A Complete Guide to Liability Insurance: Protecting Your Home, Auto, Business & Profession from Common Peril

Picture this: Your daughter is having her 8th birthday party with school friends in your back yard. Everyone is having fun until one child flips off a trampoline and winds up with a broken arm. The irate parents blame you and their lawyer threatens to sue you for a $1,200 medical bill. You can:

• Pay the bill
• Call your insurance company

Accidents happen. Liability insurance covers accidents, damages, and harm on the job, on the road, and at home, with policies available for each category. You can also obtain coverage for claims against your company or professional role.

Do You Need Liability Insurance?

With liability insurance, both you and the injured party are protected financially from unforeseen events that result in harm to body, property, business or reputation. There are different categories of liability insurance, including auto, homeowner, professional and business coverage. The amount you pay for liability insurance varies according to the type of insurance, the amount of coverage you seek, the number and dollar value of claims you make during the time you have the policy, and market-rate variables. Generally, you are insured for incidents covered by your policy that occur and are reported while your policy is in effect. (However, there are exceptions to the report timing rules that vary by policy and state rules.)

Types of Liability Insurance

Here are the common types of liability insurance.

Liability insurance is big business, particularly in the U.S. The insurance industry generates hundreds of billions of dollars annually in premiums from non-life insurance policies (i.e. from auto, homeowner, professional and business liability and property insurance).

As a result, there are many providers for each type of liability insurance. In this competitive environment, policies can differ not only in rates but also in the specifics of what a policy covers — and what it does not cover. Generally, you are insured only for incidents covered by your policy and only those incidents that occur and are reported during the time you have your policy — but as mentioned above, there are exceptions to this general rule. Liability insurance is not designed to pay for damages caused intentionally.

Automotive Liability Insurance

Most people who have a driver's license are familiar with automotive liability insurance — it is mandatory in almost every U.S. state. This insurance provides financial protection for a driver who harms someone else or someone else's property while driving a vehicle. States vary in the dollar value of mandatory coverage, and individual policyholders can purchase coverage beyond the mandatory requirement.

Automotive liability insurance covers injury or damages to third parties and their property. Auto liability insurance does not cover the driver causing the incident who, along with passengers, would be covered to a certain extent by Medical Payments coverage, if included on the driver’s policy. Auto liability insurance does not include the errant driver’s vehicle and property, which would be covered by collision or, in specific circumstances, comprehensive coverages if included on that driver’s policy.

For more on what automotive liability insurance covers (and what it doesn't), see MoneyGeek's Car Insurance 101 guide.

Homeowners Liability Insurance

Homeowners liability insurance provides financial protection for property damage or bodily injury that others suffer in connection with your actions or property. Homeowners liability insurance can have three parts:

• Personal liability
• Medical payments
• Umbrella coverage

Personal Liability Coverage

Homeowners policies are personal liability policies that pay for damage to people injured by your actions or injured while on your property. Most policies cover you, members of your household and household employees.

• What Personal Liability Insurance Covers
  The policy comes into effect if you or one of your insured housemates is found responsible for another party's injury or damage to their property. Your personal liability coverage is in effect whether you or your insured housemates are at home or away. Your policy may also include legal representation so that the insurance company pays for your legal defense in a lawsuit.

• Examples of Personal Liability Coverage Incidents
  Your child throws a baseball through a window; you trim a tree and the falling limb puts a dent in your neighbor's car; or you are sued for your errant golf shot that breaks a golf partner's Rolex.

• Personal Liability Does Not Cover
  You are not covered for intentional injuries or damages. Your policy will likely also include a list of circumstances that are not covered, called “exclusions.” Typical exclusions include injuries and/or damages that are caused by your car, or that are related to your profession, including a home office. Your insurance company will require written notice of any incident, as well as any summonses, notices, or documentation related to the incident.

Medical Payments Coverage

Medical payments policies are optional, typically inexpensive, have zero deductible and are designed to pay relatively small amounts for medical expenses of someone injured on or in connection with you or your property. Medical payments are also a component of auto insurance and umbrella coverage provides extra coverage over both home and auto insurance. The intent and result of this coverage is to prevent the expenses of lawsuits.

