How Does Umbrella Insurance Work?

With all the types of insurance out there, all the language surrounding insurance can get confusing. For example, what's umbrella insurance? Homeowners, renters, auto, life, health; the insurance industry is one of the most stable, as everyone needs some kind of insurance. However, the differences in policies sometimes leave consumers asking questions. 

Umbrella insurance is your safety net.
Umbrella insurance is an excess liability policy that covers you if your basic home insurance or auto insurance policy doesn't pay enough, or doesn't cover a specific incident. It doesn't cover replacing your house or automobile; it covers incidents where you are liable for an injury or property damage. Your basic insurance policy pays its limit, and then your umbrella insurance kicks in and pays the rest, above and beyond the basic policy, to its limit. Umbrella insurance also covers legal costs, including lawyers in the event that you are sued.

When shopping for umbrella insurance coverage, consider all your assets.
The idea behind umbrella insurance is to cover any shortfall in your basic policy, in order to protect your assets. When you're shopping for umbrella insurance, you should figure out exactly how much your assets are worth in order to ensure you get enough coverage. A general rule of thumb is to calculate that if you were to liquidate all your assets; sell your home; sell stocks; cash in bonds; and raid your savings account or other investments, how much would you have? You should carry at least that much in umbrella insurance coverage.

Assess your risk.
While umbrella insurance coverage is often determined, in part, by personal assets, you should also assess your risk when you're shopping for coverage. Generally speaking, if you drive a lot for business or do a lot of entertaining, you're at higher risk for an incident where you may be liable. Also, if you live in a wealthy town, your liability may be higher if you're sued for lost wages or property damage. Consider all of these factors when you're shopping for umbrella insurance coverage.

Do you really need umbrella insurance?
This is a question that causes a lot of disagreement. Traditionally, people with few assets are advised that basic policy limits are sufficient. Umbrella insurance providers would have you believe differently, but that's still the prevailing wisdom when shopping for umbrella insurance. If you're a middle-class family with no assets other than a modest house and your car, you probably don't need umbrella insurance. Gargantuan lawsuits don't come along that often, and in many cases it's simply not worth garnishing the wages of a middle-class worker. As many lawyers acknowledge, "You can't bleed a turnip."

On the other hand, if you're a wealthy individual with a growing pool of assets, it's advisable to have umbrella insurance. Juries are less sympathetic to wealthy individuals, and more likely to award large damages in cases against them. With inflation and the current sue-happy legal climate, it's a good idea to carry a $5 million umbrella policy.