Liability Insurance: What It Is, How It Works, Major Types

What Is Liability Insurance?

The term liability insurance refers to an insurance product that provides an insured party with protection against claims resulting from injuries and damage to other people or property. Liability insurance policies cover any legal costs and payouts an insured party is responsible for if they are found legally liable. Intentional damage and contractual liabilities are generally not covered in liability insurance policies.

Unlike other types of insurance, liability insurance policies pay third parties, and not policyholders.

Key Takeaway

  • Liability insurance provides protection against claims resulting from injuries and damage to people and/or property.
  • Liability insurance covers legal costs and payouts for which the insured party would be found liable.
  • Provisions not covered include Intentional damage, contractual liabilities, and criminal prosecution.
  • Liability insurance is often required for automotive insurance policies, product manufacturers, and anyone who practices medicine or law.
  • Personal liability, workers' compensation, and commercial liability are types of liability insurance.

How Liability Insurance Works

Liability insurance is critical for those who are liable and at fault for injuries sustained by other people or in the event that the insured party damages someone else's property. As such, liability insurance is also called third-party insurance. Liability insurance does not cover intentional or criminal acts even if the insured party is found legally responsible. Policies are taken out by anyone who owns a business, drives a car, practices medicine or law—basically anyone who can be sued for damages and/or injuries. Policies protect both the insured and third parties who may be injured as a result of the policyholder's unintentional negligence.

Liability insurance is also called third-party insurance.

For instance, most states require that vehicle owners have liability insurance under their automotive insurance policies to cover injury to other people and property in the event of accidents. A product manufacturer may purchase product liability insurance to cover them if a product is faulty and causes damage to the purchasers or another third party. Business owners may purchase liability insurance that covers them if an employee is injured during business operations. The decisions doctors and surgeons make while on the job also require liability insurance policies.

Special Considerations

Personal liability insurance policies are purchased primarily by high-net-worth individuals (HNWIs) or those with sizeable assets, but this type of coverage is recommended to anyone with a net worth that exceeds the combined coverage limits of other personal insurance policies, such as home and auto coverage. The cost of an additional insurance policy doesn't appeal to everyone, although most carriers offer reduced rates for bundled coverage packages. Personal liability insurance is considered a secondary policy and may require policyholders to carry certain limits on their home and auto policies, which may result in additional expenses.

The global liability insurance market size was valued at more than $25 billion in 2021, and is expected to reach $433 billion by 2031.

Although commercial general liability insurance protects against most legal hassles, it doesn't protect directors and officers from being sued, and it doesn't protect the insured against errors and omissions. Companies require special policies for these cases including:

  • Errors and Omissions Liability Insurance (E&O): An errors and omissions liability insurance policy covers lawsuits arising from negligent professional services or failing to perform professional duties. Lawyers, accountants, architects, engineers, or any business providing a service to a client for a fee should purchase this form of insurance. An E&O policy does not cover criminal prosecution, fraudulent or dishonest acts, or claims against bodily injury. The insured, however, is covered for attorney fees, court costs, and any settlements up to the amount specified by the insurance contract.
  • Directors and Officers (D&O) Insurance: This type of policy protects directors and officers of large companies against legal judgments and costs arising from unlawful acts, erroneous investment decisions, failure to maintain property, releasing confidential information, hiring and firing decisions, conflicts of interest, gross negligence, and other errors. Most D&O policies exclude coverage for fraud or other criminal acts. Premiums depend on the company, its location, industry type, and loss experience.

Types of Liability Insurance

Business owners are exposed to a range of liabilities, any of which can subject their assets to substantial claims. All business owners need to have an asset protection plan in place that's built around available liability insurance coverage.

Here are the main types of liability insurance:

  • Employer’s liability and workers' compensation is mandatory coverage for employers which protects the business against liabilities arising from injuries or the death of an employee.
  • Product liability insurance is for businesses that manufacture products for sale on the general market. Product liability insurance protects against lawsuits arising from injury or death caused by their products.
  • Indemnity insurance provides coverage to protect a business against negligence claims due to financial harm resulting from mistakes or failure to perform.
  • Director and officer liability coverage covers a company's board of directors or officers against liability if the company should be sued. Some companies provide additional protection to their executive team even though corporations generally provide some degree of personal protection to their employees.
  • Umbrella liability policies are personal liability policies designed to protect against catastrophic losses. Coverage generally kicks in when the liability limits of other insurance are reached.
  • Commercial liability insurance is a standard commercial general liability policy also known as comprehensive general liability insurance. It provides insurance coverage for lawsuits arising from injury to employees and the public, property damage caused by an employee, as well as injuries suffered by the negligent action of employees. The policy may also cover infringement on intellectual property, slander, libel, contractual liability, tenant liability, and employment practices liability.
  • Comprehensive general liability policies are tailor-made for any small or large business, partnership or joint venture businesses, a corporation or association, an organization, or even a newly acquired business. Insurance coverage includes bodily injury, property damage, personal and advertising injury, medical payments, and premises and operations liability. Insurers provide coverage for compensatory and general damages for lawsuits but not punitive damages.

How Does Personal Liability Insurance Differ From Business Liability Insurance?

Personal liability insurance covers individuals against claims resulting from injuries or damage to other people or property experienced on the insured's property or as a result of the insured's actions. Business liability insurance instead protects the financial interests of companies and business owners from lawsuits or damages resulting from similar accidents but also extending to product defects, recalls, and so on.

What Is Umbrella Insurance?

An umbrella insurance policy is additional liability insurance coverage that is purchased and goes beyond the dollar limits of the insured's existing homeowners, auto, or watercraft insurance. Umbrella policies tend to be affordable and offered in increments of $500,000 or $1 million.

What Is Backdated Liability Coverage?

Usually, you must have liability coverage in place when an event happens that results in a claim. Backdated liability insurance, however, is insurance that provides coverage for a claim that occurred before the insurance policy was purchased. These policies are uncommon and usually available only to businesses.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Allied Market Research. "Liability Insurance."

  2. U.S. Department of Labor. "Workers Compensation."

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