Last month, the radio show Radiolab aired a story about the Benrath Senior Center in Dusseldorf, Germany. Like many centers of its kind, some of its patients suffer from dementia and Alzheimer’s disease. On occasion, these patients would try to walk out of the center. Most of the time, staff would intervene before a patient could get out. But sometimes, a patient would leave unnoticed and wander the streets. This, of course, is dangerous.
One solution to this problem is to remodel the center and build what are known as “locked floors.” But remodeling can be expensive, and the staff at the Benrath Senior Center didn’t want the center to lose its caring feel or to look like a place designed to keep patients trapped inside. So instead, the center added a bus stop.
The bus stop isn’t real and isn’t part of an actual bus route. But patients who walk out will immediately find it, sit down on the bench and patiently wait. This gives staff time to realize the patient is missing, find the person at the bus stop and, at the right moment, bring the patient safely inside.
Bus Stop Analogy
Everyone loves a “bus stop” — an elegant solution that doesn’t have a large cost but solves a large risk.
To financial planners, personal umbrella insurance is such a “bus stop”. It allows people to manage a big risk without living on “locked floors”.
Umbrella insurance is a kind of personal liability insurance. It protects against the risk of a lawsuit and the financial ruin that a lawsuit can bring. It acts as an extension of the personal liability insurance included in auto insurance and homeowner’s insurance. It even covers some things that auto and homeowner’s insurance do not, including libel, slander, and defamation of character.
Auto insurance typically provides $100K to $500K of personal liability coverage for bodily injury to others. Because $500K of liability insurance for bodily injury does not come close to covering the liability from a major lawsuit, umbrella insurance is designed to increase the overall level of protection so that you are covered. To be a true “bus stop”, however, the cost must be low relative to the safeguard provided. Fortunately, umbrella insurance comes at a very reasonable cost. Because it covers low-probability events, it can cover a large potential liability without being astronomically expensive. Umbrella insurance is usually purchased in $1 million increments. The chart below shows some pricing details:
For an individual owning:
|Annual premium for coverage of:|
|Homes||Vehicles||Rental Properties||$5 Million||$10 Million||
|2||0||$500 – 650||$1,000 – 1,200||$3,500 – $3,700|
|2||3||1||$700 – 850||$1,600 – 1,800||
$3,600 – $4,300
Umbrella insurance has the effect of managing the financial impact of a large lawsuit at a reasonable cost, but how do you determine the right amount of coverage? Start with your net worth and then consider some risk factors that might increase the coverage you need. In a 2013 report, the reinsurance company Gen Re cites its own internal study titled “Cause of Loss Study for Personal Umbrella”, which found that auto claims represent 78% of personal umbrella claim counts and 87% of claim dollars. Because about 90% of personal umbrella claim dollars relate to auto claims, the following risks factors deserve special consideration:
Other non-auto risk factors include owning rental property, firearms, a dog, watercraft, or a swimming pool; or holding a nonprofit board position.
If some of these risk factors pertain to you, we recommend that you round up the level of personal umbrella coverage. It’s also a good idea to round up because people’s net worth often grows; rounding up coverage accounts for the possibility of your net worth increasing.
Some suggest that certain retirement accounts should be excluded from calculating your personal umbrella coverage. Retirement accounts, such as 401(k)s, have additional protections from creditors. A similar case can be made for excluding your primary residence, as homes also have additional protections against creditors. But in reality, there’s not any part of your net worth that is judgment-proof. With that in mind, taking the conservative approach of starting with your net worth and rounding up makes sense. It helps to remember the following:
And while umbrella insurance lacks the creativity of a bus stop, it is an elegant solution to a serious risk.