Why it is important for small business owners to have umbrella insurance
My firm, Lasting Wealth Principles, does not sell any insurance products, but I still believe that umbrella insurance is a particularly important wealth protection tool, especially for small business owners. Umbrella insurance provides a small business owner with extra liability insurance coverage against major claims and/or lawsuits that exceed the amount of liability coverage provided by a regular homeowners and/or automobile policy. Deciding on the amount of umbrella insurance to purchase depends on an individual’s specific financial circumstances. Small business owners should consult with their property & casualty insurance agent to make sure their homeowners (or rental) and automobile insurance policies are providing adequate liability coverage. Even further, they should discuss the specifics (e.g., terms, coverage details, premium) of obtaining an umbrella insurance policy. Note that before purchasing an umbrella insurance policy, insurance companies will generally require that a minimum amount of liability insurance be in place on an automobile policy and/or homeowners policy (most insurance companies require a minimum of $250,000 and/or $300,000 of liability insurance on an automobile and/or homeowners policy, respectively). Additionally, in the event of an insurance company covering a liability claim, reimbursement would first come from the automobile policy and/or homeowners policy. The excess of the limits of these policies would then be covered by the umbrella policy (up to its policy limit). As I go through the insurance planning part of my financial planning process with small business owner clients who have significant assets to protect, I let them know these three reasons that they should have umbrella insurance: Extra liability insurance coverage, Legal costs coverage, and Low cost of policy.
Extra liability insurance coverage
Technically, there is no maximum amount of liability that small business owners can face as their actions can result in them being held personally liable for several reasons (e.g., injuring someone, damaging another person’s property, etc.). Given the potential of a high lawsuit amount, their personal assets can be at risk. I illustrate with the following hypothetical example. Steve is a sole proprietor who has run a successful healthy snack business for 15 years. He and his wife host a party at their home with multiple guests. Unfortunately, one of their guests slips in the backyard and seriously injures themselves. Despite Steve vehemently denying any negligence, he is still sued by the injured guest for a considerable sum of money (amount exceeds liability coverage provided by his homeowners policy). A few years ago, Steve followed the recommendation of his financial planner, which was to obtain an umbrella insurance policy. As a result, this umbrella insurance policy will cover the amount owed to the injured guest if Steve is found liable. To further illustrate with amounts, I note the scenario below.
Steve’s homeowners policy has liability coverage of $300,000
The injured guest sued him for $600,000
Steve’s umbrella policy is for $1 million
If Steve is found liable and owes the injured guest $600,000, then $300,000 comes from his homeowners policy and the remaining $300,000 would come from the umbrella policy (note that the umbrella policy limit is $1 million so $300,000 is way under this amount).
Legal costs coverage
In addition to the potential of a major claim and/or lawsuit amount as noted in the previous example, small business owners would also be responsible for the attorney fees and court costs associated with defending themselves against these types of claims and/or lawsuits even if they are not liable. If the claim and/or lawsuit falls within the stated coverage of the umbrella insurance policy, the insurance company will pay for legal representation on behalf of a small business owner, so it is particularly important to understand the umbrella insurance policy’s terms and exclusions.
Low cost of policy
Given its coverage of a potential liability claim and/or lawsuit, the cost of obtaining umbrella insurance is affordable. In other words, the premium that small business owners pay for an umbrella policy is minimal in comparison to the benefits that an umbrella policy could pay out to them in the event of a major liability claim and/or lawsuit, which means that having umbrella insurance is a cost-effective way to manage risks (i.e., prudent risk management as part of an overall financial plan).
Depending on the insurance company, location, and costs of base policies (i.e., automobile and/or homeowners policies), the cost of an umbrella insurance policy will vary, but could range between $200-$500 per year for $1 million of coverage. If higher coverage limits (e.g., $2 million or $5 million) are needed for a small business owner, then costs will increase accordingly (insurance companies offer umbrella insurance policies in million-dollar increments).
Small business owners spend countless hours of work to build their personal wealth for themselves and their families, but all it takes is to be liable for one major claim and/or lawsuit that could potentially eliminate all their hard-earned wealth. Having an inexpensive wealth protection tool like umbrella insurance can protect against this type of financial catastrophe.