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ON FEB. 27, 1992, Stella Liebeck ordered a cup of coffee from a McDonald’s drive-through. Moments later, as she attempted to open the lid, the cup spilled, causing a burn that sent her to the hospital. Her injury was serious but self-inflicted and not life-threatening. Nonetheless, she sued McDonald’s, and a jury awarded her almost $3 million. That award was reduced upon appeal, but this case is often cited as an example of an out-of-control legal system exploited by personal injury lawyers.
Drive down many highways in America, in fact, and you’ll see their billboards lining the road. “Injured? Car Crash? Call Now!” These billboards may seem laughable. But if you have a high net worth, personal injury lawsuits are a real risk—and one you should protect against. That’s where umbrella liability insurance comes in.
So named because it provides coverage on top of your existing home or auto policy, umbrella insurance picks up where those other policies leave off, extending liability coverage to $1 million or more. If someone’s injured in a car accident or in your home, and a lawsuit results, umbrella insurance will cover you. Umbrella policies also cover more unusual types of claims, including accusations of libel and slander. Another key benefit: Since the insurance company would be on the hook for any verdict, it’ll pay to defend you. For all these reasons, if you don’t already have umbrella insurance, I highly recommend it.
How much coverage should you have? There’s no single right number, but below are some guidelines:
Cost of coverage. The first thing to know is that multimillion-dollar verdicts, while highly publicized, are relatively rare. Insurance companies pay few claims the size of Ms. Liebeck’s. As a result, this type of insurance is not expensive. While every individual’s risk profile is different, in general, a $1 million policy might cost between $200 and $400 a year. Because claims are less likely at higher levels, additional coverage is even more cost efficient. A $2 million policy, for example, doesn’t cost twice as much as a $1 million policy.
Recommended coverage. Because price generally isn’t an obstacle, I advocate erring on the side of buying more coverage rather than less. For most people, I suggest a policy in the $1 million to $5 million range, with $10 million as the absolute maximum you might consider. Below are further guidelines to help narrow this range.
Net worth considerations. In deciding on coverage level, net worth seems like a logical starting point. If you have $5 million in assets, for example, you might assume you need $5 million in coverage. That seems logical, but I’d approach it differently. Instead, consider the risk you’re trying to insure against. Specifically, if there’s a claim, how large might it be? Because 90%-plus of cases are settled out of court—often confidentially—reliable statistics are hard to come by. But in one roundup of big verdicts and settlements, the vast majority fell between $1 million and $5 million. That’s why I recommend coverage in that range, even if your net worth is higher or lower than that.
That said, your net worth is relevant in two respects. The first is how wealthy you appear. In the world of personal injury law, most lawyers work on a contingency fee basis, meaning they don’t get paid unless they win—and collect. For that reason, they don’t take every case. They’re much more interested in cases where the prospective defendant appears well-to-do. If you’re a doctor or a business owner, or you have a generally high profile, you’ll want to err on the side of having more coverage.
By the same token, if your financial situation appears modest, then perhaps you could go without umbrella coverage. I don’t think it’s advisable because, regardless of wealth level, you still have the same risk of being involved in an accident as anyone else. But your risk of being sued is probably lower.
Net worth is relevant in one other respect. A fundamental principle of insurance is that you should only pay to insure against losses you couldn’t afford on your own. If you have sufficient assets and feel you could afford even a multimillion-dollar claim, then maybe you can forgo coverage. Bill Gates, for example, might not carry umbrella insurance. But that’s an extreme.
Bottom line: Unless your net worth is all the way at one end or the other of the spectrum, I wouldn’t take any chances and would secure umbrella coverage in that $1 million to $5 million range.
Risk factors. In deciding on coverage, what other factors should you consider? Read through an insurance application, and you’ll find some clues. My own application included these questions:
Additional risk factors include:
Most of the above probably isn’t surprising. But some questions on an umbrella application might surprise you. For example:
In short, the application itself could help guide your coverage decision.
Exclusions. In choosing a policy, the coverage level is key, but it isn’t the only thing. Also be sure to read the exclusions. Check there aren’t any mismatches between the particulars of your life and the fine print of the policy.
A final note: If you’re a business owner, you can—and should—secure umbrella coverage for your business as well.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, he advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman and check out his earlier articles.
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Buying an umbrella policy also provides additional legal expense coverage. If you’re sued for $500,000 and only have a $100,000 auto insurance liability policy, the company may not be interested in spending extra money to defend you when they can write a check for $100,000 and be done.
Adam – Parents of teen & young drivers have a particular incentive to consider umbrella insurance due to the higher accident rates for young drivers. Auto liability insurance is typically capped in the $250K range per individual injury. Yet, disabling injury awards are often in the $1-2 million range and can be higher.
Great article, but what if I don’t have home, renters, or auto insurance? Can I still buy an umbrella policy? And if so, do you recommend any way to find an insurance company to buy this policy from, since I can’t just piggyback onto an existing policy?
A handful of major insurers will still sell you Liability Umbrella coverage If your underlying home and/or auto are not insured by them, but usually at a significantly higher face-value premium (a 50-100% higher annual cost is common).
This is because the umbrella coverage is designed (for the most part) as “excess liability”, so the coverage only triggers once your underlying auto or home insurance liability limits are first exhausted in a civil lawsuit. If you do not own an auto but have significant assets you still wish to protect, the purchase of a “named non-owner” auto policy will usually meet the requirement for an underlying “auto” policy for a modest annual premium.
Likewise, assuming you have some personal possessions and either rent or reside with someone else, the purchase of a small “renters insurance” policy will meet most companies requirement that you have “home” insurance with them in order to purchase an umbrella. The cost of these 3 policies combined is usually more favorable that simply buying an umbrella (with the large premium surcharge) as a byproduct of your not having underlying auto or home insurance with that same insurer.
I would also limit my purchase to only those insurers rated as financially strong by A.M. Best – typically, a rating of A- (or better) for financial strength on Best’s rating scale.
With our insurer, we had to have auto and home insurance with them to buy an umbrella policy. In the event of an accident or another claim involving our home or cars, they seem to first exhaust whatever applicable coverage you have in those policies before the umbrella coverage kicks in.
Very helpful article, Adam.
Good article and guidelines. I have read that certain states may exempt IRA’s, etc., from lawsuits. Also sometimes cited is the 2005 Supreme Court opinion in Rousey v. Jacoway that exempted an IRA from a lawsuit, or exempted that portion of an IRA needed to live on — that was a bankruptcy case. My understanding of these matters is vague enough that it doesn’t affect my planning but I may look into it further someday.
You can read more here:
https://humbledollar.com/money-guide/retirement-accounts-2/