Do you have enough liability insurance? If there were a vehicle accident for which you were at fault, and a family breadwinner were disabled or killed, would your auto liability policy offer enough coverage to pay for a lifetime of lost wages due to such an event?
Keep in mind, the legal system holds you accountable for injuries you cause to others. This may include garnishing your wages and seizing any assets you have in order to pay off a legal judgment.
We'd all like to believe that such events will not have any financial impact on our lives, but if you are a medium- to high-income earner or own a home, it can be financially devastating.
Consider what would happen if there were a settlement (or judgment, if it went to court) of $2.5 million as a result of an auto accident for which you were found liable.
Let's say you have insurance with a limit of $500,000 per accident. What would happen?
The auto insurer would pay its $500,000. Then virtually everything you own would be fair game for seizure to pay off the additional $2 million. Furthermore, your earnings could be garnished for years to come.
Umbrella insurance offers additional protection
With stakes this high and considering the relatively modest cost of additional liability coverage, it just makes sense for many people to purchase the added protection of an umbrella policy.
An umbrella policy provides additional coverage once the liability limits on your homeowner's or auto insurance policy are exhausted. Umbrella policies are typically sold with limits of $1 million to $10 million.
In the example above, if you had a $3 million umbrella policy, the auto insurer would pay the auto policy limit of $500,000, and your umbrella insurance would pay the other $2 million of the $2.5 million settlement or award. Your assets would not be at risk.
One myth about an umbrella policy is that only the wealthy need it. These days, the cumulative value of homes, vacation homes, rental property, cars, boats, savings, investments and so on, owned by many people who don't consider themselves wealthy, make them vulnerable to liability beyond their auto or homeowner's insurance limits.
A good question to ask yourself is whether you have assets that you don't want to put at risk in the event of a catastrophic liability.
An umbrella policy is not limited to covering liability incidents that occur in your car. Do you have a swimming pool, trampoline, swing set or other recreational equipment? Any of them too can lead to accidents and injuries.
If someone drowned in your pool and you had $500,000 of liability under your homeowner's policy, the chances are that the surviving family members would not settle for such a small amount. Your umbrella would pick up coverage after that.
Most umbrella policies can also save the day if you accidentally posted something on your social media that results in a legal action. This is because most of these policies include a "Personal Injury" clause, which covers things like libel and slander.
How much umbrella insurance do you need?
People often figure that the amount of umbrella coverage they need should be the value of their assets, but this might not be adequate.
If, for example, you have assets of $2 million and buy $2 million worth of coverage, what happens if you're found liable for a $4 million judgment?
Insurance would pay the first $2 million, plus the limit of the underlying homeowner's or auto policy, but you could lose a significant amount of your assets because of the shortfall in coverage.
The cost of an umbrella policy is relatively inexpensive. The rate will depend on how many cars you have, if you own rental properties and whether you have younger drivers under the age of 21, which will slightly increase the rate.
In most cases, you can get a $2 million umbrella policy for about a dollar a day if you have the basics, such as two cars and a home.
However, even though these policies are inexpensive, securing an umbrella to protect you should never be done based on cost. It should be based on what is the best amount of coverage to help prevent any loss of assets. The key is to preserve your quality of life.