• What Medical Payments Policies Cover
  This typically covers ambulance and emergency transport, hospital charges, surgical and medical bills, X-rays and diagnostics, dental and nursing services, for a period of up to three years. Medical payments coverage, or guest medical, is a "no-fault" coverage.

• Examples of Medical Payments Coverage
  A pedestrian trips and falls on your sidewalk and requires stitches and x-rays. Medical payments coverage pays these bills without a deductible, typically.

• Medical Payments Policies Do Not Cover
  Medical payments coverage doesn’t apply to your own medical expenses and the medical expenses of your household residents, except for your household employees. Your policy may include exclusions from coverage for certain medical procedures; check your policy carefully. Incidents away from the covered property address caused by you or your pet would likely be a liability claim.

Umbrella Policies

Umbrella policies are usually in large amounts — $1 million is a common amount — takes over if your homeowners or automobile policy amount isn't enough to cover you for a large loss.

• What Umbrella Policies Cover
  Typically, umbrella policies cover the defense costs and damages awarded in a lawsuit related to damage caused by a traffic accident or an expensive loss that would normally be covered by your personal liability coverage, but exceeds the policy amount. Umbrella policies also cover libel, slander, and defamation of character lawsuits.

• Examples of Umbrella Policies Coverage
  While driving, you are responsible for an accident injuring six people in the other vehicle, with damages totaling $600,000. Your automobile insurance coverage is $500,000. Your umbrella policy covers the remaining $100,000.

• Umbrella Policies Do Not Cover
  Insurance almost never covers intentional actions. Using the above example, if you were overcome by road rage and intentionally rammed the other vehicle, it is unlikely your automobile or umbrella policies would cover you if the other parties filed a claim against you.

What Homeowners Liability Insurance Costs

Liability insurance premiums are based on whether the property has:

• Dog
• Children
• Pool
• Trampoline
• Hazardous conditions such as disrepair

By contrast, the rates for replacement cost are based on a home's:

• Size
• Age
• Neighborhood
• Safety measures such as fire and burglar alarms, safe appliances, LEEDs certification, and so on
• History of property loss or damage

Also, some insurers include extras in their basic policies that others leave for umbrella policies. This is best illustrated with an example.

The following quotes are based on a 931 square-foot, single-family home built in 1939 in the San Francisco Bay Area. Identical information was entered into issuers' Web pages. The purpose of this comparison is not to show which company offers the cheapest or best policy, but to illustrate how tricky it is to compare quotes. Insurers don't agree on what a basic policy contains, the formula for determining the replacement value of homes, the risk factors for neighborhoods, or the values for the other variables that go into your policy premiums.

Homeowners Insurance Quotes for a Sample Home, San Francisco Bay Area

Sources: Farmers, Nationwide, Wells Fargo 2016

As the above shows, you can't compare only the cost when weighing competing liability insurance offers, especially given the fact that the liability element is buried in a policy offer.

Professional Liability Insurance

Professional Liability Insurance provides financial protection for professionals and companies that provide advice and services, and are sued in a civil lawsuit with claims of damages or negligence. In most cases, the professional or company is protecting itself financially from a claim of failure to perform, an error or omission in performance, damage to the brand (advertising harm) or financial harm as a result of a product or service. Professional liability insurance typically includes coverage for legal defense, including cases that are deemed in court to be groundless.

Most medical practitioners, lawyers and their firms are required by law to carry professional liability insurance. Sometimes companies require professional liability insurance as a condition of a contract between the company and those who provide advice, services or products.

In the medical field, professional liability insurance is malpractice insurance. In other fields, including insurance, law, financial services, accounting, construction, and real estate, the most relevant form of professional liability insurance is called Errors and Omissions (E&O) Insurance.

Professional liability insurance is separate from general liability insurance, which covers personal and bodily injury and property damage.

• What Professional Liability Insurance Covers
  Professional liability insurance typically covers claims of negligence; misrepresentation of goods or services; inaccurate or harm-causing counsel; and violation of the “good faith” terms of an agreement or contract.

