November 28, 2022

Business Update Blog

Your Umbrella Policy Needs To Be Updated Thanks To A Bull Market

Making money hand over fist in this bull market is nice. However, the more money you make, the more money you have to lose. Therefore, it’s important to update your umbrella policy coverage to account for greater wealth.

Compounding wealth has a funny way of sneaking up on us. What may have taken you 10 years to accumulate your first million might only take three years to accumulate your second million.

If you regularly invest, then I suspect your net worth has grown to all-time highs since the pandemic began. Therefore, your current umbrella policy is likely no longer enough to fully protect your assets.

What Is An Umbrella Policy?

An umbrella policy, also known as personal liability insurance (PLU) kicks in after your auto insurance policy or homeowners insurance policy is fully exhausted. Your umbrella policy sits on top of your auto insurance and homeowners insurance policies.

For example, let’s say you get into an automobile accident and cause bodily harm to a pedestrian. The pedestrian sees that you drive a new 7-Series BMW and decides to sue you for $500,000. If you drove a beater car, the pedestrian might have only sued you for $50,000 or nothing at all.

Your auto insurance policy has $300,000 liability coverage with a $1,000 deductible. You have a $1,000,000 umbrella policy with a $300,000 deductible.

If the pedestrian successfully wins the $500,000 lawsuit, your umbrella policy kicks in to cover the remaining $200,000 over your $300,000 auto insurance liability.

The reality is, accidents happen all the time, whether it is your fault or not. Even if the accident isn’t your fault, you could be held liable for an unforeseen number of reasons.

Getting an umbrella policy helps protect the assets you’ve spent a lifetime building.

More Examples Why You Should Get An Umbrella Policy

If you’re not yet convinced about getting an umbrella policy, here are some more reasons why you might want to get one. If you have an umbrella policy, these reasons should encourage you to update your umbrella policy coverage amount as well.

1) You have a teenager

An umbrella policy covers members of your household. And if you have multiple members of your household regularly going out into society, your risk of an accident goes up.

Driving teenagers puts your household at significantly higher risk of liability. Not only are they inexperienced drivers, they sometimes experiment with drugs, alcohol, and other things that may impair their judgement.

Personally, I’m scarred for life after a 15-year-old friend of mine died in a car accident in Kuala Lumpur, Malaysia.

He was supposedly evading the cops after taking his girlfriend out clubbing. He lost control of his car and hit a tree. His girlfriend, who was going out for the very first time, also died. A lawsuit ensued.

Your teenagers could bankrupt you with their careless actions. As a result, I would get an umbrella policy equal to your net worth.

2) You plan to retire early with young children.

When my car was in the shop for an afternoon, I felt as lost as forgetting to take my phone with me to the bathroom. It was then that I realized how much I depended on my one car every day.

In the late mornings, I often drive to play tennis. In the late afternoons, I often drive my son to a playground. Then there are weekly trips to the zoo, science museum, playdates, and doctor visits.

Every time I drive my car, I put our wealth at risk. As someone who plans to re-retire soon, I cannot afford to get sued due to some accident that wipes away a large portion of my wealth.

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The wealth I have accumulated is used to generate precious passive income so I don’t have to work. Losing wealth from a lawsuit means losing passive income. Losing passive income ultimately means losing the time I want to spend with my kids.

At most, I’ve got until my kids turn 18 before they will no longer want to hang out with me. In reality, they will probably stop wanting to hang out by age 14. Therefore, for me, having an umbrella policy is really about protecting the time I want to spend with my young children.

If you plan to retire early with young children in order to spend more time with them, getting an umbrella policy is a no-brainer.

3) You are a multiple tenant landlord.

When you have tenants, you invariably open yourself up to more risk. One way to mitigate risk is to put all your rental properties in an LLC. Another way to mitigate risk is to get an umbrella policy.

As a landlord, no matter how hard you screen your tenants or assess the safety of your rental property, something bad may happen.

No matter how careful you are in maintaining a property, something could go wrong. Maybe your property has faulty wiring, a leak that causes black mold, or undetected rot that causes the integrity of a protective fence to weaken.

Your tenants should have renters insurance and you should have homeowners insurance to account for most problems. But you just never know what could happen beyond the scope of your insurance policies.

4) You’re a small business owner who sells a physical product.

