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What are third-party coverages and do I need them?

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An insurance policy is a contract between you (first party) and an insurance company (second party). The wildcard is always the other guy -- the third party.

When you're piloting a ton of plastic and metal down the road at 60 miles per hour, there's a decent chance that your life will become intertwined with a third party, regardless of how carefully you drive. There's also a good chance that this third party will blame you for any damage done to his car and to his passengers. So, you should be ever-prepared to honor such a claim, and (this is America, after all) your protection should anticipate the possibility that Mr. Third Party will attempt to sue the trousers off you.

There are two types of third-party liability coverage: bodily injury liability and property damage liability. The first covers people costs -- medical expenses, lost wages, and pain and suffering. The second covers the cost of stuff -- such as somebody else's car, a telephone pole, or, heaven forbid, somebody's living room window. Both include legal protection up to the limits of your policy if the claimant files suit against you.

When it comes to these two third-party coverages, it's not hard to figure out whether you need them. Do you own a car? If so, you need them. In fact, the law requires that you carry these coverages in all but a few states.

Even if you live in a "no-fault" state, these liability coverages are important. No-fault laws were enacted to clear out jammed courts, and they eliminate garden-variety, low-dollar injury lawsuits as well as most claims for "pain and suffering." But no-fault laws will not save you from serious, mega-dollar injury claims that could lead to bankruptcy. Even pain and suffering claims are allowed under certain conditions. Remember, the potential for these low-probability, high-impact events is exactly why you buy insurance in the first place.

Each state has minimum required levels for these two third-party liability coverages. If you have assets or income to protect, however, these minimums won't be enough for you. You'll probably want a lot more coverage. Keep in mind that one ugly claim could clear out your savings and brokerage accounts, force you to sell your house, and could even attach itself to your future earnings.

Extra liability coverage is reasonably priced and should correspond to the level of assets you are protecting, not state minimums. This is not a good place to save a buck.