One Piece of (nearly) Universal Financial Advice
Unforeseen liabilities are kryptonite to most financial plans. Parting with assets earmarked for one's retired years can have dramatic financial and psychological impacts. Fortunately, simple and affordable insurance products exist to substantially reduce this risk.
We have all seen and probably played the game Jenga...54 blocks cross-hashed 3 by 3 In 18 layers with players taking alternate turns stacking the blocks on top of one another. The game was created by Leslie Scott who was raised in both England and Ghana. She invented the game based on her childhood experience of playing a similar game in her childhood with pieces purchased from a sawmill in Ghana. The name Jenga is derived from the Swahili word meaning "to build". You may be interested to know that Jenga was inducted into the National Toy Hall of Fame in November, 2020.
In certain aspects, one can view a financial plan like a game of Jenga. However, with one's financial plan, we never want the structure to collapse. We account for this by forging the basic cornerstones of our financial plan as follows:
Unlike a regular game of Jenga, we can modify the rules (and structure) to our own liking. Meaning, we NEVER try and stack the baseline blocks at the top. Rather, bedrock financial principles form the baseline foundation of our overall financial plan. And not only do we not manipulate these blocks, we fortify them with epoxy and support beams so our economic foundation never falters, thus reducing the chances of our tower collapsing on itself.
Using the mnemonic structure above, most people understand the benefits of an Emergency Fund, an Estate Plan, an executable budget, and a repeatable savings plan. Additionally, most readily grasp the need for Life Insurance and the benefits of a Pension, Social Security, and Tax-Advantaged Retirement Savings. However, the most common blind spot to risk that I see lies in another tranche of the Risk Category. Specifically, I am referring to Excess Liability Risk. Simply put, these are liabilities which are both uncommon and potentially devastating to our finances. We insure this risk with an insurance policy commonly referred to as an "Umbrella" Policy. This form of insurance is the focus today.
Imagine you have just built the home of your dreams, including your heated gunite in-ground saltwater pool, which came (mercifully) with a year of maintenance included. Further imagine your child invites a friend over to go swimming. Unfortunately this friend has an unexpected accident that is fortunately survivable, yet sadly the child will suffer for the remainder of her life with a disability requiring significant in-home care. The child's parents, one of whom is an Attorney, decides that you are liable for his child's calamity and decides to litigate. You are subsequently found liable and have to compensate the child's family with $3 Million dollars payable today.
I am not an attorney and I completely fabricated this entire story. However, while there are several iterations of plausible outcomes materially different from this scenario, let's suppose this is the final outcome. If so, this is truly a bad financial day we clearly wish to avoid - enter insurance.
Personal Liability Insurance
Most people are familiar with the common forms of Liability Insurance such as Auto, Homeowners, or Renters Insurance. Boat Owners may also be familiar with Watercraft Insurance. For each of these, the coverages are clearly defined and your Insurance Company is required by law to explain to you exactly what the policy does AND does not cover. The most familiar and easy to understand of any insurance policy is the dollar amount of the coverage limit.
If you are to be found liable for damages that exceed your coverage limit, you are ultimately responsible for judgment regardless of the limits of your insurance. If you do not understand this when you agree to the policy, this concept will be more completely explained top you if you attempt to file an insurance claim for greater than your coverage limit.
For the vast majority of potential liabilities, $500,000 of coverage is generally sufficient. As we all know, certain outlier risks similar to what I previously described, while less likely, are indeed possible - enter Personal Liability Insurance, more commonly referred to as Umbrella Insurance. I will start with another picture:
As a brief explanation, the red "Umbrella" on the top of the chart represents your liability protection. The Auto, Homeowners, and Watercraft pillars represent the underlying coverages typically required to secure an Umbrella Policy. The red shaded areas outside of these pillars represent liabilities not covered by the pillars for which you have liability protection. Examples of these coverages are provided below.
