What is an Umbrella Policy? How Does it Work?

Monday, April 10, 2017 - 8:00am

A primary concern for many insured is that they do not have any "gaps" in their coverage. The first coverage that I approach when they bring this subject up is the umbrella policy. This is a great policy for both personal and businesses to help cover any missing protection.

It is surprising how many do not know anything about the umbrella policy or do not fully comprehend the inner workings of the policy. This week's publication is dedicated to the umbrella policy. After reading this article, you will have a better understanding of what the personal umbrella policy is, what it covers, and how it could benefit you. Three main takeaways from this article are; what is an umbrella policy, what are the requirements you need to have an umbrella policy, and what do typical umbrella policies cost?

What is Liability Insurance?

Before we dive into the umbrella policy, it is important to understand what the term liability means and what liability insurance is. Umbrella policies provide liability coverage. If you are not entirely sure what liability means, read my previous blog on liability insurance. Once you have a good understanding of liability, it will be easier to follow the remainder of this article.

What are the coverages of the umbrella policy?

The umbrella policy and excess liability policy are designed to cover large claims and major lawsuits. These policies begin their coverage at $1,000,000.00 and increase from there to cover claims of such a large magnitude. When purchasing coverage makes sure you understand this is catastrophic coverage, and you are going to be purchasing a high amount of insurance.

What limits does my umbrella policy require?

There are some requirements that the insurance company will request for an umbrella policy to be enforced. This makes it critical to understand what coverages you need.

Since the umbrella policy is meant to cover the insured after they exhaust the underlying policy limits, the insurance company requires that the insured carry a minimum amount of liability coverage on the underlying policies. For instance, many umbrella carriers require the insured to carry at least $1000,000.00 in liability on their homeowner's insurance. So, if the insured has $50,000.00 in liability coverage on their homeowner's insurance, the umbrella policy no longer covers them. You must carry a minimum $100,000.00 liability on your homeowner's policy.

The other major requirement is obvious. The insurance company will require you carry insurance on every item you own. For example, if the insured has a home and two vehicles, then the insurance company requests you have home insurance and auto insurance.

This issue becomes more complicated when insureds own boats, golf carts, ATV, and RVs. You must carry liability insurance with the specified limits of coverage, on every item you own. As an agent, the areas that I see often are when a client purchases a new vehicle or toy and forgets to add it to the insurance policy. However, if an insured forgets to make a payment on a policy and that policy lapses, it creates a gap in coverage on the umbrella policy. So make sure that you do not just carry insurance on your possessions, but be certain you have the amount required for your umbrella policy to stay active.

What is the cost of an umbrella policy?

Umbrella policies and excess liability policies are inexpensive. Policies of this kind only take effect when a claim is so broad that another liability coverage is exhausted, and the underlying policy limit requirements make umbrella policies risk extremely low.

Determining the exact cost is going to be dependent on the individual's situation. A family of two with a home and two autos will pay less for a $1,000,000.00 policy than a family of five with a house, summer home, boat, four vehicles, and two teenage drivers.

Something that can be even more complicated is that the amount of coverage in your underlying limits can affect the cost of the policy.

Please allow me to use a real example. I had a client who just graduated college and was struggling financially. We were able to set up the home insurance policy with a $100,000.00 liability limit, and an auto policy that carried liability coverage of 50/100/50 (see the article on split limits). His premiums added together were approximate $3,240.00 each year.

The following year the client had some more financial stability, and I wanted to increase his liability coverage. We increased his auto insurance to 100/300/100. However, that allowed me to add an umbrella policy. The client received a discount on his home insurance and auto insurance policies for the umbrella insurance. This discount offsets his umbrella cost of $200.00. In other words, he paid $3,440.00 but now had twice as much auto liability coverage and a $1,000,000.00 umbrella policy.

The third year, I looked at the client’s policy. I wondered what the cost of increasing home and auto insurance liability would be. I increased the home insurance from $100,000.00 to $300,000.00. I then increased the auto liability to 300/500/300. However, when I did this, I found out that the premium for the umbrella policy went down because I increased the underlying limits. My client's rates stayed the same!

This made me wonder what would happen if I increased it more. So I increased the home insurance to $500,000.00 and the auto insurance to 500/500/500. I was astounded that the annual premiums dropped from $3,440.00 back to $3,240.00! By the time I finished, my client had $1.5 Million in coverage for the same cost my client was paying for $1.1 Million. Who would have thought that would be possible?

The biggest lesson in this story is that you should never assume that increasing coverage is going to increase premiums. Even though it is very common that the rates will rise, sometimes the risk lowers enough to reduce the premiums. My suggestion is that anyone with auto and home insurance should at least look at the cost to add an umbrella policy. It may surprise you how much coverage you can get with a little price change.

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