The many ways umbrella insurance protects you

Last Updated Apr 16, 2015 11:05 AM EDT

If you don't already have excess personal liability insurance, it's time consider buying it. Such a policy could save your assets.

Also called umbrella insurance because it protects you over and above the liability coverage that's part of your existing homeowner's and auto insurance, this special type of liability insurance can pay for the monetary damages arising from legal claims against you (leading it to also be known as lawsuit insurance). But it's much more than that.

Umbrella insurance can also cover the legal fees to defend you from claims of personal injury and property damage that may arise due to accidents. It can even pay for the legal fees to defend you against false arrest and claims of libel, slander and defamation of character.

Do you think all this sounds extreme, and these aren't risks in your life? Consider a few of these situations.

Let's say you're throwing a big party at your home, where alcohol will be served. With the risk of personal accidents or guests driving home after drinking, you could be open to the risk of getting sued. You may think you're safe because you hired a bartender, served food, ended the party at a reasonable hour and offered taxi services and designated drivers. But that's not going to protect you in the event of an accident for which you're held liable.

In another example, let's say the party is on your back deck -- and it suddenly collapses. This happened in real life, and the first liability claims for personal injury were filed the next day! The takeaway here is that if you entertain at home for large groups of people, the risk of a large liability claim is real.

Or have you ever rented a car? Before you do that again, search the Internet for drug busts involving folks who rented a car in which illegal drugs had been left behind. I know, a likely story. But it has apparently happened to lots of people, who've been arrested after being stopped in such a rented car. A check with the local police found they get called frequently to pick up illegal drugs and other items when rental car companies are cleaning returned vehicles.

If you check a rental car insurance policy, you'll discover it doesn't really cover you for any losses other than damage to the vehicle and loss of possessions.

Or do you have teen drivers at home? Have a pool, a boat, ride motorized vehicles? Have a large amount of assets, savings, etc. to protect? I think you get the picture.

And don't assume the liability coverage in your home and auto policies is sufficient. Most home insurance covers liability claims only up to $300,000 for personal liability, and most automobile policies provide up to $250,000 per person and $500,000 per accident for bodily injury. Amounts covered for property damage are lower, typically around $100,000.

Auto policies include liability insurance to cover the medical expenses, pain and suffering, and legal costs for you, your passenger, the driver of the other vehicle and his passengers. While most states require you to have mandated minimums of liability for auto insurance, they're usually quite low and don't provide the protection you need because, depending on the situation, a lawsuit can involve damages of a million dollars or more.

Here's another thing: Auto and homeowners policies don't cover certain types of liability claims, such as defamation of character, libel, slander and false arrest. But excess liability insurance should cover the legal costs of defending against such charges, including the costs of clearing your reputation.

The bottom line is that umbrella insurance is an important complement to your existing homeowner's and auto policies. It provides protection in excess of the other policies' limits and can be purchased in increments of $1 million to $2 million or more. It costs as little as $250 to $500 a year.

I typically suggest buying it in an amount that equals your net worth, or more. Speak to your insurance agent or financial advisor for guidance on how big of an umbrella you should get.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.