How Umbrella Insurance Works

Umbrella insurance is a type of personal liability insurance and can be indispensable when you find yourself liable for a claim larger than your homeowner's or auto insurance will cover. If you own a boat, umbrella insurance will also pick up where your boat’s liability insurance leaves off.

Umbrella insurance even covers certain liability claims those policies may not, such as libel, slander and false imprisonment. And if you own rental property, umbrella insurance provides liability coverage beyond what your homeowners policy covers.

While the chances are slim that you will be sued and end up owing someone more than what your existing insurance policies will pay out, if you did find yourself in that situation, you could lose all the money you’ve worked so hard to save. Umbrella insurance is designed to make sure you never find yourself living that nightmare. Let’s take a closer look at what umbrella insurance covers, who needs it, how it works, how much it costs and what it won’t cover.

What Umbrella Insurance Covers

Here are some examples of incidents an umbrella policy could cover if your homeowner's insurance or auto insurance wasn’t enough:

– Your dog runs out of the house and viciously attacks a neighbor who was going for a walk and minding her own business. Your neighbor sues you to cover her medical bills, lost wages and pain and suffering.

– Your daughter gets into a fight at school and punches another girl, breaking her nose. The girl’s parents sue you.

– You cause a 10-car accident and your auto insurance property damage coverage isn’t high enough to pay for all 10 accident victims' replacement vehicles. Nor is your personal liability coverage high enough to pay for their medical bills.

– You send sandwiches to your son’s school for a field trip lunch. Several students become sickened with food poisoning and their parents sue you.

– Your teenager throws a party at your house while you’re out of town. Someone brings alcohol to the party, and one of the party guests gets arrested for driving under the influence on the way home. You get sued.

Umbrella policies also cover malicious prosecution, wrongful entry, invasion of privacy and other harms.

As you might have gleaned from these examples, umbrella insurance covers not just the policyholder, but also other members of his or her family or household. So if your teenager isn’t the best driver, you can sleep better at night knowing your umbrella policy will cover the injured parties’ medical bills if your kid is found liable for a major accident. That being said, make sure you understand how your policy defines a household member so you’ll actually have the coverage you need.

You might have also noticed that even though umbrella insurance acts as coverage above and beyond your homeowner's and auto insurance, the incident doesn’t have to involve your property or your vehicle for your umbrella insurance to cover it. You’re also covered worldwide, with the exception of homes and cars you own under other countries’ laws. 

Do You Need Umbrella Insurance?

There’s certainly a fear factor involved in the decision to buy umbrella insurance. Many insurance companies say you need it because of the lawsuit-happy world we live in, where anyone can sue you for anything and ruin you financially. You can find plenty of personal liability horror stories in the news, where juries awarded multimillion-dollar judgments to the victims that individuals had to pay. But how likely are you to find yourself in such a situation? Do you really need umbrella insurance? (For related reading, see: It's Raining Lawsuits: Do You Need An Umbrella Policy?)

As a general rule, you might hear you should purchase umbrella insurance if the total value of your assets, including ordinary checking and savings accounts, retirement and college savings and investment accounts, other investment accounts and home equity, is greater than the limits of your auto or homeowners liability. The idea behind this advice is that you want to have enough liability insurance to fully cover your assets so you can’t lose them in a lawsuit.

This recommendation doesn’t quite make sense, though, because jury awards can easily exceed insurance policy limits. The real question you should ask yourself is, am I at risk of being sued? Everyone is, so in a sense, umbrella insurance makes sense for everyone. It’s a small price to pay for the extra peace of mind.

But some people are more likely to need an umbrella policy than others. If you engage in some activity that puts you at greater risk of incurring excess liability, you’re an even better candidate for an umbrella policy. Personal liability risk factors include owning property, renting it out, employing household staff, having a trampoline or hot tub, hosting large parties and being a well-known public figure. Having a teenage driver also puts you at increased risk, as does owning a dog or owning a home with a swimming pool. Basically, the more likely you are to be sued, the more strongly you should consider purchasing umbrella insurance, but anyone who is risk averse will sleep better at night knowing they’re protected by an umbrella policy.

An Example of How Umbrella Insurance Works

Let’s say your homeowners insurance has a personal liability limit of $300,000. You throw a large holiday party, and one of your guests slips and falls on your icy front steps. She ends up with a concussion and some astronomical medical bills and decides to sue you. In court, the jury sides with your party guest and awards her a judgment of $1 million. This judgment is $700,000 higher than your homeowners insurance liability limit.

