Chapter 4 Introducing the Personal Umbrella Policy

IN THIS CHAPTER

check Discovering the three major coverage advantages of an umbrella policy

check Understanding how an umbrella policy integrates with your other insurance

check Determining how much coverage to buy

You don’t have enough liability insurance. Period. No one does.

Most people are grossly underinsured for injury lawsuits. Common liability limits on auto and home policies are either $100,000 per person or $300,000 per accident. That’s not much for a human life — not enough to pay for all the medical expenses of the person you severely injure, plus a possible lifetime of lost wages and compensation for pain and suffering.

If you don’t have nearly enough protection, what can you do? Here’s some really good news: You can buy a second layer of liability coverage, called a personal umbrella policy, that sits on top of your other personal liability coverages for your car, home, boat, and so on. It defends you and pays legal judgments against you when a covered lawsuit exceeds your primary liability insurance limits.

Best of all, an umbrella policy is amazingly inexpensive — usually about $150 to $200 per year for $1 million of coverage. And about $75 to $100 per year for each additional $1 million of coverage. Note: This is not a typo. These costs are truly per year — not per month!

Buying an umbrella policy is flat-out the best value in the insurance business. It includes some of the broadest coverage at an incredibly low price. Buying an umbrella policy also satisfies two guiding principles from Book 3, Chapter 1: not risking more than you can afford to lose and not risking a lot for a little.

Affording an umbrella is easy. You don’t even have to increase your insurance bill — just shift dollars away from less important coverages. For example, you can save a few hundred dollars by raising the deductible on your car insurance and homeowners insurance by $500, or by dropping collision coverage on an older car. Use that savings to more than pay for an umbrella policy.

This chapter introduces you to the basics of umbrella policies, fills you in on how an umbrella meshes with your other insurance policies, and helps you determine how much coverage you need.

Discovering the Umbrella Policy’s Major Coverage Advantages

If you decide to buy an umbrella policy, you gain more than just higher coverage limits for injuries and property damage you cause — although the higher limits are a great advantage. You also receive

Additional coverage for defense costs when the defense coverage under your primary policies runs out
Coverage for many types of lawsuits not covered by your other policies (those famous coverage gaps everyone complains about)

Additional coverage to defend yourself

What actually happens when you’re sued for a dollar amount greater than your primary liability insurance limits? You receive, from your insurance company, a piece of mail — probably registered mail — that looks something like this:

We Care About You Mutual Insurance Company
Re: Your June 19, 2010 Accident
Dear Mr. Soon-To-Be-Very-Poor:
You are being sued by Mr. James Johnson, the injured party in the above-referenced accident, for $650,000. Your automobile liability insurance limit with us is only $250,000. We will pay your defense costs for the first $250,000 of this lawsuit. You will be responsible for your own defense costs beyond that amount.
We strongly suggest you hire your own attorney right now to protect you for that part of the lawsuit not covered by our policy.
Yours truly,
Grumpy Corporate Attorney
We Care About You Mutual Insurance Company

Why do they send you this letter? Because each of your primary insurance policies defends you only for lawsuit amounts up to your liability policy limit. If you’re sued for more than your liability limit, you’re personally responsible for the amount of any lawsuit that exceeds your primary liability limit, including the cost of defense for that difference. Those added defense costs often run $75,000 or more. One huge advantage of an umbrella policy is that it pays for those added defense costs.

Gap coverage

Let’s say Mike and several of his friends are all turning 50 at about the same time, so they decide it would be fun to have a jumbo group 50th birthday party. They rent a big barn at an empty local fairground and decide to make beer and wine available, at no charge, which adds a potential liability for alcohol-related car accidents.

The fairgrounds requires the friends to carry $1 million of liability insurance for the one-day event that also has to include the fairgrounds as an insured party. For Mike, a one-day, special-event policy would cost about $500. But if either of his friends had an umbrella policy, the friend might be covered automatically. Neither one does. Mike signs the contract because he has an umbrella policy that fully covers him for $2 million of liability for this type of rental contract. His umbrella is also broad enough to automatically protect the fairgrounds, as he is contractually agreed to do, and is broad enough to cover the risk of liability for alcohol-related car accidents.