The more you serve people, the higher the chances are that something bad might happen to you. Just ask doctors trying to help patients how much they have to pay in medical malpractice insurance.

Let’s say you operate a chocolate store and one of your employees has a psychotic break. Your employee stabs a customer who was extremely rude and impatient. The customer could sue you for negligence. An umbrella policy would protect you.

Or maybe you run a restaurant that is already struggling to survive thanks to COVID. To boost revenue, you open up an outdoor dining area where cars used to park on the street. Then one unfortunate evening, a car barrels through the outdoor dining area causing injuries to your diners.

One litigious diner breaks his leg and can’t walk properly for the next six months. He believes you didn’t properly reinforce the outdoor dining area. As a result, he sues you for $1 million, which is about all you have. An umbrella policy should be there for you beyond your business insurance.

5) You’re a personal finance enthusiast.

If you have been reading Financial Samurai since 2009, chances are extremely high you’ve grown your net worth way faster than the average American. Reading financial topics will naturally make you care more about your finances.

Maybe in 2016, you decided to invest in various heartland real estate opportunities after reading, Focus On Trends: Why I’m Investing In The Heartland Of America.

Or maybe in March 2020, you read, How To Predict A Stock Market Bottom Like Nostradamus, and decided to buy more stocks around that time.

If you did either of these things, at the very least, you need to protect your gains.

Some of you might decide to diversify into bonds or lower-risk assets for capital preservation. But for those of you who plan to continue interacting in day-to-day society, updating your umbrella policy coverage to reflect your wealth gains makes sense.

In a lawsuit, savings accounts usually are fair game. However, retirement accounts, such as a 401(k) and IRAs, are typically protected from a liability lawsuit.

Note that although 401(k) retirement plans are protected under the Employee Retirement Income Security Act of 1974, individually held IRAs get only a partial exemption in bankruptcy. So you would have to rely on state laws for protection.

6) You’re a high profile individual

If you’re a celebrity, politician, sports star, or any other type of high profile individual, getting an umbrella policy is important.

Risk is a numbers game. The more people who know you, the greater the chance that someone might sue you. Even if you didn’t do anything, someone could still bring a lawsuit against you.

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Practice stealth wealth if you want more peace of mind.

Example Where You Don’t Need An Umbrella Policy

Of course, not everybody needs or wants an umbrella policy. We all have various levels of risk tolerance as well.

Let’s say you drive a $38,000 Ford F150 and earn $65,000 a year. Screw the 1/10th rule for car buying! You’re also married and have no children yet. Eventually, you plan to buy a house. But before you do, you want to pay off $9,000 in credit card debt and your $25,000 car loan.

At age 30, your net worth is about $70,000 versus $250,000 in my average net worth for the above average person post. There is no need to get an umbrella policy because your auto insurance liability coverage is $100,000.

Although your car loan prevents you from investing in the stock market or saving more for a down payment, at least it saves you from needing an umbrella policy.

You still feel invincible with an attitude that you can work forever! My hope is at the very least, you will get a 30-year term life insurance policy given you plan to have children eventually and buy a house with a mortgage.

A 30-year term at age 30 is the best age to get life insurance. It’s like locking in a 30-year fixed-rate mortgage at an all-time low. The time period between age 30 to age 60 is usually also when you have the highest number of responsibilities.

Be Careful Getting Too Large Of An Umbrella Policy

In a lawsuit, how much liability insurance you have and your overall assets can be ascertained by a personal injury lawyer.

A creditor can require your appearance at court for an asset hearing, where the creditor can ask you questions under oath about your assets and demand you produce documentation regarding your wealth and ability to pay.

Failure to appear at an asset hearing generally results in a bench warrant being issued for your arrest. Failure to tell the truth under oath could have financial consequences as well.

Just be careful getting an umbrella policy far larger than your net worth.

If you have a net worth of $1 million but have an umbrella policy of $3 million, an injury lawyer may be more motivated to go after you. After all, it costs the same amount of time to sue someone for $1 million as it does for $3 million. 

The irony is, if you had no umbrella policy and only an auto insurance liability coverage of $300,000, the lawyer may not want to pursue you. Or, he may only sue for the maximum of $300,000, even if you have millions of dollars in net worth. Injury lawyers go through a cost-benefit analysis before deciding to pursue personal assets.

