Grab an Umbrella

Adam M. Grossman

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:

  • Do you operate any aircraft?
  • Do you own any watercraft? Are they used in racing activities?
  • Do you conduct business or farming operations at any property you own?

Additional risk factors include:

  • Teenage drivers
  • A pool, trampoline or zip line
  • A boat, ATV, RV or snowmobile
  • Dogs
  • Renting your home through Airbnb

Most of the above probably isn’t surprising. But some questions on an umbrella application might surprise you. For example:

  • Do you serve on any nonprofit boards?
  • Do you coach any children’s athletic teams?

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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