• Examples of Professional Liability Insurance Coverage
  A tax preparation firm or professional would need a liability insurance policy if a client claimed financial harm, alleging their tax returns were improperly prepared.

• What Professional Liability Insurance Does Not Cover
  Professional liability insurance policies often differ in what is and what is not covered. Generally, policies restrict coverage to claims made during the policy period through what is called a claims-made basis. If a policyholder drops coverage, even for a limited period of time, any acts that originated under the initial coverage period are invalidated. Insurance companies may offer a tail provision, for an additional premium, that provides coverage specifically for events that occurred during the regular policy period but are not reported until after the policy terminates.
  
  Professional liability insurance does not include coverage for criminal prosecution, nor does it cover defamation claims like libel and slander, breach of contract or warranty, employer liability, or personal injury. In most cases, professional liability insurance does not cover data breaches and other technology issues.

What Professional Liability Insurance Costs

Professional liability insurance rates are based on your profession, the state in which you work/are headquartered, and the specific areas of coverage you choose. Your choices will likely include: claims of negligence, alleged damages, and legal defense costs.

The following examples are based on a marketing consulting company in the San Francisco Bay Area. These E&O policies, which include legal defense, cover negligence, damages, brand damage/libel and slander, copyright infringement, and punitive damages caused by officers, staff, or temporary or contract employees. The quotes do not include general business liability insurance.

Sources: GEICO, Progressive, Insureon 2016

Business Liability Insurance

Business Liability Insurance provides financial protection in the event of a lawsuit or third-party claim of physical injury or property damages caused by you, your employees or your business operations. Business liability insurance is also called Business General Liability (GL) or Commercial General Liability (CGL) insurance.

In some industries, like construction, business contracts often require liability insurance coverage. Businesses in these higher-risk categories may choose to add vendors and subcontractors to their liability policy for the duration of a contract. A certificate of insurance (COI) is used to verify and summarize insurance coverage for your business as proof of insurance is often required for clients in specific industries.

• What Business Liability Insurance Covers
  Business liability insurance typically covers claims of physical injury, including medical bills; damages to property; and harm from false or misleading advertising. Business liability insurance covers the cost of legal defense and, if a firm is successfully sued, any settlement or award like compensatory damages, nonmonetary losses, and punitive damages. Even as a corporation or an LLC, a business owner may be financially liable for claims. If a business already has professional liability or business owner insurance, the business should structure its business liability insurance policy to avoid costly duplications.

• Business Liability Insurance Examples
  Some businesses are legally or contractually required to purchase specialized forms of business liability coverage. For example, bars and restaurants serving alcohol need alcohol liability insurance. Businesses that work with or produce toxic materials need environmental and pollution liability insurance. Manufacturers need product liability insurance.

• What Business Liability Insurance Does Not Cover
  General business liability insurance does not cover property, workers' compensation, or state disability, which are separate types of insurance coverage that may be required by state or federal law.

What Professional Liability Insurance Costs

Business liability insurance rates are based on the type of business, the state (settlements are much higher in some states than others), the specific areas of coverage you choose and the financial caps on coverage. For businesses that have higher-risk operations, insurance companies typically offer Excess or Umbrella policies that provide higher financial caps, for an additional premium.

The following examples are based on a real estate agency in the San Francisco Bay Area. These policies include legal defense and cover claims of bodily injury and medical expenses, damage to someone else's property, libel and slander, copyright infringement, and punitive damages based on actions by officers, staff or temporary or contract employees.

Business Insurance Costs for a Small Business

A Tricky Decision for Businesses: Occurrence vs. Claims-Made Policies

Businesses purchase liability insurance to provide financial protection against lawsuits. Most insurance companies offer policies on an occurrence basis, meaning they agree to cover claims made and/or reported during the time in which an insurance policy is in effect. Policies that are based on occurrences limited to the policy period are called claims-made policies.

However, a business may face a lawsuit concerning an incident that occurred prior to the policy period. If the business has a policy on an occurrence basis, the insurance company is not required to cover the claim. A second possible scenario is that an incident occurs wherein a customer is injured or property is damaged, but the injured party does not choose to file a lawsuit — not yet. The fact of the incident creates a business risk that the injured party may file a lawsuit sometime in the future, at a time when the business may or may not have liability insurance. These are called long-tail claims, in insurance jargon.

