What it means
Most liability policies have a maximum payout. If a car accident causes $1,200,000 of damages and your car insurance limit is $300,000, you would personally owe the rest unless you have further cover.
An umbrella policy fills that gap. It does not replace the underlying policies, and it only starts paying when their limits are used up, which is why it is called an umbrella that covers everything below it.
Insurers usually insist that you hold certain minimum limits on the underlying policies before they will issue an umbrella. If you let those limits fall, you may be left with a gap that the umbrella does not cover, and you could have to fund the difference yourself.
Umbrella cover comes in blocks, often $1,000,000 at a time, and the premium for the first block is typically modest compared with the protection it gives. Further blocks usually cost less per block, which makes it economical to buy a higher limit.
Businesses use commercial umbrella or excess liability policies for the same purpose, sitting above general liability, auto and employer liability policies. The terms and the extent to which the umbrella follows the underlying policy differ, so wording matters.
Umbrella policies have exclusions, such as damage you cause on purpose and certain business activities if the policy is a personal one. Read the policy to confirm what is covered, and check whether defence costs are paid on top of the limit or inside it.
In practice
Real-world examples.
Example
A family with two cars and a swimming pool buys a $2,000,000 umbrella policy. A teenage driver causes a serious crash with claims reaching $1,500,000. The auto policy pays its $500,000 limit and the umbrella pays the remaining $1,000,000.
Example
A small manufacturing company holds $1,000,000 of general liability cover. It buys a $5,000,000 commercial umbrella because its customers' contracts require higher limits. The umbrella costs far less than raising the limit on the underlying policy. The company shows the certificate of insurance to its customers when they ask for proof of cover.
Example
A landlord who owns four rental properties buys an umbrella policy after a tenant's visitor is injured in a fall. The extra cover protects both the properties and the landlord's savings. He also keeps his underlying policy limits at the level the insurer requires. At each renewal he checks that the umbrella limit still matches the value of what he owns.
Formula
Calculation
Umbrella payout = the smaller of (claim - underlying limit) and umbrella limit, when the claim exceeds the underlying limit
A homeowner faces a lawsuit after a guest is seriously injured, and the court awards $1,200,000. The underlying homeowner policy has a liability limit of $300,000, and the umbrella limit is $1,000,000.
Amount above the underlying limit = 1,200,000 - 300,000 = $900,000.
Umbrella pays the smaller of 900,000 and 1,000,000, which is $900,000.
The underlying policy pays $300,000 and the umbrella pays $900,000, so the whole $1,200,000 is covered and the homeowner pays nothing out of pocket. Without the umbrella, the homeowner would have owed $900,000.Case study
Seen in the real world.
Hollis Joinery is a fictional carpentry business, and this is an illustrative case. It carried $1,000,000 of general liability insurance and had never needed to claim.
A customer fell from a staircase that the business had built and suffered a serious injury. The claim was settled at $3,400,000, which was far more than the underlying policy. Because the owner had added a $5,000,000 umbrella policy for an annual premium of $2,800, the umbrella paid $2,400,000 on top of the $1,000,000 from the primary policy.
Without the umbrella, the business would have faced a bill of $2,400,000, likely ending the company. The illustrative story shows the point of an umbrella, which is protection against the rare, very large claim at a modest cost. The owner now reviews the limit every year, because the business has grown and the cost of serious injury claims tends to rise over time.
Watch out
Common mistakes.
- Assuming an umbrella pays first. It only responds after the underlying policy limits have been used up.
- Letting the underlying limits drop below what the insurer requires. This can leave a gap that you have to cover yourself.
- Assuming it covers everything. Exclusions, such as intentional acts, still apply.
Questions
People also ask.
How much umbrella cover do I need?
A common approach is to match your net worth and future earnings at risk, then compare with the premium. An adviser can help set the figure.
Does it cover my own injuries or damage?
No. It is liability cover for harm you cause to others, not insurance for your own property or health.
Is it expensive?
The first million of cover is usually inexpensive compared with the amount of protection it gives.
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