Personal Liability Insurance "kicks in" when you are liable for an amount that exceeds your underlying policy's coverage. Meaning, if you are liable for a $750,000 claim due to an auto accident and have only $500,000 of coverage, your Personal Liability Policy will cover the difference - in this case $250,000.
Personal Liability Coverage is not limited to the types of coverage in the underlying policies. Rather, the coverage is general in nature. So long as coverage is not specifically excluded, you will usually have liability protection. For example, if you were to write a negative review for a Barber Shop online, the owner might sue you for damages. If you were found liable, your Personal Liability coverage would insure against the risk.
What is Covered By an Umbrella Policy
Specific coverages vary with each Insurance Company; however, in general the following are covered:
- Lawsuits causing personal injury to others
- Damage to other people's property
In addition to liability protection, most Umbrella Policies include Legal Representation, which is a tremendous benefit. If you ever find yourself liable for potentially millions of dollars, it will most likely be unfamiliar territory. Therefore, having an Attorney to navigate you through the legal maze will be a tremendous comfort. And more importantly, liability scenarios will be in the Attorney's wheelhouse, which will hopefully result in your not having to write a multi-million dollar check.
What is not Covered by an Umbrella Policy
Generally speaking, Umbrella Policies cover the other person and his/her property. Your property will need to be insured via different coverage. Also, if you are self-employed, liabilities related to your business are generally not covered. For business liability protection, you will need a commercial liability policy. Breaches of Contracts are usually not covered. For example, if you sign a contract to build your home and then refuse to pay the builder, your Umbrella Policy will not pay. And finally, intentional and criminal acts are of course not covered.
How Much Liability Protection Do You Need
The answer varies of course. As a very general rule of thumb, coverage equal to your net worth Is advisable. To repeat, this is general guidance - individual situations will vary. For example, depending upon which state you reside, your Individual Retirement Accounts (IRAs) and home equity may be fully excluded from claims. Additionally, employer-sponsored retirement accounts such as 401(k)s are protected from most lawsuits under the federal Employee Retirement Income Security Act of 1974 (ERISA).
So, to refine the Net Worth Rule of Thumb, you may want to calculate an Adjusted Net Worth figure that excludes ERISA Accounts and Home Equity. And if you have any doubts, consulting a Financial Planner who can work in concert with your Insurance Provider is strongly encouraged.
What Does an Umbrella Policy Cost and Where Do I Get It
Securing an Umbrella Policy is actually very simple. Your Property & Casualty Insurer almost always will provide Umbrella Coverage. Simply call whoever provides your Auto or Homeowners Coverage and they will guide you through the process of getting a quote. If your insurance provider cannot provide the coverage, they usually will direct you to a partner company who can. Why Property & Casualty Insurers do not inquire to their Customers about securing this type of policy is beyond me.
Individual Provider coverage costs will vary. Generally speaking, Umbrella Policies are usually $150 to $300 per year for each $1 Million of coverage. As an example on the lower cost end, I have a $3 Million policy that costs $389 - here is a screen shot of my coverage if you prefer a picture:
If your Insurance Provider quotes rates significantly higher than the $150-$300 per million range, shop! Also, certain factors will impact your Umbrella Policy's cost. The most likely culprit for cost increases is undoubtedly teenaged drivers. Not only is Auto Insurance expensive for our young ones - they also drive up the cost of Umbrella Protection. Please do not let the increased costs deter you...you want Umbrella Coverage when your son or daughter is out on the road - believe me!!!
We all work hard and are looking toward the future where we will enjoy the fruits of our labor. The last thing any of us want is to have an unanticipated incident upset our plan and either permanently impair our financial future or return us closer to the starting line. An Umbrella Policy is an inexpensive way to lay-off those outlier risks we don't generally contemplate. And if the previously unthinkable were to happen, we can address the concern knowing our Umbrella Policy sits as a granite-like roadblock between opposing counsel and our money. And even better, this protection can be had for a very reasonable rate.