As a result, many businesses now routinely report incidents to their insurance carrier as potential claims, even if the incident has not generated a lawsuit. The upside of this practice is that it protects the business from lawsuits at a future date since the potential claim has been registered with the insurance carrier. The downside of this practice is that it can increase the business's insurance premium.

A second problem with reporting a potential claim arises when a business seeks to change its insurance provider. Once the business makes a change, the original provider will no longer be required to cover the claim; and the new provider will likely be reluctant to cover claims from a prior period. If it does, the new carrier is likely to charge a premium price for the coverage.

One potential strategy for businesses facing high liability insurance costs is to negotiate a policy with a deductible, which can lead to a lower insurance premium. This approach is called Self-Insured Retention (SIR). With SIR, the business pays out-of-pocket for smaller claims and retains the insurance company for larger claims.

Where to Buy Liability Insurance

There are more than 2,700 liability insurance providers in the U.S. — but 25 insurance companies provide more than 50 percent of all the business. Most people are familiar with the biggest brands, which include Allstate, State Farm, GEICO, Nationwide, Progressive, Liberty Mutual, and Prudential.

The large number of providers is explained by the industry practice of independent insurance agencies that represent multiple insurance providers and a newer phenomenon of online services that offer quick quotes.

For any type of liability insurance — auto, homeowner, professional, and business — a consumer can get a quote within a matter of minutes, or with independent agents, within a day. The more pressing need for the purchaser is to carefully assess the value of one's possessions, the cost to replace it, and the likelihood of an incident that puts those possessions at risk. With that information in hand, you will be able to get an insurance policy that best suits your needs.

Reader Resources

Automotive Liability insurance

• Shopping for Automobile Insurance
  Published by the Illinois Dept. of Insurance, but offers information and advice applicable to automobile owners in every state.

• 10 Things You Should Know About Buying Auto Insurance
  National Association of Insurance Commissioners tells you where and how to shop for auto liability insurance, including smart tips about discounts and optional coverage.

Homeowners Liability Insurance

• 12 Ways to Lower Your Homeowners Insurance Costs
  The price you pay for your homeowners insurance can vary by hundreds of dollars. Learn 12 things to consider when buying homeowners insurance.

Professional Liability Insurance

• Decision-Making Tips for Buying Professional Insurance
  What to look for in a professional liability policy and what coverage differences there are with different carriers, complete with a comparison guide.

• Medical Liability Insurance Shopping Guide
  Published by the Texas Dept. of Insurance, but offers helpful shopping advice for medical professionals in all states.

• Guide to Purchasing Lawyer's Professional Liability Insurance
  The Virginia State Bar Association's tips on how to compare policies, what are must-haves and what are options are pricey. (A Microsoft Word file.)

Business Liability Insurance

• Five Tips for Buying Business Insurance
  Steps to assess what types of insurance are best for a business, and how to secure coverage to provide adequate protection and minimize risks.

• 4 Key Tips When Buying Business Insurance
  For the self-employed, risk has a personal financial dimension. This is a guide to making sure you are properly covered.

Fun Facts About Liability Insurance

2 Types of Automobile Liability Insurance

Most states require you to buy bodily injury and property damage liability insurance, which covers you when you're at fault in an accident.

1 Out of 3 Dog Bites

Dog bites account for around one-third of all homeowner insurance liability claim dollars each year.

1 Out of 900 Relatives

1 out of 900 homeowner liability insurance claims are in regards to a family member or a relative's claim against another family member (according to the last count in 2017).

Good Ol' Ben

In 1752, Ben Franklin started the first modern insurance company in the U.S., called the "Philadelphia Contributorship for the Insurance of Houses from Loss by Fire." The company still operates today.

Billions for a Big Blow

One of the largest insurance payouts in history followed the eruption of a volcano in Iceland, leading to a payout of $3.4 billion.

Saving Private Spielberg

American film director Steven Spielberg is insured for $1.2 billion.