It was a blue-sky Colorado day as my clients were driving to the airport after a week of snow skiing when they hit a patch of ice, causing their car to veer into the oncoming lane. Fortunately, my clients and their children had buckled their seatbelts…unfortunately, the two ladies in the oncoming vehicle had not. Both hit the windshield and suffered significant facial lacerations that required surgery. They sued my client and won a high six-figure judgment. Six months earlier, as part of our annual financial review, we recommended that our client purchase a $1 million personal umbrella liability policy. As a result, the legal claim was paid by their insurance company. Had that not been the case, our clients could have lost everything.
So when I’m asked, “Should I purchase an umbrella liability policy?” I almost always respond with a definite “Yes!” The answer to that question almost always leads to the following question, “How much coverage do I need?”
A long-time friend was trying to decide whether to increase his umbrella liability coverage, and his thought process went something like this:
“I have a $3 million net worth with $1 million in an IRA and the balance in personal investments and my home. Since the IRA is protected under federal law, I thought I’d increase my umbrella policy from $1 million to $2 million to cover my ‘exposed’ net worth.”
There was a flaw in his thinking. First, IRAs are protected from the claims of creditors under most circumstances. But let’s assume my friend got a judgment against him for $4 million. The insurance company would cover $2 million of the claim, and he’d be personally responsible for the remaining $2 million. So the correct answer is not as simple as matching the policy limits to your net worth.
How much is enough?
In deciding how much coverage you should purchase, consider these factors:
- In most of these cases, attorneys typically settle the case rather than trying the case before a judge or jury. In personal lawsuits, most plaintiff attorneys prefer to settle for insurance proceeds rather than bankrupting families and putting them out of their homes. So owning a decent amount of insurance can be a significant incentive to arriving at a settlement without going to court where anything might happen in front of a jury.
- When considering personal umbrella liability coverage, think about your individual situation. Are you a natural ‘target’ for lawsuits? For example, doctors, dentists, and business owners sometimes feel like they are walking around with a bulls-eye on their back. Everyone thinks they have wealth and are therefore quick to sue them. If your wealth is conspicuous such as expensive homes and cars, you may be a bigger target.
- Consider your lifestyle. If you’re one of those who still think you have the skillset to text and drive, or if you think you can have a couple of cocktails at a party and still drive home, you’ll be more likely to be in a case that includes a considerable judgment. People with swimming pools or other recreational property are also more at risk.
- If you have young drivers in your household, you are at greater risk. Studies suggest that two-thirds of drivers between ages nineteen and twenty-nine text and drive, while over eighty percent use their cell phones while driving.
How much does it cost?
The good news is that a personal umbrella liability policy may be one of the best insurance bargains. A $1 million policy typically costs between $150 and $350 per year. A $5 million policy will typically cost between $500 and $1,000 per year. The bad news is you may be required to raise the basic liability limits on your homeowners and auto insurance policy. The umbrella policy typically has a $300,000 or $500,000 deductible, meaning that you must raise your basic coverage to ‘match up’ the two policies so that there is no gap in coverage.
The bottom line?
If you have accumulated assets, you should consider the purchase of an umbrella liability policy. Meet with your financial advisor or property & casualty insurance representative to get their recommendation for the appropriate coverage based on your individual facts.
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Stewart H. Welch, III, CFP®, AEP, is the founder of THE WELCH GROUP, LLC, which specializes in providing fee-only investment management and financial advice to families throughout the United States. He is the author or co-author of six books, including 50 Rules of Success; J.K. Lasser’s New Rules for Estate, Retirement and Tax Planning- 6th Edition (John Wiley & Sons, Inc.); THINK Like a Self-Made Millionaire; and 100 Tips for Creating a Champagne Retirement on a Shoestring Budget. For more information, visit The Welch Group. Consult your financial advisor before acting on comments in this article.
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