Personal Umbrella Liability Insurance Isn’t Only for the Rich
Good to Know
Conventional wisdom would have us believe that personal umbrella liability policies are needed only when one’s net worth exceeds $1,000,000. The purpose of this blog is to challenge that potentially dangerous assumption.
As background, we live in an amazing country, land of the free because of the brave. Yet the United States of America has the dubious distinction of being one of the most litigious countries in the world. For example, a Harvard Law School Study1 found that, for every 100,000 citizens, the USA had the highest number of annual lawsuits filed and the highest number of attorneys.
The threat of liability lawsuits is all too real, yet too few of our clients have been made aware of what can be taken in a judgment. Next, we’ll identify assets subject to judgment and bankruptcy creditors, discuss costs of defense, and conclude with the pros and cons of personal umbrella liability coverage.
Assets Subject to Judgement Creditors
Earnings Power
This may be one of the most overlooked creditor risks a client has, especially if the client has a six-figure income. For example, the net present value of an individual’s earnings of $150,000 annually over 30 years with a 4% assumed interest (discount) rate is almost $2.6 million. While federal law generally limits the amount that can be garnished from an individual’s income, a significant risk to disposable income remains.
Home equity
Homestead exemptions granted under state statutes can generally protect home equity with notable exceptions. For example, Florida statutes protect up to 100% of home equity from bankruptcy creditors while New Jersey statutes provide no such protection.
In many states with no or very limited home equity protection from creditors under state law, the debtor can file for bankruptcy under federal bankruptcy law, which can generally protect about $25,000 ($50,000 if married) in home equity from bankruptcy creditors. Before assuming home equity is completely protected from creditors, clients should consult an attorney.
Retirement plans
Investments held in employer-sponsored qualified retirement plans, such as an individual’s 401(k) plan account, are generally protected from bankruptcy and non-bankruptcy creditors under federal law without limit. However, that protection only applies to funds while held inside of the plan. Distributions from the plan are NOT generally protected from creditors.
Federal law protects IRA assets from bankruptcy creditors up to an indexed limit ($1,362,800 in 2021) while some states may provide a higher level of protection. State law varies significantly with respect to creditor protection from non-bankruptcy creditors. This is a complex area of the law. Your client should consult an attorney to confirm his or her protection.
Jointly titled assets
Property owned in a Joint Tenancy with the Right of Survivorship is generally subject to the claims of each joint tenant’s creditors, not just one joint tenant’s creditors. In a very real sense, ownership of property in this form can multiply one’s exposure to creditors.
In those states that allow a Tenancy by the Entirety form of joint ownership (for spouses only), the property is generally protected from each spouse’s individual creditors but not from joint creditors. Once again, your client should consult an experienced attorney to confirm his or her risks and creditor protections.
Defense Costs
A simple lawsuit can cost up to $10,000 to defend. A more complex lawsuit can cost over $100,000 depending upon variables such as the size of the claim, length of the process, the need to hire expert witnesses, and opposing counsel’s strategies. Defense costs for covered claims are generally paid by the insurance company (within limits) and are not subtracted from the policy’s coverage limit.
Pros and Cons of Personal Umbrella Liability Coverage
Pros
- Liability for claims not covered by auto or homeowner policies such as slander, libel, false arrest, and invasion of privacy (conditions apply) are covered.
- Coverage is highly cost-effective. Depending upon the facts and circumstances, an initial $1,000,000 of umbrella coverage could cost $300 or less annually.
- Umbrella coverage adds to the underlying liability coverage. For example, a $1,000,000 umbrella policy coupled with a homeowner’s policy with a $300,000 liability limit provides $1,300,000 in liability protection.
Cons
- A minimum level of underlying auto and home coverage is required.
- Claims such as claims for damage to the policy owner’s property, liability for intentional acts or injuries, communicable disease illness, and contractual disputes are not generally covered.
Disclaimer
The information presented herein is provided purely for educational purposes and to raise awareness of these issues; it is not meant to provide and should not be used to provide tax, legal, compliance or financial advice. There are variations, alternatives, and exceptions to this material that could not be covered within the scope of this blog.
1 Ramseyer, J. & Rasmusen, E. (2010, November). Comparative Litigation Rates. Retrieved from http://www.law.harvard.edu/programs/olin_center/papers/pdf/Ramseyer_681.pdf
