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The Case For and Against Umbrella Insurance
written by Mike Ballew July 3, 2022
Eggstack

Umbrella insurance helps protect your assets from claims that exceed the liability limits of your auto and home insurance. Let's look at the case for and against umbrella insurance.

The Case FOR Umbrella Insurance

As presented by every insurance company, this is the case for umbrella insurance: If your net worth exceeds your home and auto insurance policy liability limits, you need umbrella insurance to protect the difference between your net worth and the liability limits. Otherwise, if you get involved in a lawsuit those assets could be at risk.

Here's an example: Suppose you have a net worth is $1 million consisting of your home equity, retirement savings, and the funds in your personal checking and savings accounts. The liability limits on your home and auto insurance policies are $300,000. The difference between your net worth and the liability limits is $700,000 ($1,000,000 - $300,000). Therefore, you need $700,000 of umbrella insurance to protect those assets. If you don’t have it and you get sued for $1 million, you will be completely wiped out. No house, no 401(k), no retirement – just dumpster-diving and work till you drop dead. So goes the insurance industry’s case for umbrella insurance.

Here are some examples of liabilities that a typical umbrella insurance policy would cover:

  • Someone in your household gets sued for posting libelous comments online.
  • Your teen causes an auto accident with a physician and you get sued for $1 million in lost wages.
  • Your mail carrier trips over a crack in your driveway and is permanently disabled.
  • A guest at your home dives headfirst into the shallow end of the pool.
  • You throw a holiday party and someone falls on your icy front steps.
  • Your overgrown tree topples over and crashes through a neighbor’s roof.
  • Your dog chews off your neighbor’s foot.

The Case AGAINST Umbrella Insurance

The problem with the insurance industry’s case for umbrella insurance is it doesn’t make any sense. Let’s look at that example again: $1 million net worth, $300,000 liability limits, therefore you need $700,000 in umbrella insurance. If you don’t have umbrella insurance and you get sued for $1 million, you will be totally wiped out.

Here’s a question: are lawsuits capped at $1 million? Of course not. Here’s another question: what happens if you buy $700,000 in umbrella insurance and instead you get sued for $2 million? The exact same thing – totally wiped out, dumpster-diving, the whole thing. 

Don’t believe it? Here’s the math: $2,000,000 lawsuit - $1,000,000 net worth - $700,000 umbrella insurance - $300,000 liability limit = $0.

The case for umbrella insurance is based on faulty logic: that your exposure is limited to the difference between your assets and the liability limit. It is not. In the real world where things actually make sense, you don’t know how much umbrella insurance you need because you never know how much you’re going to be sued for. Miss it by just a little bit and you’re wiped out anyway plus you’ve wasted money on umbrella insurance.

Here's something else you won’t hear from any insurance agent: every state has protections against losing your primary residence and your retirement savings. The whole gambit of listing every possible risk and the apocalyptic consequences really just amounts to fearmongering.

Confront any insurance agent with those two facts and what do you get? They will say a million dollars in umbrella insurance only costs $250 annually and you might need it. If you need it and don’t have it, you’ll wish you did.

How to Decide if You Need Umbrella Insurance

The decision whether or not to buy umbrella insurance really comes down to two things: assets and risk. If you don’t have much in the way of assets, you don’t need umbrella insurance. With regard to risk, how likely is it that you might get sued? 

Do you own a dog? How about a pool? Do you own rental property or a vacant lot? What about a trampoline or a hot tub? Do you like to throw parties? Do you have teenagers? If you have significant assets and you answered yes to any of those questions, you might need umbrella insurance.

Final Thoughts

Working from home, I like to watch car crash videos on YouTube while I eat lunch. There are so many, it seems everyone has a dashcam these days. Most of the time they don’t show the drivers, but occasionally they do. I saw one the other day where a couple looked at each other right after they’d caused an accident. By the expressions on their faces you just knew what they were saying: “What is wrong with you? Didn’t you see that car coming?"

Think about how it must feel to be that driver. “My bad. I messed up." Multiply that by a thousand and that’s how it might feel to tell your significant other that you’re being sued and you don’t have enough insurance to cover it. Your whole life is about to come crashing down all around you. “My bad" probably isn’t going to cut it. 

Assess your risks and determine whether you need umbrella insurance. Weigh the risks against your displeasure with paying $250 annually for every $1 million in umbrella insurance. That is what it comes down to. 

Finally, consider these two tenets which are equally true: 1) The chance of any of those things happening to you is extremely remote, and 2) Anything can happen to anyone at any time. The choice is yours. Good luck, we’re all counting on you.

The Case For and Against Umbrella Insurance
Photo credit: Pixabay Eggstack News will never post an article influenced by an outside company or advertiser. Our mission is to help you overcome uncertainty about retirement planning and inspire confidence in your financial future.
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MIKE BALLEW
Eggstack founder, Financial Planning Association member, engineer, and software developer.