We've talked about all the different types of auto insurance. I'd like to now talk about whether you should get an umbrella policy. An umbrella policy is also known as a personal liability insurance (PLU). This article will specifically describe how does an umbrella policy work and how much does it cost.
When you've spent a lifetime building assets for your retirement, the last thing you want is to get sued for all you're worth! Accidents happen all the time and the more you are worth, the more the injured person may go after your assets.
How An Umbrella Policy Works
Let me share an example of how an umbrella policy can protect the policy holder.
If someone in a $230,000 Porsche 911 Turbo runs you over after running a red light, you're probably more inclined to hire a lawyer and sue for big bucks.
However, if someone in a 1985 Honda Civic runs you over, you may think getting financial remedy is not worth it. If you are the person with the Porsche, you probably want to get an umbrella policy.
Auto insurance policies only cover so much. My auto insurance policy has a maximum $500,000 liability per accident. I could get more liability, but the increase in premiums would make my insurance less worthwhile. Because I have assets well over $500,000, I elected to get an umbrella policy to cover the rest of my estimated net worth.
However, you don't need to get an umbrella policy to cover your entire net worth if you do not wish.
The chances of me getting sued for over $500,000 are slim because: 1) I've got to be found negligent in the accident, 2) I've got to create massive damage in the accident, 3) The victim needs to go through the process of suing, 4) The victim needs to win, 5) Cases are usually settled out of court for less, 6) I drive half the national average, 7) I'm a pretty careful driver with a slow car, and 8) I'm a nice guy!
Unfortunately, even nice guys get unlucky sometimes.
If I do get sued for say $1 million, I'm protected because my auto insurance coverage will kick in to pay the umbrella policy deductible, and then my umbrella policy covers me for the rest. The only out of pocket expense I incur will be my auto insurance deductible of $1,000.
Why Get An Umbrella Policy
Here are some reasons and examples for why you should consider getting an umbrella policy.
1) You drive a fast car and have a net worth of $1 million dollars.
You enjoy hitting the bars and clubs every weekend in your $75,000 BMW M3. Your hobbies include snowboarding, rock climbing, sky diving, and poker. Given you go out on the weekends, you also tend to have at least one drink before getting behind a wheel. At the age of 36, you just don't want to settle down and have amassed a nice nut.
Assessment: You are higher risk than average. Get an umbrella policy with liability coverage of at least $1 million if not $2 million given you're in the growth phase of your career. Also get comprehensive auto insurance that covers the damage of your car and liability of around $500,000 per accident.
2) You drive a $12,000 SUV, have a 12 year old son, are a homeowner, and worth $3 million dollars.
You never go out to party on the weekends anymore (partly thanks to the pandemic). Your idea of a good time is snuggling up with your husband to watch Revenge on DVD. In six years, your son plans to go off to college at a cost of $50,000 a year for 4 years. You also have a homeowners insurance policy with $500,000 in liability coverage and a $5,000 deductible.
Assessment: You are an average risk person. Get an umbrella policy with liability coverage between $2 million to $3 million. Weight the value of peace of mind vs. the increase in monthly premiums for higher coverage.
Make a decision what the likelihood is that you will be sued for your entire net worth. $3 million is a nice figure that lots of people would love to lay their hands on. Your SUV is probably not worth getting comprehensive auto insurance, so just got with liability. If it gets destroyed, it sounds like you can easily buy a new one.
Given the huge increase in real estate values since the pandemic began, your homeowner's insurance policy likely needs to be increased. My favorite way to find an affordable homeowner's insurance policy is with PolicyGenius. You can get great real quotes in minutes, all in one place.
3) You drive a $8,000 Honda Accord, are the only working spouse, have three children, are a homeowner, and worth $800,000.
You spend all your time at the office and then at home with the kids. Seldom do you ever go out. You've sworn off alcohol ever since you drove your car straight into a tree six years ago. You are working like a mad man to provide for your family and wonder whether tuition costs will continue to spiral out of control. Every time you think of the fact that three people are depending on you, you start to get a panic attack.
Assessment: You are an average risk person who definitely needs an umbrella policy. You do everything a normal person would do as determined by the insurance actuaries, but you've got three dependents. If something happens to you, or you cause an accident, a lot of people will be negatively impacted.
Not only get a $1 million umbrella policy get another $1-2 million in term life insurance policy that will go towards your kids if you die. A comprehensive auto policy is probably a waste of money, but it depends on your liquid assets and how safe of a driver you are now.
4) You have two teenagers and a net worth of over $1,000,000.
