The Good News About Umbrella Insurance

An elderly motorist hit another car, and its driver died. A lawsuit ­followed, and in the end, the man who’d caused the accident lost nearly everything. He was allowed to keep a small IRA and to remain in his home, which he had designed. But when he dies, I’m told, the house will go not to the beneficiary of his choice but to the plaintiffs.

Let this be Exhibit A in the argument for sufficient umbrella or excess-liability insurance, which the anecdotal evidence suggests is under-utilized in the risk-management portfolios of the wealthy.

People sometimes use the terms “umbrella insurance” and “excess-liability insurance” interchangeably, though their meanings differ. Excess-liability insurance adds to the coverage provided by the underlying policy (homeowner’s, auto and so forth). Umbrella insurance broadens coverage—for example, to include libel and other personal injury. Many ­policies contain elements of both, and that is how I’m using the term “umbrella” here. Also, this discussion is limited to personal and not commercial coverage.

Not surprisingly, the first question that people usually ask about such coverage is, “How much is enough?” Unfortunately, there’s no answer to that query except maybe, “Whatever will allow you to sleep at night.” This isn’t like life insurance, where you can estimate the economic hole left by a premature death in a fairly straightforward way. Liability exposure rests on a shakier, philosophical foundation. What is the value of a life? How do we assign a dollar value to pain and suffering? The risk lies not only in the unforeseen tragedy that we might one day cause but in the inclinations of the injured and the uncertainty of the legal process.

The good news is that umbrella coverage is cheap, making it easy to be conservative. A common-sense approach to risk management is to absorb the cost of small and common losses and transfer the cost of rare and potentially severe ones. So, if you can buy millions in coverage for hundreds in premiums, why not load up and try to gain back some premium dollars with higher deductibles on your underlying auto and homeowner’s? If you’re still looking for a benchmark, I suggest starting with your net worth and including an amount for future wages, which can be garnished. But every situation is different, so you’d be wise to check with an attorney who understands your situation and which of your assets might enjoy some ­protection under the law.

By no means is the amount of coverage the only important decision. Umbrella policies vary greatly, and you need to understand the differences. Consult an independent agent or broker who is accustomed to advising ­clients of your wealth level and who works with multiple providers. Be sure that the providers themselves deal ­frequently with clients like you. Are their coverage limits high enough for your situation? What special provisions or services do they offer for wealthy individuals and families?

The policy that you purchase needs to be customized as much as possible to your life and circumstances. If you own an airplane, that fact should obviously be brought front and center. Do you have teenagers who drive? Teenagers who drink? If you serve on a volunteer board of directors, ask whether you will be covered under its umbrella policy or whether you need special directors-and-officers coverage. In any case, ask about uninsured-motorist coverage.

Don’t forget about legal fees in the event you are sued. Will the ­policy cover them without their being counted against the policy limit? What about expert-witness fees? How much freedom will you have in choosing the attorney?

Because umbrella policies pick up where underlying coverage leaves off, it is critical that the two work seamlessly together—not only regarding coverage limits but also policy periods and definitions of terms. Regarding coverage areas not included in underlying policies, you’ll want to know what level of damages you’ll have to pay before the policy kicks in. This is known as the self-insured retention.

Ask your attorney to sift through the policies looking for gaps.

Mistakes happen. It’s best to do everything you can to avoid the big ones.

Paul Palazzo, a Certified Financial Planner, is the managing director at New York-based Altfest Personal Wealth Management