Without a personal liability umbrella, you have to pay that $700,000 out of pocket. In your situation, the money will have to come out of your retirement account, your main source of savings. The loss is devastating and means you’ll have to work 10 additional years, find a higher paying job or cut back your expenses to replenish your savings and get back on track to be able to retire. But if you have $1 million in umbrella insurance, your umbrella policy will cover the portion of the judgment that your homeowners insurance doesn’t, and your retirement savings will remain intact. The umbrella policy will also cover any attorney fees and other expenses related to the lawsuit that weren’t covered by your homeowners policy. That coverage is in addition to the $1 million. (For related reading, see: How to Protect Your Retirement From Lawsuits.)

So if you have a $5,000 deductible on your homeowner's insurance, you’ll pay that amount out-of-pocket. Then, your homeowners policy will pay the next $295,000, which gets you to the $300,000 policy limit. Your umbrella insurance doesn’t have a separate deductible in this case, because the homeowner's policy covered part of the loss. Your umbrella policy pays the remaining $700,000 of the judgment plus legal expenses, so you’re only out- of-pocket $5,000 for the $1 million judgment.

What if you were found liable in a case where your homeowner's or auto insurance didn’t apply? Then you’d pay an umbrella insurance deductible, called self-insured retention, before the umbrella policy kicked in.

How Much Does Umbrella Insurance Cost?

The cost of an umbrella liability policy depends on how much coverage you purchase, the state where you live (insurance rates vary by state) and the risk that insuring you presents to the insurance company. The more homes or cars you own, and the more household members your policy will cover, the more it will cost.

But umbrella insurance is quite cheap compared to other types of insurance, especially considering how much coverage it provides. The Insurance Information Institute says most $1 million policies cost $150 to $300 per year, and you can expect to pay about $75 more per year for $2 million in coverage, and another $50 per year for every extra $1 million in coverage beyond that. Most insurance companies’ umbrella liability policies start at $1 million in coverage, with higher limits available. 

Why is umbrella insurance so cheap? It’s partly because you have to carry plenty of homeowner's and auto insurance before an insurance company will issue you an umbrella policy. You’ll probably have to carry the maximum liability coverage available under your homeowner's and auto policies before you can purchase an umbrella policy. 

Most people already have at least $100,000 in homeowner's coverage. Minimum auto insurance liability coverage depends on your state’s laws, but is typically $25,000 per person and $50,000 per accident. The maximum you can usually purchase is $500,000 in personal liability under your homeowner's policy and $250,000 per person and $500,000 per accident under your auto insurance policy. If you don’t already have this much coverage, your homeowner's and auto insurance premiums will go up, making the umbrella policy more expensive than it might seem at first glance.

If increasing your coverage and purchasing an umbrella policy is too expensive for you, as an alternative, you may be able to purchase endorsements to your auto or homeowners insurance that increase your liability limits beyond the usual maximums. You probably won’t get as much coverage as an umbrella could provide, but you’ll still be better protected than you were before.

Another possible requirement for getting umbrella insurance is that you have your auto and/or homeowner's insurance with the same company that issues your umbrella policy. But even if the umbrella insurer you choose does not require you to have your homeowner's and auto insurance policies with that company as a condition of getting umbrella insurance, it might be cheaper this way to get the insurer’s bundling discount. Then again, switching insurers might mean higher premiums, so you’ll want to compare quotes. Another consideration is it might be easier to have all your policies with the same company for administrative reasons in the event that you need to use your umbrella policy. (For related reading, see: Bundle Your Insurance for Big Savings.)

What’s the Catch?

One great thing about umbrella policies is that they provide broad coverage. They cover any incident that the policy does not specifically exclude, unlike some insurance policies, which only cover specifically named incidents. But no insurance policy covers everything. Here are some things your umbrella policy likely won’t cover:

– Damage you or a covered member of your household causes on purpose. If you pushed your party guest down the stairs, umbrella insurance wouldn’t cover the costs of the lawsuit or judgment (and neither would your homeowner's insurance).

– Liability incurred in business or professional activities. You’ll need business liability insurance to cover these incidents.

– Liability you agreed to assume under a contract you signed.

– Liability related to a war. Good luck finding any type of insurance that covers war-related damage; the financial losses associated with war are too high for insurance companies to cover.

– Damage to your own property. Remember, it’s a liability policy, so it will only cover you if you’re held responsible for damage to someone else’s property. Make sure you have enough homeowner's insurance to cover damage to your own property. (For related reading, see: Find The Best Homeowner's Insurance.)

The Bottom Line

Even the most careful person with the best intentions can end up on the hook for a huge judgment from a personal liability lawsuit. While you’re unlikely to find yourself in this situation, it’s still smart to protect yourself against such a devastating financial loss. Umbrella insurance can help you do that.