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who needs umbrella insurance

Insurance is a complicated topic, but it’s one that everyone needs to understand to properly protect themselves. There are a lot of types of insurance: car insurance, life insurance and homeowners insurance, for example. One insurance product you may have heard of and never quite understood is umbrella insurance, which complements existing coverage.

For help understanding and addressing your insurance needs, consider working with a financial advisor.

What Is Umbrella Insurance?

who needs umbrella insurance

Umbrella insurance is a form of catastrophic coverage that supplements an existing plan. This means that an umbrella insurance policy doesn’t independently give you coverage for your house or automobile. Instead you get it as an add-on to an existing policy such as a homeowner’s or auto plan.

The umbrella insurance plan then provides you with additional coverage if your underlying insurance plan runs out.

For example, say that you have car insurance with $250,000 worth of coverage. You get into an accident with an extremely valuable sports car causing $400,000 worth of damage. Your auto insurance would pay for the first $250,000 worth of that claim and then run out. This would leave you paying for the remaining $150,000 in damages on your own.

If you have umbrella insurance, that’s when the policy would kick in. You would use up the $250,000 of your underlying policy, then your umbrella insurance would pay for the additional $150,000.

The purpose of umbrella insurance is to protect you from unforeseen events. A standard insurance policy will cover you for the ordinary scope of risk that someone can anticipate. You’ll buy car insurance based on what could ordinarily happen on the road, for example, or homeowner’s insurance based on the value of your house. Umbrella insurance protects you from edge case scenarios, the kind of things that most people wouldn’t consider practical risks but which can cause catastrophic damage if they occur.

In most cases, an umbrella policy is defined by the policy that it supplements. This means that it will protect you from the same harms as the underlying insurance policy with additional financial protection. However some umbrella policies do add supplemental forms of coverage as well. For example, your homeowner’s insurance may not necessarily come with general liability protection but your umbrella policy might add this form of protection.

Most umbrella policies have a cap set in the millions of dollars. For example, you might have a homeowner’s policy with $500,000 worth of coverage and an umbrella policy that covers an additional $2 million. Unlimited umbrella policies exist, but they’re uncommon and expensive.

You can buy umbrella insurance as a supplement to most types of insurance plans, but it’s most common for homeowner’s and vehicle insurance plans. You cannot get an umbrella supplement to life insurance and out of pocket caps have made umbrella and umbrella-style policies increasingly rare in health insurance.

Should You Get Umbrella Insurance?

who needs umbrella insurance

Most people who think about their insurance needs should probably seek out some form of umbrella insurance policy.

This type of coverage gives you three main forms of protection:

  • High Risk to Yourself – If an accident or disaster happens that exhausts your insurance policy, leaving you to pay for the remaining costs of your own property that was damaged or destroyed;
  • High Risk to Others – If an accident or disaster happens that exhausts your insurance policy, leaving you to pay for the remaining costs of someone else’s property that was damaged or destroyed;
  • Asymmetric Risk – If something happens that your existing insurance does not cover at all, leaving you to pay for all of the damages.

The most common example of asymmetric risk is legal liability. Many, if not most, umbrella policies add some form of liability coverage, meaning that if you’re sued the insurance plan will cover your legal fees and losses. While this is good to have, it’s probably not essential for most consumers to worry about.

Who Could Benefit Most From Umbrella Insurance?

On the other hand, there are some people who should seriously consider umbrella insurance. Ask yourself about your own property. How much do you own, and how readily could you replace it if something happened? If you’re relatively young, you may not have much to replace, so a simple renter’s insurance policy will probably cover everything you need. However, many people might want more protection than they currently have just based on what it would cost to replace their possessions in case of a total loss.

The risk of harm to others depends on what you own. You generally are liable for harm that happens with or on your own property. For most people that means two things: their car and their house. If you’re a homeowner, however, umbrella insurance is almost always a good idea. You don’t want to be on the hook for some disaster that just happens to occur on or because of your property.

The same is true with a vehicle. If you don’t own a car, you don’t need to worry. If you do have a car, though, umbrella insurance is often a good idea. As above, you don’t want to be on the hook for some black swan event where the car you hit is a million dollar antique or its passenger was in delicate health. This is known as the “eggshell plaintiff” rule, meaning that you’re on the hook even if you had no idea that someone else was unusually delicate or vulnerable, and it can lead to enormous costs.

In particular, umbrella coverage is usually worth it because it’s cheap. A good policy can cost you around $25 per month. Like most insurance, this is money that you probably will spend and never see again. Every now and again, though, someone gets monstrously unlucky. If that happens to you, an umbrella policy can be the difference between financial ruin and somebody else having a bad day.

The Bottom Line

An umbrella insurance policy gives you additional coverage when your current policy runs out. If you have any asset that requires insurance, like a home or a car, it’s very likely a good idea.

Insurance Tips

  • Find out exactly how much life insurance you need with SmartAsset’s free life insurance calculator.
  • A financial advisor can help you with your insurance needs. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: ©iStock.com/ipopba, ©iStock.com/PeopleImages, ©iStock.com/Cecilie_Arcurs

Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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