What Is Umbrella Coverage and Why Should Your Customers Buy It?

I came across this comment in a social media group that I subscribe to. Someone was lamenting that their personal umbrella premium went up. As I read the post, I noted that even with the premium increase, that person was paying a fairly reasonable amount of money for plenty of coverage. All in all, anyone that shops for umbrella liability (especially personal umbrella) policies should find that they are not very expensive and significant limits are available.

Have you ever wondered why umbrella policies can be less expensive? It has much to do with the reason that other insurance can be very expensive. It’s the claims. Most primary policies (the personal auto and homeowners, for example) are priced in part based on the claim history for the class of insured and the policy type and limits. Umbrella insurance normally works in the same way, but the opposite direction. The lack of claims makes them less expensive.

Businesses often purchase umbrella liability. They might buy it because of a contractual obligation, or simply to get higher limits than are available in their primary liability layer. But why should individuals consider an umbrella liability policy? Should only those ultra-rich customers consider buying umbrella liability? The answer speaks to the needs of the individual customer and the purpose of an umbrella policy.

What is an Umbrella Policy?

Contrary to the comments in the social media post, an umbrella policy doesn’t cover damage to your umbrellas, but the image works. An umbrella is intended to cover a range of policies and exposures.

An umbrella policy first provides coverage over other lines of insurance. Most liability policies provide specific coverage, such as the liability portion of the personal auto policy only provide coverage for the liability associated with the operation of an auto that is covered by the policy. The liability portion of the homeowners’ policy provides coverage for those personal liability exposures that a person has, not including the exposures related to the ownership, use or maintenance of an auto.

Umbrella policies provide coverage over all of these policies. You know that you need to examine and read the insurance policies that your clients have and those that they are considering to understand how their coverage might apply, but let’s look at ISO’s Personal Umbrella Liability Policy (DL 98 01 02 15). The insuring agreement and a few definitions show us how coverage might apply. We are not examining the whole policy, just the insuring agreement and a few definitions.

Insuring Agreement

We will pay damages, in excess of the “retained limit”, for:

1.”Bodily injury” or “property damage” for which and “insured” becomes legally liable due to an “occurrence” to which this insurance applies; and

2.”Personal injury” for which an “insured” becomes legally liable due to one or more offenses listed under the definition of “personal injury” to which this insurance applies.

The first thing that we note about the insuring agreement is that coverage applies to damages in excess of the retained limit. This is telling us that this policy takes up coverage after a certain point above this retained limit as it is defined in the policy. Let’s look at (part of) that definition.

“Retained limit” means:

1.The total limits of any “underlying insurance” and any other insurance that applies to an “occurrence” or offense which:

a. Are available to an “insured”; or

b. Would have been available except for the bankruptcy or insolvency of an insurer providing “underlying insurance”; or…

You caught me. I didn’t give you the whole definition, but that was on purpose. We’ll get to it, but this first part serves our initial purpose. The retained limit includes the limits of something that the policy calls “underlying insurance.” If we weren’t insurance people, we would already assume that we know what that means. But we are, so we don’t. We look.

“Underlying insurance” means any policy providing the “insured” with primary liability insurance covering one or more of the types of liability listed in the Declarations and at limits no less than the retained policy limits shown for those types of liability listed in the Declarations.

As we look at these provisions, we see that the umbrella liability policy is designed to pay damages that exceed the underlying insurance limits. The umbrella carrier will require that certain limits be maintained, but if the client needs an umbrella policy, they should already be interested in maintaining those underlying coverages at the level required.

Umbrella liability policies can also provide coverage beyond the coverages provided by the underlying insurance. There was a part of the definition of retained limits that we didn’t look at yet. Now’s the time.

“Retained limit” means:

2.The deductible, if any, as stated in the Declarations, if the “occurrence” or offense:

a. Is covered by this Policy; and

b. Is not covered by “underlying insurance” or any other insurance.

The rest of the definition of retained limit provides us with coverage for other exposures that are not covered by any other insurance as long as it isn’t excluded in this policy. This is the biggest difference between an umbrella policy and an excess policy. An excess policy provides only excess coverage over the underlying insurance while an umbrella may provide broader coverage than the underlying insurance.

Why Buy an Umbrella Policy?

The simple answer to this question goes back to why we buy insurance in the first place. We buy insurance to protect assets that are at risk and that we cannot absorb those losses and maintain operations at their current level. That sounds like a business answer but consider a family or an individual like a business.

A family has a budget. There is money coming in and money going out for different things. There is money that goes out for regular expenses, such as a mortgage, vehicles, insurance and food. There is money that gets set aside for a rainy day, because the rain comes. There is also money that goes out for debt service and for future expenses, like college for the kids or retirement.

In making these budgets, families must decide what kind of losses they can absorb. That’s where insurance in general and the umbrella policy specifically come into play. Someone should buy an umbrella policy to protect their assets from their liability exposures. Keep in mind that liability policies are designed to pay money that the insured becomes legally liable to pay. Without insurance, the insured has to come up with that money somewhere.

Who Needs an Umbrella Policy?

At this point, you might be thinking that only those people who have a big pile of money need an umbrella policy, but let’s think this out a little. Anyone that has assets should want to protect them, including the one asset that we all have, but none of us can quantify, our time.

It’s easy to quantify the assets of an individual or family when you look at the balance sheet of their lives. If you take what they own and subtract what they owe, you end up with their net worth in that moment. That simple measure is an indicator of where they might start selecting liability limits.

Yet, this is also the place to take into account the lives of the client. Is their income increasing? Consider the possibility that a child starts driving and with their new license in hand, takes a car out for a ride to enjoy the freedom of the open road. Then the unthinkable happens and she causes an accident where there are several damaged vehicles, and many people are seriously injured or killed. The liability from that could easily extend beyond the limits of the primary auto policy. Once those limits are exhausted, the liability isn’t just erased, the money has to come from somewhere. That could be a personal umbrella policy.

While that situation might seem unlikely, the point is that the umbrella policy, like the primary liability policies, is designed to protect assets in the event of an unlikely situation. So the question comes back to who needs an umbrella policy? Don’t only look at the current assets and situation but look ahead five to 10 years into the future to see what might be out there and then answer the question about what assets need to be protected.

What Should You Watch For?

No two policies are the same so it’s worth paying attention to the details. Without discussing specific details of policies I haven’t read yet (but I am willing to read them), here are a few thoughts about what to watch for in an umbrella policy.

Watch for a form-following umbrella. This is really what it sounds like. To be fair and to the point, the rise of excess policies has made form-following umbrellas a little less easy to spot. In short, a form-following umbrella will follow the exclusions of the underlying insurance policies. It should closely mirror the exclusions of the underlying insurance so that when a loss is covered on the underlying, the umbrella doesn’t have an exclusion that applies.

Watch for the underlying insurance requirements. Here’s where limits of insurance can turn around and bite the client. If they fail to maintain the proper amount of insurance, the umbrella may not cover the losses until the loss gets to a required level.

An umbrella policy is not just a requirement of the rich and famous, or big business. Find out whether someone needs it or not and for the money, err on the side of caution and get it.