Rental properties come with many benefits. They’re a great source of passive income, offer you flexibility to sell when the timing’s right, and you always have the option to move back into them if you need.
However, if your current tenant or one of their guests breaks their back while falling down the stairs, gets shocked by your faulty electrical system, or if a former tenant breaks in and robs the place before you change the locks, you could be held liable. Suddenly, your seemingly smart investment can turn into a migraine of monumental proportions.
That’s when an umbrella insurance policy comes in handy. Umbrella insurance acts like a blanket by providing you (as the landlord) with additional protection that other types of rental property insurances don't cover. If an incident involving a past or current tenant, one of their guests, or someone else occurs on, or involves your property, umbrella insurance can protect you from having to pay hundreds of thousands of dollars.
In this post, I will discuss everything you need to know about umbrella insurance, including:
Let’s get started with this topic.
What Is Umbrella Insurance?
An umbrella policy adds additional liability insurance over and above another insurance policy—hence the term “umbrella.”
An umbrella policy is considered a supplemental insurance policy, because it kicks in when your standard policy hits its maximum liability coverage. Instead of paying for the rest of the damages out of pocket, your umbrella policy covers them.
While many landlords never have to worry about reaching the liability limits of their other insurance policies, freak accidents and life-changing incidents happen all the time. You don’t want to be the one footing the remainder of the bill for the actions of your tenants, or for faulty electrical wiring you didn’t even know about.
How Does An Umbrella Policy Work?
Let’s say there’s an issue with the flooring of your staircase, and one night your tenant’s boyfriend slips, falls, and breaks their back. They sue you for the medical expenses incurred during their stay in the hospital, months of physical therapy, lost wages, and for the pain and suffering they experienced along the way. Your landlord liability insurance policy caps out at $250,000, but you’re sued for $500,000. Without an umbrella policy, you’re personally liable for the remaining $250,000.
Your umbrella coverage kicks in once your landlord insurance maxes out, protecting you from having to pay $250,000 out of pocket.
Excess Liability Policies vs. Umbrella Policies
People commonly confuse an umbrella policy with an excess liability policy. While they are similar, there are several key differences worth knowing.
An excess policy provides coverage that exceeds your basic coverage limits. If you have liability coverage for $250,000 and purchase an excess liability policy for another $250,000, you are protected for up to $500,000 (Note: the excess policy only kicks in after the initial liability coverage caps out).
Excess policies do not protect you if you don’t first have initial liability protection, and the excess protection may come with more restraints than your current policy.
Umbrella insurance policies provide additional coverage for claims when you don’t have an existing policy. For example, your landlord liability insurance will cover the $250,000 hospital stay for the tenant’s boyfriend who fell down the stairs. However, it might not cover the $250,000 for physical therapy, lost wages, and pain and suffering.
An umbrella policy covers those damages. It also provides additional coverage for other things not included in your rental property insurance, like slander, libel, and legal expenses.
Who Needs An Umbrella Insurance Policy?
If you own a rental property, you should consider getting umbrella insurance.
You have to think about your personal assets: your home, car, bank accounts, investment accounts, and also your estimated future income, which is potentially your most valuable asset. If an incident happens involving your rental property, and you lose the lawsuit and owe a substantial amount of money, you might not have enough coverage for the damages ensued. The rest would have to come out of your pocket. It could drain your investment and bank accounts, and cause you to sell the rental property to cover the rest.
If you’re forced to sell your rental property, you're not only out that money–you’re also going to miss out on that additional revenue stream. If you were renting your property out for $2,000 a month, that’s a future loss of $24,000 a year, or $120,000 over five years (minus the costs of property taxes, mortgage payments, and maintenance).
An umbrella policy provides extra protection, both in coverage amount and scope. It can mean the difference between keeping your current and future assets secure and financial jeopardy.
Rental Property LLC vs Umbrella Policy
Another popular option landlords consider is to form a limited liability company (LLC). Let’s size up LLCs with umbrella policies, so that you can determine which is a better fit for your rental property.
