Umbrella insurance is a separate policy of insurance which meshes with each of your primary policies such as auto, homeowners and boat insurance, providing you with an additional layer of personal liability protection. It is referred to as ‘umbrella’ insurance as it spans all primary policies which include personal liability coverage, and provides a top up to those policies specifically for that coverage.
Umbrella insurance presupposes that you have one or more primary policies. Also, the additional coverage it provides is limited to personal liability insurance only - it does not ‘top up’ any other type of coverage provided by your primary policies. However, it does provide a much wider scope of personal liability protection than primary policies, and consequently eliminates many ‘gaps’ in coverage as explained below.
You need umbrella insurance because the personal liability limits under primary policies such as auto and homeowners insurance are grossly inadequate. For those types of policies, the liability coverage is usually capped at $100,000 per person and $300,000 per accident. Problem is, a maximum claim amount of $100,000 is trifling in comparison with the judgment which a court of law could award against you for injuries which you cause to another person.
Let’s say you’re driving home after a long day, you get distracted and you fail to give way at an intersection. You drive into the side of another car, and cause moderate to severe injuries to the bank executive driving the other car. It takes four months before he is back at work even part time, and he is looking forward to a long period of rehab and medical treatment to make a full recovery. He files a lawsuit against you, and a court orders a total compensation payment to the injured banker of $650,000 for medical bills, loss of earnings and pain and suffering (not counting any punitive damages which the court might also award against you).
At this point your auto insurance kicks in, right? Sure it does, all $100,000 of it. The first $85,000 of that goes in defense costs, leaving just $15,000 from your insurance company to settle the compensation amount awarded against you. So where does the balance of $635,000 payable to the injured banker come from? Your own assets of course, and if they are not enough, from your income for however many years that might take.
In the above example, a personal umbrella policy would have paid all of the claim amount ordered against you, and (if you chose the right umbrella policy) all of the punitive damages which the court might have ordered as well. This would have left you out of pocket only to the extent of an insignificant policy deductible. So that’s why you need umbrella coverage.
The rates are really cheap, making it the best value coverage in the entire insurance industry. Umbrella policies are sold in blocks of $1 million, and the first $1 million will cost you less than $200 per year. Each additional $1 million will cost you less than $100 per year, meaning that you could get $2 million in coverage for under $300 per year. That’s less than $25 per month. As with any insurance policy, be sure to get a number of quotes from different insurers.
Umbrella insurance links with the personal liability insurance provided by your primary insurance policies, and it provides any necessary additional liability coverage in excess of the primary policy’s limits. It will pay for both defense costs and judgments against you, in excess of the primary policy limits and up to the amount of umbrella coverage which you have chosen.
Umbrella policies require that you maintain specified minimum levels of liability protection under your primary policies. If you do not effect that level of coverage, or if you allow your level of liability coverage to fall below the minimum level, then in the instance of a claim you would become personally liable for the amount by which your coverage fell below the minimum.
For example, if your umbrella policy required that you maintain at least $300,000 of personal liability coverage, and you allowed that coverage to reduce to $100,000, then you would become personally liable for the $200,000 shortfall in any judgment made against you. Similarly, if you allowed your primary coverage to be canceled (due to non-payment of the premium, for example), then you would become personally liable for the full amount of the minimum liability coverage required in the event of a claim. That’s why it’s important to always maintain the minimum level of personal liability insurance required by your umbrella policy.
Gap coverage is one of the major benefits of umbrella insurance. Personal umbrella policies don’t just provide a top up to the liability insurance provided by your primary policies, they also provide liability coverage which your primary policies do not cover at all. These are known as ‘gaps’ in coverage, and left uninsured they can be perilous to your financial health.
There are many activities we engage in which are not covered by primary insurance policies. For example, if you rent a venue for an event such as a wedding reception or a family reunion, you will sign a contract in which you indemnify the owner of the venue for any damage, injuries or loss which you might cause, even if it is not your own fault. Similarly, if you rent a boat, a jet ski, a snowmobile or any other kind of recreational vehicle, you will sign a rental contract in which you assume liability for any damage or loss caused to the vehicle, injuries caused to any other party while you are using the vehicle, and any damage or loss to others’ property.
Another example is employing a nanny or a nurse. Primary insurance policies do not provide employer’s liability insurance, but a good umbrella insurance policy will. There are many other examples of potential gaps in liability coverage, and these should be assessed in relation to each policyholder’s individual circumstances, together with the amount of coverage needed.
Figure 1 illustrates how umbrella policies work by providing both top up coverage and gap coverage. It shows coverage for a policyholder who has auto insurance and homeowners insurance, and a personal umbrella insurance policy of $1 million. The auto and homeowners policies provide liability coverage of $300,000 each, and the umbrella coverage tops these up by $700,000 each to a total of the umbrella policy’s limit of $1 million. Not only does the umbrella policy provide that top up coverage, but it also provides a full $1 million in gap coverage for a range of perils not covered by the auto and homeowners policies at all.
For gap coverage, the umbrella insurance ‘steps down’ and acts as though it were primary coverage as well as umbrella coverage. It therefore provides full protection for defense costs and judgments against you, up to the maximum amount of umbrella insurance you have taken.