first $250,000 will be covered under the auto insurance policy, the next $1 million will be covered under the umbrella policy, but the next $250,000 you will still unfortunately be responsible for.
HOW MUCH OF THIS INSURANCE DO I NEED?
Personal umbrella policies start at a minimum of $1 million of coverage and most insurance companies offer up to $10 million, with only a few companies covering high net worth clients up to $100 million. It should be noted that it is common for umbrella policies to only cover half the value of the policy for personal injury claims (such as libel, slander, etc.), although these can be adjusted with a policy rider. For example, a $1 million umbrella policy may cover $1 million bodily injury and property damage, but only $500,000 personal liability.
In order to obtain a personal umbrella policy, you will be required to maintain a minimum amount of liability coverage for your auto, homeowner’s and watercraft policies. Generally the requirements are $250,000 /$500,000/$50,000 for auto liability and $300,000 for homeowner’s liability. For watercraft liability insurance the requirement is generally $300,000-$500,000. Check with your insurance company to make sure you know their minimum requirements on the underlying policies.
You should have total liability coverage of an absolute minimum of your net worth. This total includes the coverage on your basic policies (homeowner’s, auto, etc.) However, since future income can also be factored in a lawsuit when determining damages, it is highly recommended to have higher coverage to reduce your exposure to loss.
Follow these steps to determine your ideal umbrella policy coverage:
- First, you should determine your net worth. You have already done this if you have completed PF102: Creating a Net Worth Statement.
- Second, you should determine your current liability coverage under your homeowner’s, auto and boat policies. Use the liability coverage for “each person” rather than “each occurrence” to be conservative in your estimate of how much personal liability coverage you need.
- Third, consider the methods in the spreadsheet to find a total liability coverage you should consider. The methods are discussed below.
- Third, you should consider your risk for needing the insurance in the future. For example, if you hold a lot of parties in your home, you may want to increase coverage since your risk of someone getting injured and filing a lawsuit against you would be higher.
The homework assignment for this class will be to calculate your umbrella policy coverage needed under a couple different methods:
- Method 1: Calculate total liability coverage of the total of your net worth (this is an absolute minimum).
- Method 2: Calculate total liability coverage of twice your total net worth.
- Method 3: Calculate total liability coverage of your net worth, plus 5 times your annual income.
Note in the spreadsheet that first you calculate what your total liability coverage needs are and then you determine how much additional coverage you need to be provided by an umbrella policy.
WHAT IS THE DEDUCTIBLE?
Personal umbrella policies don’t have a deductible like other policies, but instead have something called a self-insured retention that is similar.
If the covered loss is applicable to either auto, homeowner’s or watercraft policies, those insurance policies cover the loss first (and the deductible for those separate policies applies) and then AFTER those coverage limits are used up, the umbrella policy covers the remaining amount up to the limit of the policy. There is no self-insured retention in those cases.
For example, assumed you have homeowner’s insurance with a $300,000 limit and a $2,500 deductible. In addition, you are very smart and have a $1 million personal umbrella policy. If someone slips and falls on your icy steps and obtains a legal judgment in the amount of $750,000, you will have to pay your $2,500 homeowner’s deductible, your homeowner’s insurance will cover $297,500 and your personal umbrella policy will cover $450,000.
If the covered loss is separate from auto, homeowner’s or watercraft policies (such as a lawsuit for slander), you will have to first pay the self-insured retention (SIR). The SIR is generally around $250, but can be $1,000 or higher depending on your policy.
HOW MUCH DOES IT COST?
Personal umbrella liability policies are relatively inexpensive for the amount of coverage that they provide. For the minimum coverage of $1 million, the cost is around $250-$300 annually for someone who owns one home and two cars. There is an increased cost for those that own rental properties, own more cars or boats or are deemed to be a greater risk for the insurance company.
Some of the factors that affect umbrella policy premiums include:
- Your age, as well as your spouse and children (teenager drivers increase the cost of the premiums)The amount of coverage you wish to obtain (minimum of $1 million)
- Your location
- Your credit score and history (a measure of risk)
- Your history of driving infractions
- Risk factors such as owning a dog, trampoline, swimming pool, etc.
- Discounts such as multiple insurance policies with one agency, memberships, etc.
WHERE DO I OBTAIN COVERAGE?
Personal liability umbrella policies can be obtained through the same insurance companies as your other basic policies. Many companies will not offer an umbrella policy to you unless you have other policies through them. As a reminder, the types of insurance companies include:
- Direct sellers such as Geico,Progressive, and Esurance
- Large national insurance companies such as Allstate, State Farm, USAA (veterans and military), Farmers, Liberty Mutual, AAA, Nationwide, etc.
- Independent insurance agents that offer insurance policies from multiple companies (I highly recommend that you ask friends and family for referrals and use an independent agent).
The more policies you have with one insurance agency, the better discount you can get for the various policies. Just be sure that if you aren’t purchased insurance from one of the major companies that you check their financial strength rating.
HOW DO I MAKE A CLAIM?
To make a claim, you go through the steps for your basic insurance policy first (homeowner’s, boat, auto, etc.). Since most insurance companies require you to have these coverages with them in order to be insured for a personal umbrella policy, they will already have the information for the accident, but you will need to know what’s covered under your policy.
In the case of personal liability claims that aren’t covered by the other basic policies, you should call your insurance company and report the incident (at the very beginning of the issue) and consult with them to get the appropriate paperwork to file for the situation.
Because insurance companies are in the business to make a profit, it is in your best interest to get your own attorney as well because so much money can be at stake if someone is filing a lawsuit against you.
The key points you should take away from this class include:
- Personal umbrella insurance is a necessity in today’s environment if your net worth exceeds your basic liability coverage under your homeowner’s, auto and boat policies. You should also consider it if your net worth is lower, but close to those coverages, because your future income could also be included in a lawsuit judgment.
- You may need to increase your liability coverage under your basic policies to be able to be covered under an umbrella policy.
- Umbrella policies do not kick in until the liability limits are used up under your basic policies and then they cover the additional amount up to the separate umbrella liability limit.
EXAMPLE: THE SMITH FAMILY
Jim & Mary Smith do not need a personal liability umbrella policy at this time, because their auto and homeowner’s insurance is sufficient to cover their assets. While there may be potentially some situations that could arise that wouldn’t be covered by these policies, their risk is low. As they assess their net worth on a regular basis, they will consider an umbrella policy when they have a higher net worth.
If you aren’t sure whether you have sufficient insurance coverage, use your net worth statement to analyze your current assets and your summaries of your auto and homeowner’s insurance to find gaps.
- IMPROVING– At a minimum, compare your auto, boat and homeowner’s insurance coverage to your estimated net worth.
- INVESTED– Use your net worth statement and compare it to your auto and homeowner’s policy coverages. Obtain a quote from your current insurance agency for a minimum of twice your net worth.
- UNSTOPPABLE– Calculate your personal liability umbrella insurance needs with the 3 methods above and get quotes from an independent insurance agent (consider combining with other policies for a discount).
Make sure you keep a copy of your calculation saved as an excel file and also in your Financial Plan binder under the Tab Insurance-Personal Liability Umbrella. You should analyze your insurance needs periodically throughout the future as your needs change (annually is recommended).
Use the following handout to summarize your current personal umbrella liability insurance coverage (now or if you obtain a policy after this course).