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What does umbrella insurance cover, exactly? Do you really need it? And, if so, how much?

penguin holding umbrellaI recently reviewed our umbrella insurance policy. I’ve carried it for years, but without really digging into the details of the coverage. It was recommended to me long ago, and appeared to be relatively cheap, so I added it to our auto policy at USAA and figured “OK, we’re covered.”

But the reality may not be that simple.

Umbrella insurance can cover a host of personal liabilities, in addition to bodily injury or property damage from an auto accident where you’re at fault. But it might not. And umbrella insurance can protect your net worth from a tragic mistake on your part, or looting by unscrupulous personal injury lawyers. But it might not.

To get at the truth and try to understand umbrella insurance better, I spent several hours scouring the web and talking to insurance companies. In the end I got a somewhat better understanding of the umbrella insurance product, which I’ll share below. But I was left with plenty of questions too.

Given the minimal data publicly available on umbrella policies (the insurance companies are holding all the cards), this article may raise more questions than it answers. But maybe readers can address some of those lingering issues in the comments below….

What is Umbrella Insurance?

Umbrella insurance policies typically function as extensions to the liability coverage of existing auto and homeowner’s/renter’s policies. In addition to increasing the liability limits of those policies, umbrella typically adds additional liability coverages or does away with exclusions in the underlying policies.

Wikipedia describes it this way: “…an umbrella policy may cover certain risks from the first dollar of loss or liability incurred, which were never covered under the primary policies. For those risks that are left uncovered by primary policies but are covered under the umbrella policy, the latter is said to “drop down” to cover them as primary insurance and fill in the gaps in the underlying policies.”

But note that the details are specific to your policy. If a certain liability coverage is important to you, check that it’s present in your umbrella policy. Don’t assume. There is substantial variation in policies.

Also note that umbrella liability coverage is typically added to existing liability coverage. Thus, if you have a $1 million umbrella policy coupled to $1 million of liability coverage in your auto policy, you would end up with $2 million of overall coverage.

Why Would You Need It?

According to Wikipedia, “Most personal umbrella losses are related to auto accidents, with a 2013 analysis finding that 78% of claims and 87% of losses related to autos.”

However that leaves 22% of claims to other causes, and there are a lot of them, too many to rule out for most of us. Here is just a partial list of liability-inducing activities, based on my research:

  • renting or borrowing property: real estate/vehicles/boats/snowmobiles/aircraft
  • doing home renovation
  • having pools/hot tubs/ponds/trampolines or other “attractive nuisances”
  • landlording and having tenants
  • owning vacant land
  • employing domestic help
  • being responsible for a fuel leak
  • receiving home office clients or service personnel
  • engaging in partnerships
  • participating in sports that could injure others like skiing, surfing, hunting, or racing
  • coaching youth sports
  • volunteering
  • serving on boards of directors, especially nonprofits
  • involvement with condo associations
  • any involvement with an organization that does not carry Directors and Officers (D&O) insurance
  • posting reviews of products and businesses
  • engaging with strong opinions on social media
  • having public prominence or a public profile of success and wealth
  • entertaining, especially larger parties
  • owning ATVs or boats
  • owning certain breeds of dogs
  • driving a luxury car

That’s an overwhelming and potentially depressing list! Most of us would be hard pressed to live our lives the way we want, while avoiding all of those activities. But then there is the question of probability….

How Likely Are You to Need It?

At a high level, umbrella insurance makes sense to me. It covers the classic scenario where insurance is warranted: The loss is low probability, but not impossible, and it is too expensive to self-insure. (By definition, you can’t self-insure against getting wiped out financially, against your total net worth disappearing.)

So, we’ve seen a lengthy list of plausible reasons why you might have liability exposure that could be reduced with umbrella coverage. Most of us have heard or read stories about people getting sued for what appears at first to be harmless behavior related to these very activities.

But, what are the odds? How often is umbrella insurance actually used? And for how much?

According to the Insurance Information Institute, in 2017, claim frequency for bodily injury was 1.1 per 100 car years (365 days of insured coverage for one vehicle). The average claim severity was $15,270.

But averages aren’t particularly useful when evaluating umbrella insurance. We’re interested in worst-case scenarios. $15K is not exactly scary. But knowing that you’ve got about a 1% chance of being involved in a settlement for bodily injury each year, is a warning, if nothing else.

Unfortunately, the numbers we need are not readily available. In my unscientific review consisting of a couple hours of web searching, and scanning several long Boglehead threads on the topic, I saw a lot of vague speculation, and a number of scary anecdotes, but NO hard statistics backed up with references.

Unsurprisingly, insurance companies have no great motivation to disclose their profit margins on umbrella policies.

Yes, it’s easy to find examples online of “actual umbrella claims.” There are plenty of horror stories of seemingly minor mistakes by well-meaning individuals leading to multi-million dollar settlements. But, without a statistical background, this is nothing but scare tactics. You can pick up a newspaper any day of the week and read all the bad news you want, but that gives you very little reliable information on the odds of it happening to you.

Some time ago I asked an insurance company representative with several years’ experience about umbrella settlements: she had yet to be involved in a single one at her company.

For now, we’ll have to be content with the understanding that, while individual odds are probably low, there is a long list of seemingly innocuous activities that you could be sued for….

How Much Do You Need?

