What is Umbrella Insurance and How Does it Work?

Imagine. Mary Poppins floats down onto your front lawn to attend a party. She snaps shut her umbrella and strolls in for some games and hors d’oeuvres. But before she can even reach the charcuterie board, she trips on a stray croquet ball and smashes her tailbone, shouting supercalifragilisticexpialidocious! Next thing you know, ol’ Mary pulls a lawsuit out of her carpet bag and threatens to sue you for millions.

After years of hard work, your whole estate’s at risk! While Mary’s umbrella might protect her from the rain, what can possibly protect you from Miss Poppins’ lawsuit? The good news is, you can have your own financial umbrella to protect you from life’s rainy days with umbrella insurance.

What is umbrella insurance? An umbrella policy protects you from lawsuits and large claims that your homeowners or auto insurance policies don’t cover.

I’ll answer all your questions about what umbrella insurance is, how it works, and what it covers. It’s pretty much your money’s best friend.

What Is Umbrella Insurance?

Umbrella insurance is a form of personal liability coverage that protects you (plus your family and other household members) from large claims or lawsuits that go above your other insurance policies.

To understand that fully, we need to talk about your auto and homeowners policies. You probably know they cover damage to your car and home, but they also provide personal liability coverage if someone gets injured on your property or if you injure someone (or their property) in a car accident. But that coverage has limits. Typically, the highest you can set your liability limit is $500,000. A lawsuit could bust through those limits pretty quick.

So, what can you do?

An umbrella insurance policy helps fill gaps in your primary liability insurance like homeowners, auto and even boat insurance. 

How Does Umbrella Insurance Work?

Umbrella insurance works by stepping in to cover any legal or medical fees or lawsuit payouts that are higher than your other insurance liability limits (for most people, that’s auto and homeowners).

If you injure someone in a car accident and they sue you for a million dollars, your car insurance liability will only pay for up to $500,000 (or whatever your policy says) and umbrella will pay the rest.

Let’s look at a real-life example of an umbrella policy in action.

Example of an Umbrella Insurance Policy

Say you’re driving home after visiting family for Thanksgiving. You’re still in a food coma from four slices of Aunt Gayle’s chocolate pecan pie, traffic’s bad, and you end up in a horrible pileup. Other people got some bumps and bruises, but you’re physically okay. But it gets worse when you find out the accident was your fault.

Now what? You’re liable for the vehicle damage and medical bills of all the other drivers in the accident. (Ouch!) Two of the drivers sue you for lost wages from missing work. (Oh boy.) And you’re suddenly looking at a $800,000 bill. You have your car insurance liability limit as high as it goes, but it still only takes care of $500,000, and that means you have to foot the other $300,000! Yikes.

Let’s hope you had umbrella insurance. It would swoop in and take care of the $300,000, including legal expenses. Talk about a game changer for your savings and assets. That’s the power of an umbrella policy. It prevents you from wiping out your savings or going back into debt.

Homeowners insurance works the same way.

So, if you host a huge Christmas party and good ole’ Mary slips on a rollaway Christmas ornament and sues you, you’ll be covered for any legal fees or court judgments (if you lose the lawsuit) above and beyond your home insurance liability limits.

And one more piece of good news. In most cases, there’s no separate umbrella insurance deductible. Once you pay your primary policy deductible (auto or homeowners), you won’t have to pay it again. But there can be exceptions to this—some policies have an umbrella deductible, known as self-insured retention, that’s normally in the range of $250–500, but can go as high as $10,000.

What Does Umbrella Insurance Cover?

So, what’s under the umbrella? What does umbrella insurance cover? If you have an umbrella insurance policy, you’re protected in these five main areas:

Bodily Injury

Picture this. Your kids decide to host a neighborhood trampoline party, and one of those kids breaks their arm. Well, umbrella insurance has you covered. It’ll help with medical bills or lawsuits (if the parents get really upset).

Bodily injury protection also covers things like pet incidents (dog bites), car accidents and sports accidents (if you put me in a pair of skis, someone is getting hurt). So, if you decide it’s time for a black diamond and things get out of control, you’ll be covered if that 70-year-old man tries to sue you, claiming you took him out. (Google “Gwyneth Paltrow ski crash trial” if you don’t believe this is a thing.)^[1]

Legal Fees

Lawyers are expensive. So if someone sues you—whether it’s justified or not—you could be facing some pretty hefty legal fees. And the last thing you want is to pay out of pocket to defend yourself. Don’t let others take a piece of your wealth—get an umbrella policy.

