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Do You Need More Liability Insurance?

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By tmeri
March 2, 2005

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Do You Need a Personal Liability Umbrella Insurance Policy? You sure might. You probably have insurance on your car, in case of an accident. But check the limits. Even with a good policy, you may only have a $100,000 pay-off if you are at fault in an accident in which someone is injured. You also might have a homeowner's policy, and if someone is hurt on your property, that may help to protect you.

But in today's world, if you are responsible for someone else's injury, a jury could award a plaintiff far more than $100K on the actual damages alone. If someone were permanently disabled, for example, he may have special medical expenses for the rest of his life. You could be liable for that.

An umbrella policy can protect you from financial ruin if you accidentally harm someone. It will not protect you if you deliberately harm someone or are negligent. You will still have to be careful with other people's lives and property. But no matter how careful you are, accidents can still happen.

Who Pays for the Damages Awarded by a Jury? Often when this topic is discussed, there is misunderstanding on how much insurance you need to carry for personal liability. The typical (incorrect) belief is that you need an amount to match your assets. For example, if your net worth is $200,000, a $200,000 policy should cover you. Wrong.

In order to understand why that logic fails, you first need to understand how insurance and court awards work. Let's say you are sued because someone (hereafter called the plaintiff) is injured in a car accident that was your fault. Your insurance company will first try to get the plaintiff to settle for some amount less than the policy. If the plaintiff agrees to that, then the insurance company will pay it, and you will owe at most your deductible.

But suppose the plaintiff is not happy with the settlement offer. If the plaintiff thinks he can get a jury to award significantly more than the settlement offer, you are now going to be a defendant in the lawsuit.

If you lose the lawsuit, the jury will then determine damages. These usually come in the form of actual damages (medical costs, for instance), pain and suffering, and punitive damages. Pain and suffering are also considered actual/compensatory damages. Your insurer probably will not pay for punitive damages.

Once the jury decides upon the award amount, the pay-off begins. The insurer will pay up to the policy limit on the compensatory damages. If the compensatory damages are greater than the limit, you will be on the hook personally for the rest.

So for example, if you decided to carry a $200K policy because your net worth is $200K, and the jury awards $1M in actual damages, it would be paid something like this:

$200,000 from the insurer
$200,000 from your portfolio
$800,000 outstanding that you will be paying off as you earn money

As you can see, you need to cover all of the awarded damages, not just up to your net worth.

How Much Insurance Do You Need? Well, you need a policy of sufficient size that a jury is unlikely to award more than the amount of the policy. But more effective, get a policy that is large enough that the plaintiff is likely to settle without a trial. THAT is the goal.

How big is that? Umbrella policies generally start at $1,000,000. Is that enough? Probably not. You should consider a bigger policy. You should be able to find these policies easily up to $5,000,000. I used to think $2M was generally enough. I'm starting to think that is a bit too low. The bigger your policy, the more likely a plaintiff is to agree to a settlement.

But What if I'm Poor? Isn't That a Deterrent to Being Sued? Yes. If you have no assets, then the plaintiff's lawyer is likely to advise not going after you because collecting will be so difficult. In some ways, having an umbrella policy may just attract a lawsuit in that case because it represents an asset.

But on the other hand, emotions run high in issues like this, and an angry plaintiff may decide to persist just to get a judgment against you, even if you have no assets. That judgment will be around to kill your FIRE plans the rest of your life or until you are able to pay it off.

What Does an Umbrella Policy Cost? In the grand scheme of things, umbrella insurance is one of the cheapest insurance policies there is. It costs me well under $200/year for a $2M policy. The cost to you will depend upon a number of factors, including which state you hang out in and how much your other liability policies pay. Your insurance company may require you to max out coverage with your auto policy before they give you an umbrella policy, so be aware, it may cost more than just what you'll pay for the umbrella policy. But if you are not carrying at least $100,000 medical on your auto policy, you are not carrying enough insurance there, anyway.

This is one insurance product I don't think many people can afford to skip. Call your insurance agent and see what it would cost you.

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