Injury lawyers are generally looking for insurance funds, and sometimes turn down new cases, or withdraw from existing cases, as soon as they realize that there is no insurance.

Insurance companies also don’t want you to have more umbrella policy coverage than you need. You pay the monthly or yearly premiums, but they pay the full amount.

The good thing to note is that the higher your umbrella policy, the more inclined your insurance company will be to fight for your rights!

Umbrella Underinsured Motorist Coverage (UIM)

A Financial Samurai reader, who is also an attorney added some great advice that I’m adding here. He recommends purchasing an Umbrella policy that also has umbrella underinsured motorist coverage (UIM). This gives you umbrella UIM protection above the regular UIM limit you have on your policy.

Normal umbrella coverage only covers the injuries of people you injure through your negligence. The more likely scenario is that you and your family are injured by someone else.

The average liability coverage driver’s have is only $50,000 and many drive without insurance. Assume your family of three is hit by a driver with only $50,000 in coverage, killing the main bread winner and seriously disabling the other two.

In a normal scenario, you would be limited to recovering the $50,000 and whatever UIM coverage you have on your regular policy, say $300,000. A total recovery of $350,000 would not even begin to cover the lifetime of lost earnings for the deceased and the daily in home nursing care for the disabled.

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Umbrella UIM would kick in above the $350,000 and provide your family another million or more in coverage. As an attorney, the most common scenario he sees is that there is rarely enough insurance coverage to cover the losses in a serious accident.

Solutions If You Can’t Get Umbrella Underinsured Motorist Coverage

If your insurance carrier doesn’t provide UIM, the main way to protect your family in case of your injury or death from an uninsured/underinsured person is to increase your auto liability coverage. Increasing your auto liability should automatically increase your uninsured liability coverage.

For example, I have $300,000 per person, $500,000 per accident auto liability coverage. I can increase the coverage up to $1,000,000 per person and $1,000,000 per accident for $50 a year. If I do, the coverage also extends to uninsured liability coverage.

The other solution is to have an appropriate life insurance policy that covers your debts and family’s living expenses. If you are the main or sole income earner with young children, life insurance is a must.

Check Policygenius for the best rates. My wife recently used Policygenius to double her life insurance coverage to match mine for less money. Having different amounts of life insurance coverage made no sense since we are equal partners.

The Cost Of An Umbrella Policy Is Inexpensive

After doing my latest net worth update, I called USAA, my umbrella policy provider. They said a $4 million umbrella policy costs $510 a year and a $5 million umbrella policy costs $620 a year. This policy is for a two-adult household.

Then I checked with Liberty Mutual and they had similar rates. In other words, the cost of an umbrella policy for a two-adult household for us is between $150 – $200 a year per $1 million. That’s pretty good value for peace of mind.

The larger your household and the less products you have with the insurance company, the likely more expensive your umbrella policy. Therefore, if you want to save on your umbrella policy, your best bet is probably to go with one carrier for your auto insurance, homeowner’s insurance, and umbrella policy for a multiple product discount.

Also know that with regular insurance carriers, there is often a $5 million umbrella policy limit. If you want to get an umbrella policy for more than $5 million, you’ll have to contact speciality insurance providers like Chubb.

Here is a survey from ACE Private Risk Services that measured the cost of an umbrella policy.

The ACE report provides these typical annual costs:

  • $383 for $1 million in coverage for a household with one home, two cars and two drivers
  • $474 for $2 million in coverage for the same household
  • $608 for $5 million in coverage for the same household
  • $999 for $10 million in coverage for the same household
  • $1,578 for $10 million in coverage if the household also has 2 more homes, 2 more cars, a boat under 26 feet, and a driver who is under 25

I hope by now you’ve come to the conclusion that getting an umbrella policy is a wise decision. If you haven’t updated your umbrella policy coverage amount in a while, please do so. Call your current insurance carrier and see what they have to offer.

Ideally, your umbrella policy coverage keeps pace with your net worth plus a buffer. This is why updating it every time your net worth grows by $500,000 – $1,000,000 is a smart move.

While you’re at it, you might as well update your life insurance coverage as well. Protecting your wealth, especially if you have children, is one of your main duties as a parent.

Readers, do you have an umbrella policy? When was the last time you updated your umbrella policy? Have you ever had to use your umbrella policy? How much does your umbrella policy cost? Please note your homeowners insurance policy likely needs to be increased as well.

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