There is a lot of sloppy thinking around the issue of how much umbrella insurance you should purchase. And, unfortunately, lacking good data, I’m at risk of perpetuating the problem here.

Most unsophisticated discussions of umbrella insurance limits point to your net worth as the key factor. Every time I’ve asked an insurance agent about recommended limits, I’ve gotten that answer. Or, “talk to your financial advisor.”

Once source I came across stated that umbrella insurance only makes sense if you have assets to protect.

Wrong! Unfortunately, in today’s complex world, your exposure to liability is in no way limited to your net worth. A more sophisticated analysis focuses on risk and future earning potential. If you plow into a bus, causing multiple bodily injuries, the settlement could be many, many millions. Not only could your net worth be wiped out, but, if you’re still in your earning years, your future earnings could be attached. (Several sources on the web state that up to 25% of your income could be garnished in a liability settlement.)

I don’t believe in insuring against every contingency. You can worry yourself sick and still not cover all the possibilities. But still, you should understand that your damages in a liability suit are not limited to your net worth! Your net worth might be $2 million and you might have that much in umbrella coverage. But this doesn’t prevent somebody from suing you for $4 million.

Other questions to ask when considering policy limits, relate to the insurance company’s defense of any claims against you. Are those legal costs charged against your policy limits? Also, will the company’s lawyers defend you until the case is closed, even if your limits are exceeded?

Settlements

So where does that leave us?

The sole statistic I could find on liability settlements was this one from Jury Verdict Research: “13 percent of personal injury liability awards and settlements hit the million dollar mark or higher. ” And that could be an understatement, because it’s not clear whether this includes cases settled out of court.

Without good data on the probabilities for liability lawsuits, or their average settlements, we are guessing in the dark about reasonable policy limits. Yes there are plenty of stories online about huge settlements in the tens of millions of dollars, but there is precious little data that I could find to indicate the likelihood of such settlements.

In the end, we are forced to conclude that a huge settlement against us is a statistical possibility. And, as long as it’s relatively cheap, purchasing as much umbrella insurance as we can afford, might be a reasonable course of action.

Protected Assets

Fortunately there are several points of good news when considering liability suits against you. The government has stepped forward to protect a few of your most critical assets: retirement accounts, your home, and Social Security.

According to Fidelity, assets held in employer-sponsored retirement accounts are generally protected from civil liability under the provisions of the Employee Retirement Income Security Act of 1974 (ERISA). And those same protections also generally apply to up to $1 million worth of your assets held in IRAs.

It’s also likely that your primary residence, or at least portion of that equity, is protected by state laws. To know how much for certain, you’ll have to research “homestead exemptions” — laws intended to prevent forced home sales to meet creditor demands — in your state.

As for Social Security, the situation in unclear. That income stream is protected from many kinds of private debt, but can be garnished for taxes and “victim restitution,” among other debts.

Overall, the good news is that you may not need to factor in the potential loss of all these assets when determining how much umbrella insurance you should carry.

Buying Umbrella Insurance

Despite the murkiness around settlements and probabilities, another aspect of umbrella insurance is encouraging: it tends to be relatively cheap. If you don’t have prior accidents or lawsuits, you can probably get $1 million in coverage for just a few hundred dollars a year.

Finding the insurance may be very simple, if your existing auto carrier offers it. If not, your life will be harder. Many major insurance companies (Esurance, Geico, and Progressive, for example) will only sell umbrella policies to existing auto insurance customers. If your company doesn’t offer it, you may have to switch your auto coverage elsewhere.

And, unlike many insurance products, umbrella insurance is not widely available from consumer-friendly websites. You can’t go comparison shopping on the web, the way you can for health insurance. Many of the umbrella products and associated web sites that I found in my research are intended for use by professional insurance agents, not consumers.

Standalone Policies

If you strike out on obtaining umbrella insurance from your auto insurance carrier, and don’t want to change companies, you can attempt to find and purchase a “standalone umbrella policy” from a separate company.

There is relatively little information available online about these kinds of policies, and you may have to talk to an agent if you are serious about purchasing one.

The best source I found was this article comparing standalone policies. It’s by the author of Insurance for Dummies but is dated 2011.

In the article he mentions four companies that offer standalone umbrella insurance: Auto-Owners, RLI, USLI, AAIC.

Of these, only RLI appears to currently operate a consumer-facing website where you can get a quote. For the other companies, you’ll need to track down an agent who represents them.

The RLI site is reasonably friendly and it takes only a few minutes to answer the key rating questions and get a quote for $1 million in personal umbrella policy coverage. It takes a little longer to complete and submit the full application. The qualification requirements are succinctly summarized here.

Remember, with these policies in particular, and with all umbrella policies in general, the detailed coverages are not a given. If a liability is not specifically excluded, you may be covered. But, if you engage in many of the liability-likely activities listed earlier, read the fine print to know for sure.

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[The founder of CanIRetireYet.com, Darrow Kirkpatrick relied on a modest lifestyle, high savings rate, and simple passive index investing to retire at age 50 from a career as a civil and software engineer. He has been quoted or published in The Wall Street Journal, MarketWatch, Kiplinger, The Huffington Post, Consumer Reports, and Money Magazine among others. His books include Retiring Sooner: How to Accelerate Your Financial Independence and Can I Retire Yet? How to Make the Biggest Financial Decision of the Rest of Your Life.]

 

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