Injury to People’s Reputations

Slander. Libel. Defamation. These are just a few of the tasty treats awaiting you if you like to leave online reviews and Bonnie Baked Good decides you were too hard on her brown butter ganache yuzu tarts.

Think I’m making this up? It happens.^[2]

If you damage someone’s reputation, even if it’s online, you could be sued for all you’re worth. Umbrella insurance will protect you if you’re at risk of any slander, libel or defamation lawsuits. This kind of coverage is especially important nowadays with everything that goes on in social media and online.

Property Damages

An umbrella insurance policy covers you if you get into a bad car accident and the repair costs to people’s property are more than your car insurance’s liability limits. It even covers rental equipment, like if you crash a rented Jet Ski into the dock (not that I’ve done that, but it was dang close.) Or if your kid accidentally damages school property, you’re covered.

Rental Property

If you own rental property, umbrella insurance can give you extra coverage from liability you have as a landlord. So, if someone breaks their ankle on the steps of your rental property and sues, you’ll be protected.

What Does Umbrella Insurance Not Cover?

Umbrella insurance doesn’t cover everything. Here are some of the incidents that fall outside that umbrella:

Personal Property

When it comes to you accidentally damaging your own stuff, umbrella insurance won’t help with that. This is because it’s a liability policy, meaning it only kicks in if you’re at fault for harming other people’s property. So, if you thought driving your motorbike into the pool was a good idea because you just watched Hot Rod again, and now the oil and gasoline and brake fluid have damaged your pool, don’t expect an umbrella policy to cover the repair costs (or your waterlogged bike).

Intentional Harm

If you hurt someone on purpose or damage their property intentionally—what is wrong with you? And also, umbrella insurance isn’t going to bail you out. You’ll be paying those medical bills or lawsuits out of your own pocket. Just another reason crime really doesn’t pay . . .

Water Damage

A lot of people assume flood damage is covered by property insurance. Well, they’re wrong. And umbrella insurance won’t help either. If you live in an area prone to flooding, you need separate flood insurance.

That said, if you accidently leave the bathtub faucet on, flood your apartment, and your neighbors take you to court for water damage in their apartment . . . you might need adulting lessons. But on the bright side, umbrella insurance covers lawsuits in that situation.

Business Incidents

If you own your own business, a personal liability umbrella policy won’t help with those kind of liability incidents. You need commercial insurance for that (sometimes called commercial umbrella insurance).

Contracted Worker Injuries

If you’re remodeling your home, make sure your contractor carries their own insurance. This is because your umbrella insurance policy won’t cover you if a worker gets hurt on your property.

Some people accidentally sign a contract that makes them liable for the workers. The moral of the story? Read the fine print. And while we’re talking about construction companies, umbrella insurance also won’t help if you’re sued for not keeping your end of the bargain in a contract.

War-Related Expenses

World War III? The zombie apocalypse? Umbrella insurance won’t touch war-related expenses (it’s not that big of an umbrella, folks). So don’t expect your umbrella insurance policy to pay for damages to your belongings or property if they’re blown to kindom come.

Who Needs Umbrella Insurance?

Now, you might still be wondering how to know if you need umbrella insurance. Here’s a good rule of thumb: If you have a net worth higher than $500,000, you definitely need an umbrella policy.

Or if you’re making good money, starting to build up some wealth in your retirement accounts, and have a paid-for home or a good chunk of equity, you also need it. Without it, you’re setting yourself up for financial risk.

Basically, the more assets you have, the more you have to lose. And a lot of people are willing to sue over just about anything these days, so wealthy folks often have a target on their backs.

If someone suffers a serious injury on your property or winds up in a car accident that was your fault, how much do you think you could be sued for?

$500,000?

$1 million?

$5 million?

More?

The answer to all of those is yes.

But with a rock-solid umbrella insurance policy, you won’t be up in the middle of the night worrying about some gold-digging house guest cooking up an expensive lawsuit to wipe out your hard-earned wealth—or who you might have offended on the internet. You’ll have peace of mind knowing your money is protected.

