You probably already buy a variety of insurance policies to protect your assets and your loved ones. But beyond the standard auto, homeowners or life insurance policies, you may have overlooked an important and affordable type of insurance: umbrella insurance. That's largely because the financial protection it provides comes into play only under certain—but often vital—circumstances.
Sometimes known as excess liability or personal liability insurance, umbrella insurance doesn't stand alone. Instead, it supplements other liability policies most people already have in place, such as auto, homeowners, or renters insurance. It's designed to kick in when the liability coverage on those policies has been exhausted.
"The main purpose of an umbrella policy is to protect you and your assets from the financial fallout of common risk scenarios like owning a swimming pool or even from certain unforeseen events," explains Matthew Kenigsberg, CFA, CFP®, of Fidelity Financial Solutions.
"Generally, if you get into an automobile accident or someone has a mishap involving your property, you may be held responsible for damages or injuries. Umbrella policies are intended to cover any resulting liability that exceeds the amount covered by your other standard insurance policies," adds Kenigsberg.
In some cases, depending on the provider, umbrella policies can also be written to provide a broader form of coverage, which can cover types of damages not covered by the underlying policies, such as libel or slander, and can help to pay for the costs associated with legal fees.
Paul has $500,000 of liability coverage as part of his auto insurance. He is in a car accident and is found to be at fault. His umbrella policy will not pay out until after the first $500,000 has been disbursed from his auto insurance policy. Assuming he has $2 million in umbrella coverage, and the other party involved in the crash settles for $1.5 million in damages, the $1 million in excess liability above his auto policy threshold would typically then be covered under his umbrella insurance.
To best answer that question, consider the assets you own, and the role they play in fostering your financial security. When thinking about assets, there are obvious items that come to mind: your car, house, investment accounts, and checking and savings accounts. But more broadly, even your projected stream of future income can be viewed as an asset. In fact, it may even prove to be the most valuable asset of all.
In the event that you become the target of a lawsuit for a substantial sum of money, but don't have enough insurance to cover the damages that may arise, the expenses would have to come out of pocket. This could create significant financial hardship. An umbrella policy can forestall the prospect of financial ruin due to an unintentional misstep or an unforeseeable accident.
You may also wish to consider increasing the liability limits on your auto or homeowners insurance policies. This strategy may suffice for some common mishaps, but may not protect against all potential expenses. For example, a car accident could result in court proceedings, or an idle remark could lead to a lawsuit for slander. Unfortunately, the possibilities are endless.
Umbrella insurance picks up where other liability policies leave off, both in terms of dollar limitations and scope of coverage. Put simply, it provides extra (or "excess") liability coverage and is effectively insurance of last resort, but coverage will not take effect until after other sources of coverage have been used fully.