Personal Liability Insurance: Small Cost, Big Protection with Umbrella Policies

Most people don't think much about personal liability insurance — until someone slips on their sidewalk and threatens to sue. Whether you know it or not, you likely already have some type of insurance that protects you in case you're liable for an accident or an injury. This sort of coverage is often bundled with car, homeowner's or renter's insurance. Still, you may want to add additional liability coverage through an umbrella policy. Not only are umbrella policies relatively cheap, they even cover accidents outside the home — such as a weekend softball game when your errant throw hits someone in the face. This guide explains how personal liability insurance works and how you can use it to protect yourself and your finances.

Here are some real-life crises in which you might need umbrella coverage.

Coverage for an umbrella policy generally starts at $1 million, although insurance companies will sell you more protection at a price. You may in fact want to go higher. The policy can protect your future earnings as well as your life savings. Personal liability umbrella policies can protect you if you are sued for:

• An accident you're involved in on your property or somewhere else
• Slander and libel
• False arrest, detention and/or imprisonment
• Abuse of process
• Accidents that occur on rental property
• Malicious prosecution
• Shock and mental anguish
• Wrongful eviction and wrongful entry

The good news: Umbrella policies are relatively inexpensive, especially when compared with the coverage that they can provide.

Some liability coverage is automatically included in all homeowners and renters insurance policies, but umbrella coverage is good if you have a high net worth," says Illinois independent insurance agent Adam Rothschild of the Rothschild Agency says. "You should buy as much liability coverage as you can afford. The court can determine how much you need to live and garnish your wages until your judgment is paid off. That could take years, maybe decades." Asked who else should consider buying umbrella insurance, Rothschild has one word: "Everybody".

Personal liability policies hover around $400 annually for $1 million of umbrella coverage. The reason for the low cost compared to other types of insurance coverage is that the policy picks up where your homeowners or renters insurance leaves off.

That is, if your homeowner's insurance pays for $500,000 worth of damages and your umbrella policy covers $1 million worth, you won't tap into the umbrella policy until your regular homeowner's insurance has kicked in $500,000. Because few people are sued for home accidents and even fewer for more than $500,000, insurance companies can afford to keep their rates low.

But big claims do happen. About 13 percent of personal injury liability settlements and court-ordered awards are $1 million or more.

If you own a small business, you might even want to check into a commercial umbrella policy, which provides extra liability coverage in addition to your company's existing policies. Adding $2 million of commercial umbrella coverage to an existing $1 million general liability policy, for example, would effectively provide up to $3 million in protection.

Although an umbrella policy covers many costly risks, it doesn't protect you from risks related to your own business (even if you operate it from your home). This includes babysitting and child care services you provide in the home.

Here are some other scenarios a personal liability policy doesn't cover:

• High-risk use of your vehicle, such as drag racing
• Using tractor trailers or farm tractors(unless you buy rider insurance that specifically covers these vehicles)
• Fines and penalties for breaking the law(such as drinking and driving and, in many states, texting and driving)
• Intentional damage caused by you or a member of your household
• Additional health insurance
• Intentional acts such as discrimination, sexual harassment and vandalism
• Damages arising out of business or professional pursuits(unless you have a separate commercial umbrella policy)
• Liability you accept under the terms of a contract or agreement
• Damage covered by a workers' compensation policy
• Liability resulting from war or insurrection
• Liability related to the ownership, maintenance and use of aircraft, certain watercraft such as skis and air boats, and most recreational vehicles

Your policy may have other exclusions, so be sure to read it carefully. Ask your agent if you have any questions.

Civil suits cost the U.S. economy $233 billion each year, according to the American Association for Justice. The average compensation payout for a civil injury suit is $60,000. The average awarded in a punitive damage lawsuit is $50,000. Most of us don't have that kind of money to spare.

A report by ACE Private Risk Services shows that wealthy families often underestimate the risk to their lifestyles by not carrying enough liability insurance. The ACE report notes that judgments in some U.S. civil cases have run into tens of millions of dollars.

The legal entanglements can get complicated. Some states, like California, require the court to compare the level of fault between all defendants in an injury lawsuit. This means the cash damages are assessed in proportion to the fault of each defendant. However, the plaintiff lawyer's strategy will be to get most of the blame laid on the wealthiest defendant, so the richest defendant could get saddled for most or all of these damages.

The ACE report cites these annual average costs for umbrella liability coverage in different amounts and scenarios:

• $383 for $1 million in coverage for a household with one home, two cars and two drivers
• $474 for $2 million in coverage
• $608 for $5 million in coverage
• $999 for $10 million in coverage
• $1,578 for $10 million in coverage if the insured also has 2 additional homes, 4 cars, a boat under 26 feet, and one driver younger than 25.

Working with an independent insurance agent can help you determine the right amount of coverage needed for your family. An agent can also help with quote comparisons and finding discounts on multiple policies.

Can you be turned you down for umbrella coverage, even though you have homeowners liability and auto insurance and have been faithfully paying your premiums? Yes. Insurers may refuse to sell you umbrella coverage if you have a trampoline, a pool with a diving board or other potentially hazardous property, according to the International Risk Management Institute (IRMI).

IMRI notes that companies may also deny umbrella coverage to people with poor driving records or with homes that have fallen into disrepair.

If you're turned down, keep shopping: Another company may be willing to sell you a policy, although you may have to pay a few extra hundred dollars a year.

When you've decided to add umbrella liability coverage, consider:

• Your net worth
  An umbrella policy usually starts at $1 million. You want a policy at least equal to your net worth and ideally more in case you are ever hit with a financially catastrophic court judgment that could impact future income, well beyond your current net worth. Talking to a lawyer who specializes in wealth protection or a financial advisor is the first step in determining your actual net worth.

• Your credit history
  Expect to pay more on insurance if you have a low credit score. Insurance companies may assign you to a higher risk pool, which will increase your cost.

• Driving history for all family members
  Umbrella policies cover every member of the household, so each driver in the family will be evaluated for risk. Having teenage drivers will affect your rates even if they've never been in an accident.

• Individual risk profile
  Do you like to throw a lot of parties where alcohol is served? Do you own a boat, aircraft, ATV or snowmobiles? You may have to pay a larger premium.

• Location
  Where you live can affect premiums. It's generally more expensive to buy insurance in urban areas with a high crime rate. If you've had other insurance claims, this may drive up your costs as well

• Who you buy from
  It may be cheaper to buy umbrella coverage from the same company that provides your homeowners or renters insurance. Shop around, making sure you're getting equal levels of coverage among different companies.

Adam Rothschild is an independent insurance agent and risk manager at the family-owned Rothschild Agency in Merrilville, Indiana.

• Insurance Information Institute
  Insight on buying personal liability umbrella coverage from the national organization dedicated to improving the public's understanding of the insurance business and how it works.

• Find an Independent Insurance Agent
  Database of independent agents searchable by zip code through the Independent Insurance Brokers and Agents of America. Always work with an insurance agent licensed to do business in your state.

• Umbrella Insurance Basics
  Information from the International Risk Management Institute covering a broad range of umbrella insurance scenarios.

• Risks of not having umbrella coverage
  A rundown of worst-case scenarios and information about umbrella policies from the American Institute of CPAs.

• Consumer Alert Homeowners Insurance Checkup
  Things to consider when renewing an insurance policy, including whether to expand coverage with an umbrella policy, published by the National Association of Insurance Commissioners,the US association of state insurance regulators.