How Much Umbrella Insurance Do I Need?

Now let’s take a look at how much umbrella insurance you might need.

Umbrella insurance starts at $1 million worth of protection. You might think that’s enough, but now’s not the time to skimp—just like it wasn’t the time when you paid your nephew in Skittles to photograph your wedding.

The rule of thumb is that your umbrella policy should cover your entire net worth. You might need more than the $1 million minimum coverage if more than two of the following apply to you:

• You own property
• You have recreational vehicles (Jet Skis, dirt bikes, etc.)
• You have an inexperienced driver in your household
• You coach kids’ sports
• You regularly invite people over to your home
• You have “attractive nuisances” to a curious child (trampoline, pool, etc.)
• You drive a luxury car
• You serve on a board or nonprofit
• You regularly post reviews of products and businesses
• You participate in sports where you could injure others (hunting, skiing, etc.)
• You frequently travel outside the U.S. and worry about liability claims
• You are a landlord
• You have a public profile of success and wealth

After you’ve calculated your assets, ask yourself, How much risk do I have of being sued? Chances are, you’re more at risk than you think.

How Much Does Umbrella Insurance Cost?

For the amount of coverage you get, the price of umbrella insurance is dirt cheap. You can easily get $1 million of coverage for around $150 to $300 a year.^[3] People spend more at Starbucks in a year, so no excuses here!

What Factors Determine the Cost of Umbrella Insurance?

A couple different things go into the cost of umbrella insurance. Your individual rate will depend on factors like where you live and how many homes, vehicles or boats you need to insure. People also play a role—we’re talking residents and drivers (inexperienced drivers cost more).

You’ll also obviously pay more if you need higher amounts of coverage. Your umbrella insurance cost will be much higher if you need a policy worth $10 million.

A $1 million policy is where you get the best deal. But no matter how much you need (and how much it costs), you still need it.

Average Umbrella Insurance Limits by Carrier

Most umbrella insurance is available in $1 million limit increments of coverage. That means you can buy a policy for $1 million, $2 million, $3 million . . . all the way up to (in one company’s case anyway) $100 million! If you need $100 million in umbrella insurance, hats off to you. Standing ovation. Drinks all around. And you’re paying.

What Do I Need to Qualify for Umbrella Insurance?

Most insurers don’t let you get a stand-alone umbrella insurance policy. You’ll need auto or home liability insurance in place first.

And you’ll need a certain amount of liability in those other policies. Most insurance companies require you to have $250,000 in auto insurance liability and $300,000 for your homeowners insurance.^[11] So keep in mind, you might end up paying a little more on your auto or home insurance premiums to get umbrella insurance.

Here are two examples of different carriers’ minimum limit requirements:

How to Buy Umbrella Insurance

If you have wealth, you’re at risk of being sued. It doesn’t matter how nice and friendly you are, there are suit-happy fraudsters everywhere. And it definitely doesn’t matter how much time and energy you’ve put into getting out of debt, building savings, and growing your investments. All it takes is one nasty lawsuit to take it all away.

For Marc J., the peace of mind that comes with umbrella insurance didn’t even cost him very much.

“Our $1 million umbrella is $131 per year through a RamseyTrusted pro bundled with our home and auto,” he said on the Ramsey Baby Steps Facebook Community Group. “The minimal cost net of what it lowers my homeowners and auto insurance to is more than worth it for me to transfer any additional risks to protect our assets.”

-Marc J.

If your net worth is above $500,000 and you don’t have umbrella insurance, what are you waiting for?

Sitting down with a RamseyTrusted insurance pro can take the mystery out of any kind of insurance—including umbrella coverage. They’ll be sure to help you understand what’s covered—and what isn’t—while getting you all the coverage you need to protect your assets.

Plus, working with an independent agent who isn’t tied to one insurance company might help you save money. That’s because they can shop around for rates from dozens of different companies and find the best deal for you. They might even be able to bundle umbrella insurance for a bigger discount.

Don’t put this off! Now that you’ve got the answer to What is umbrella insurance?, protect your assets today and experience the peace of mind that comes from knowing your wealth is off-limits to other people.