To briefly explore the insurance issues involved in a little more detail, the exposures that Mike faces are as follows:

Liability for his own actions that cause injuries
Liability he assumes in the contract, agreeing to be responsible for the actions of everyone else at the event
Liability if any partygoer drinks too much and causes an auto accident, resulting in a lawsuit — a lawsuit that any provider of alcohol beverages at a social event may face
The costs to defend and protect the fairgrounds for any lawsuit brought against it
Liability for damage caused by anyone to the rented barn, such as a fire caused by a guest’s carelessly thrown-away cigarette

Many of these risks aren’t covered by any other policy, at least not for the amount required by the fairgrounds. Mike’s umbrella covers every single risk, automatically. His group saves the $500 cost of a one-day policy that may not have even covered all five risks just listed. He sends the fairgrounds proof of insurance, and everybody’s happy!

But one little problem remains: On the remote chance that a lawsuit exceeds Mike’s $2 million umbrella policy limit, by contract, Mike would be solely responsible for that excess amount. Therefore, each of his fellow birthday celebrants separately signs a legal agreement to share equally in all losses not covered by the umbrella. (And let’s finish the story by saying that the party is a great success.)

What’s the point? To illustrate a little-known, major advantage of a good umbrella policy. It not only provides a second layer of liability coverage on top of your other liability policies, but it also fills a lot of the gaps — the gaps between the policies.

A really good umbrella policy covers many of the lawsuits against you that aren’t covered by your auto, home, or other personal policies. In fact, the only real difference between a poor umbrella policy and a great one is how well it covers the cracks.

Coordinating an Umbrella with Your Other Insurance

The coverage under an umbrella policy can be triggered when you’re sued for more than your primary liability limits. It also can be triggered when you’re sued for something covered only by your umbrella and not by your primary policies (in other words, the gaps). When the latter happens, the umbrella “steps down” and defends and protects you as if it were primary coverage, subject only to a modest deductible, called a self-insured retention (SIR) — typically, $250 or $500.

In the fairgrounds story, four of the five risks that Mike assumed — the last four risks — were gaps and were covered only by the umbrella policy. If any of those four risks occurred, Mike would have paid only the $500 umbrella deductible, or SIR.

This section fills you in on how you might need to change your primary insurance to meet umbrella requirements and gives you tips for avoiding gaps between your primary and umbrella coverage.

One reason that umbrella policies are so inexpensive is that they generally don’t cover small lawsuits. An umbrella policy requires that your automobile, homeowners, and other personal policy liability limits (also known as primary liability limits) meet certain minimum requirements. Depending on the insurance company, the minimums vary from about $100,000 to $500,000. To get an umbrella policy, you must first raise your primary liability limits to these minimums and guarantee that you’ll always maintain them. If you violate this guarantee and fail to meet these minimum requirements, you’ll be personally liable for the difference between what you’ve guaranteed your coverages will be and what they actually are.

For example, say that the minimum auto liability coverage needed to obtain the umbrella that you have is $500,000, but you’ve allowed your coverage to slip to $250,000. If you’re found liable for $700,000 in damages, the umbrella policy still kicks in after the first $500,000 has been paid — $250,000 by your auto insurance company, and $250,000 by you. (You promised to maintain $500,000 of coverage. You broke that promise by carrying only $250,000. You owe out of your own pocket the $250,000 shortfall.)

Insurance companies offering umbrella policies are not consistent in the amount of primary liability coverage that they require. Talk to your agent to be sure that your primary coverage always meets your umbrella requirements.

Because an umbrella policy requires you to maintain specific primary liability insurance limits, you must be aware of very serious dangers:

Don’t let any primary policy cancel for nonpayment. If you do and you’re sued, you’ll have to pay the loss out of your own pocket, a loss that otherwise would have been covered.
Pay attention to all notices that come from your umbrella insurer. They often require you to raise one or more of your primary coverage limits as a condition of keeping the umbrella. If you don’t see or don’t read the notice and don’t raise your limits as required, you’ll be personally responsible for the gap.

Determining How Many Millions to Buy

Here’s a bottom-line recommendation: Buy $1 million more umbrella coverage than you think you need. If you think you don’t need an umbrella at all, buy a policy with $1 million of coverage; if $1 million sounds right, buy a $2 million policy; and so on.

