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What is umbrella insurance? Why do you need it?

Umbrella insurance is for millionaires, right? Wrong.
Umbrella insurance is for millionaires, right? Wrong.
Photo by Patrick Smith/Getty Images

We all know that if you drive a car, you are required to carry liability insurance. The government mandates this for all drivers in order to pay for injuries or damages that you might cause to others while behind the wheel.

Likewise, if you own a home, you probably carry homeowners insurance. In addition to protecting your house and personal assets, homeowners insurance also provides liability coverage which protects you if you are found responsible for an injury to someone else or damage to their property. This coverage typically protects you for incidents both inside and outside your home.

Most people assume that they are fully protected by simply carrying an auto policy and a homeowners or renters policy.

But what happens if you find yourself in the midst of a lawsuit that runs into the hundreds of thousands or, gasp, millions of dollars?

Enter umbrella insurance.

Umbrella insurance (or excess liability insurance) provides coverage above and beyond what your other policies provide. It serves as an added layer of protection to insulate you from lawsuits of all kinds.

Why umbrella insurance is important

Many people carry the false belief that only a wealthy individual needs umbrella coverage. Often the thinking goes, “I don’t have enough money for a lawyer to go after me, so there’s no need to be worried.”

Unfortunately, that myth could cost you dearly. Here’s why:

If you are found liable for damages that exceed the liability coverage under your auto or homeowners policy, your personal assets are very much at risk.

A judge can seek to pay the award from your bank accounts, investments, and possibly even the equity in your home. The latter could require you to sell your home and use the funds to satisfy the judgment.

Even worse, a judge can garnish your wages in order to pay for the damages. This means your future earnings could be redirected towards the injured party.

And with medical costs continuing to skyrocket, it is certainly not out of the question for a bad accident to result in a settlement or award that would greatly exceed the coverage on your standard auto or homeowners policies.

So even non-millionaires could be put in a world of hurt without additional coverage.

That’s where umbrella insurance comes in.

Say, for sake of argument, you have $500,000 of liability coverage on your auto policy. In that case, umbrella coverage would kick in if you were found liable for damages above that amount. For example, if you caused a serious accident in which several people were badly injured, an award could easily exceed $1 million.

Typically, umbrella policies start with coverage of $1 million and go up to $10 million (usually in $1 million increments).

Some insurers add this amount to your existing coverage. So in the previous example, the insured would have total coverage of $1.5 million ($500,000 from their auto policy plus $1 million from their umbrella coverage).

Other insurance companies provide umbrella coverage on a total liability basis. Thus, a $1 million umbrella policy would provide total coverage of up to $1 million ($500,000 from the auto policy and another $500,000 from the umbrella coverage).

For most people, a $1 million or $2 million policy is more than enough. However, if you are a high net worth individual or a high income earner, you may want to consider more coverage. As always, talk to your financial planner or insurance professional before making any decisions.

So what does a $1 million umbrella policy cost? Are you ready?

About $200 a year. That’s less than $17 a month.

Liability coverage, whether through an auto, homeowners, renters, or umbrella policy is typically very inexpensive. Thus, in order to protect yourself and your family, it can be a very wise decision to seek the greatest protection you can (within reason of course).

Even if you never need it, an umbrella policy might help you sleep better at night for about $0.50 a night.

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