Try as you may, you feel you can no longer control your children. They aren't very good students, aren't going to win any athletic scholarships, hang out with the wrong crowd, and have a lot of angst. Because you don't want to be the uncool mom, you allow your teenagers to drive.
Assessment: Your teenagers put you at huge risk because you are responsible for all their actions before the age of 18. Everyday you pray they come home safe. Absolutely get a $1 million umbrella policy! Your teenagers could bankrupt you in a heartbeat!
5) You are a landlord and/or business owner with a $500,000 net worth.
When you have customers, you invariably open yourself up to more risk. I feel sorry for doctors who are trying to save lives but constantly operate under the assumption they will get sued by their patients.
As a landlord, no matter how hard you screen your tenants or assess the safety of your unit, something bad may happen. Same thing goes from running any business.
Assessment: You absolutely should get an umbrella policy worth $1 million or greater for potential garnished wages. Landlords should have landlord insurance and business owners have various business insurance options. The world is a very litigious place. Live the American dream but protect yourself.
Example Where You Don't Need An Umbrella Policy
Of course, not everybody needs or wants an umbrella policy.
Let's say you drive a $27,000 Jeep, earn $65,000 a year, are married with a non-working spouse, have no children, do not own a house, have $8,000 in credit card debt, and are worth a combined total of $60,000.
At the age of 27, your vehicle is a blight on your finances because of the cost. All that money spent paying the monthly payments could go towards a downpayment on a house, or investments in the stock market. You still feel young and invincible with an attitude that you can work forever!
Assessment: You are a risk taker because you're putting your life in harm's way with poor financial habits. As a result, you will likely never amass a net worth even close to $1 million. This is great because you therefore don't need an umbrella policy. Your expensive comprehensive auto insurance policy which acts as a lead balloon on your net worth will do.
Don't Get Too Big Of An Umbrella Policy Either
How much insurance you have can be estimated via public records. If you are deemed at fault in an accident, by the time a lawyer calls you they will make a guesstimate as to how much insurance coverage you have.
If you have a net worth of $1 million, but have an umbrella policy of $5 million, guess what? The lawyer is probably going to be more motivated than if you had a smaller policy. After all, it costs the same to sue someone for $1 million or $5 million.
The irony is, if you had no umbrella policy and only an auto insurance liability coverage of $300,000, the lawyer may not want to pursue, or will go for a maximum of $300,000, even if you have millions of dollars in net worth. This now becomes a game of how good you are at hiding your assets!
Insurance companies also don't want you to have more umbrella policy than you need due to their liability reasons obviously. You pay the monthly or yearly premiums, but they pay the full amount.
The good thing to note is that the higher your umbrella policy, the more inclined your insurance company will be to fight for your rights!
Umbrella Policy Insurance Amounts Depends On Your Situation
You can certainly go without an umbrella policy, but I wouldn't recommend it if you have a net worth beyond your auto or homeowners liability coverage.
My auto insurance liability covers $500,000 per accident. Sounds like a lot. However, what if I cause a 10 car pileup on the freeway? Suddenly, $500,000 doesn't seem like that much anymore.
You've got to check the latest insurance rates and make an informed decision. According to the Insurance Information Institute, a $1 million umbrella policy typically costs between $150 to $300 a year.
Each incremental $1 million dollars of personal liability insurance costs on less and les. Here is what it will cost me for various levels of umbrella policy with my insurance company. Here is what an umbrella policy will cost me after checking with AllState, a trusted insurance provider.
Average Cost Of An Umbrella Policy In 2021
An umbrella policy's cost depends on your personal situation as highlighted above. Umbrella policy rates will be different for everyone. Here are some average quotes I found after checking three insurance carriers.
- $150 – $190 a year for a $1 million umbrella policy.
- $285 – $335 a year for a $2 million umbrella policy.
- $365 – $430 a year for a $3 million umbrella policy.
- $525 – $610 a year for a $5 million umbrella policy.
As you can see, it generally costs about $150 more a year for $1 million more in umbrella policy coverage. If you are worth in the millions of dollars, you won't even notice a difference in premium costs. Even if you are only worth $500,000, $185 a year is chump change for your peace of mind.
Hence, my recommendation is to cover yourself for the full amount of your net worth up to 50% more to account for growth. In other words, if your net worth is $2 million dollars, get an umbrella policy worth $2-3 million dollars.
When it comes to insurance, I always believe it is better to be safe than sorry. If you are wavering to get an umbrella policy, then you most definitely already need one!
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How Does An Umbrella Policy Work And How Much Does It Cost? is a Financial Samurai original post.