Most people underestimate the economic value of a serious injury, as determined by a court of law. Also, an extra million of coverage costs very little — around $75 a year. When it comes to catastrophic lawsuits, you’re better off erring on the high side. No one ever went bankrupt over a $75 premium.

Reviewing available limits

Personal umbrella policies are sold in million-dollar increments. Most insurers offer a maximum available coverage limit from $2 million to $5 million — several go up to $10 million. Beyond $10 million, the choices are limited, and the cost per million escalates because those buying more than $10 million of umbrella coverage are generally quite wealthy and highly vulnerable to lawsuits.

Assessing how likely you are to be sued

In addition to the seriousness of an injury, several factors influence not only the likelihood of your being sued for more than the amount your policy covers you for but also the dollar amount of the lawsuit.

Your current financial status factor

The size of your current income and/or current assets, particularly liquid assets like investments, affects the probability of your being sued for an amount that’s greater than your automobile or homeowners liability limits. If you have a high income and/or a high net worth, congratulations! You’re very suable.

People who have only one of the two — a high income or a high net worth — often overlook how suable they really are. These are people like new doctors or lawyers in their first year of practice, making almost six figures, but with no money in the bank — yet — and seniors on a modest retirement income but with a large, mostly liquid, portfolio. Both types of people are highly suable and definitely should have an umbrella policy — probably with limits of $2 million or more.

Your future financial status factor

If you get a large judgment against you today, for more than your liability insurance limits, it sits out there in limbo waiting for your financial situation to improve. Most people easily overlook their future suability when they’re assessing their need for an umbrella policy. If you’re a medical student, a law student, a computer engineer — anyone training for a high-paying career — keep this in mind. If you think you may have a lot more money in the future than you have today, you need an umbrella policy to cover your liability risks.

The exceptional risk factor

Lawsuits can occur from either activities (such as hunting, fishing, or playing sports) or exposures (such as cars, homes, boats, and animals). The exceptional risk factor recognizes that one or more of the activities or exposures in your life has a greater potential of causing serious injuries or death and, thus, more substantial lawsuits. Examples include owning a pit bull, operating a day-care center, having a swimming pool (especially one with a diving board), and having a trampoline in your yard.

If you have these or other exceptional risks in your life that have large lawsuit potential, you’re a candidate for an umbrella, even if you’re only of modest means.

The legal environment factor

The legal climate in your geographic area is definitely a factor in the size of legal judgments and jury awards. In California, where there are a zillion lawsuits for substantial amounts of money, you need a larger umbrella policy limit. In rural Arkansas, where the pace is slow, people don’t lock their doors, and lawsuits are rare, you may still need an umbrella, but the legal environment is probably not a factor in how large it needs to be.

Your personal comfort factor

Insurance is all about peace of mind. When you decide on an umbrella policy limit, do a gut check. If you still feel fearful of possibly not having enough insurance, spend an extra $75 and buy another $1 million of coverage.

Maybe you’re a typical middle-class American. Your income, assets, and other factors suggest that a $1 million umbrella policy is about right — but your gut disagrees. You’d feel a lot better getting $2 million of coverage, especially when the extra million costs you only $5 a month.

Your moral responsibility factor

Some people live by that golden rule about caring for your fellow men and women. They’re often of modest means and not necessarily very suable. They may not really need an umbrella. Their agent may suggest a liability limit on their automobile, homeowners, and other policies — say, $300,000 — and they’ll say, “Oh, no, I want more than that. If I seriously hurt someone, I want to make sure he’s fully cared for — that I can provide for him by paying all his medical bills, all his lost wages, and pay him something extra for all the pain and suffering I put him through. I can’t undo the hurt I’ve caused in his life. But at least I can help take care of his financial burden.” Such people are rare and wonderful.

Setting your limits: Recommendations

So you’ve thought long and hard about your own lifestyle, considered all the factors that go into deciding to buy an umbrella policy, and now you just want a dollar figure. Here are recommendations for umbrella policies:

Buy a personal umbrella policy of at least $1 million.
Buy at least $2 million in coverage if you have some affluence.
Buy at least $5 to $10 million in coverage, or more, if you’re very affluent.
Buy $1 million more than you think you need.
Buy a policy that covers the major liability gaps in your primary insurance program.