Rental Property LLC
An LLC business structure limits your personal liability. In other words, you can’t be personally liable for the debts your business incurs. Since you’re considered a separate entity from your LLC, this also means you're not personally liable for when your LLC gets sued.
Unfortunately, LLCs won’t protect you from all lawsuits. It’s a complicated business structure with different regulations in every state. There are also limits to an LLC’s legal protections. If you failed to fix the flooring on your staircase, or neglected to maintain your rental property in another way that resulted in your tenant or one of their guests getting injured, you could still be held liable.
Umbrella Coverage In Comparison
While rules and regulations for LLCs vary by state, your umbrella policy can cover multiple rental properties across many states. That added flexibility alone can make an umbrella policy a more viable option for landlords in these types of situations.
However, umbrella policies can have more loopholes than an LLC. An umbrella policy only covers liability, not everything else your standard policy covers. For added coverage, require your tenants to get renters insurances as part of the lease agreement. Also, ask your insurance company for clarification about where you’re still vulnerable for liability.
What Does Your Umbrella Policy Cover?
Before you buy umbrella insurance, you should know exactly what you’re getting coverage for. It’s complicated insurance, but it can be divided into three distinct categories:
1. Body Injury Liability
First off, umbrella insurance covers the cost of injuries another person endures. Often, these consist of the medical bills and liability claims for injuries, including:
However, body injury liability also extends to other situations, including:
2. Property Damage Liability
Umbrella insurance also covers the cost of damages to someone else’s physical property. This includes:
3. Personal Liability
Personal liability covers other actions that you can be sued for, including:
What Doesn’t Your Umbrella Policy Cover?
Your umbrella liability policy covers many things, but it doesn’t cover everything. As a reminder, because your umbrella policy is a liability policy, it only covers liabilities.
Here are a few things that your umbrella policy probably doesn’t include:
How Much Does An Umbrella Insurance Policy Cost?
When it comes to liability insurance, having too much is always better than having too little. Umbrella policies are typically sold in increments of $1 million, with the first million costing between $150 and $350 a year. If you want to purchase more than $1 million, coverage costs around $100 per million after that.
Costs can vary based on many factors, including where you live and where your properties are located, and how many homes, cars, and boats you want to insure.
How Much Umbrella Liability Insurance Do You Need?
Here are a few simple ways to estimate how much umbrella insurance you need.
Based On Assets
Many experts suggest you get an umbrella policy equal to or greater than the total amount of your assets, regardless of your liabilities. If you own $2,500,000 in assets and have $500,000 in liability insurance, then you should purchase an umbrella policy worth $2,000,000.
Based On Net Worth
Many property owners determine how much umbrella policy they need based on their net worth. Estimating net worth is a simple calculation.
Net Worth = Assets - Liabilities
In other words, your total net worth is equal to your assets (what you own) minus your liabilities (what you owe). The amount of your umbrella policy should be greater than your net worth. If your current liability coverage is less than your net worth, you might not need umbrella insurance.
Based On Future Income
If you lose a lawsuit and owe more than what you currently have in liability coverage, your future earnings could be garnished by up to 25%.
To protect your future income, multiply your annual income by five. Then, add that number to your total assets. If your annual income is $200,000 and you have $1,000,000 in assets, you should consider purchasing $2,000,000 in total liability insurance.
Pros And Cons Of Umbrella Insurance
A lot was covered in this post, so let’s quickly recap the pros and cons of umbrella insurance:
Final Thoughts On Umbrella Policies
Purchasing an umbrella policy is usually a smart financial decision for landlords with small portfolios. However, umbrella policies aren’t right for everyone. Determining how much coverage you need ultimately depends on the assets, incomes, and types of property you own.As with many decisions that involve investing in real estate, I recommend consulting with a lawyer before buying an umbrella policy to see if it’s the right decision for you. After analyzing your personal financial situation, as well as your real estate portfolio and other assets, they can help you make the right decision.