The 1969 Woody Allen film, Take the Money and Run, is one of my personal favorites. The most memorable scene is when Allen is captured after escaping from prison and his punishment is solitary confinement with an insurance salesman.
Not many people are interested in discussing their need for insurance. It’s certainly not an exciting topic (nor is investing for some). For many, discussing mortality and disability risks are unpleasant subjects. In addition, most people don’t like being “sold” something. There are so many different types of insurance (and from many different companies), that many are left wondering, “Do I really need this? Is it worth the expense? Am I wasting my money?”
Unfortunately, ignoring those issues often leads to failure to address important risks.
The reality is that insurance protects us from worst-case scenarios – events that could have catastrophic consequences to our families. While it may not be exciting, insurance plays a vital role in the financial planning process.
Perhaps the most important message of my book, Your Complete Guide to a Successful & Secure Retirement, is that having a well-designed investment plan is only a necessary condition for investment success. The sufficient condition is integrating it into a well-designed life and financial plan that includes estate, tax and risk management (insurance of all kinds) planning. There are many important non-investment risks to consider, such as mortality, disability, the need for long-term care and even longevity (living longer than expected). If these risks are not integrated into the overall financial plan, even the best investment plan can fail.
Analyzing the need for life, health, long-term care, disability and “personal lines” insurance (property and casualty products), is a critical part of the financial planning process. All types of insurance should be considered, and all existing policies should be reviewed annually by an independent risk management specialist to ensure coverage is adequate but not more than required.
As discussed above, despite its importance, insurance risks are often overlooked. And it is my experience that one of the most overlooked risks is the need for excess personal liability insurance – coverage provided by an umbrella policy.
Providing excess personal liability insurance (above the coverage provided by your homeowner’s and auto policies) is one of the most underutilized types of coverage. This relatively inexpensive yet vitally important coverage provides protection from major claims and lawsuits. Umbrella coverage can come into play, for example, if someone were to slip on your sidewalk during winter and sue you for not properly cleaning and salting. A judgment against you for $500,000 can come from savings – or it can be paid by the insurance company backing your umbrella policy.
In addition to covering you for accidents on your property or car accidents in which you’re at fault, an umbrella policy can also protect your dependent children (for example, if your child causes a car accident), accidents caused by you or your dependent children while operating a watercraft, accidents that occur on rental property you own, and personal injury lawsuits arising from slander, libel, defamation of character, false arrest, detention or imprisonment, abuse of process, malicious prosecution, shock or mental anguish, and possibly more.
Unfortunately, many believe that only famous people need this type of coverage. This might explain why the Spectrem Group, in their 2019 white paper The Insurance Gap: Why the Wealthy are Underinsured, found that even among wealthy individuals, there is a significant gap between one’s net worth and liability coverage. For example, more than one-third of investors with homes valued between $2 million and $5 million have liability coverage of less than $2 million. Similarly, among investors with a home in the $1 million to $2 million range, more than one-quarter have coverage of less than their home value. Spectrem Group even found that among investors worth between $15 million and $25 million, almost 30 % have no more than $2 million in excess liability coverage. In addition, they found that very few with a net worth of more than $1 million have coverage at least equal to their net worth. Each of these families is risking a major portion of their net worth in extreme cases of liability.
While a general rule of thumb has been to purchase an umbrella policy with limits that are at least as much as your worth, anyone who owns a home or a car should have at least a $1 million umbrella policy even if they have less than $1 million in assets. That’s because, in the event you are sued, you could be forced to pay a legal judgment from your current assets and future earnings. The policy can also pay for legal defense costs, which can quickly add up even if you win your case. It’s an inexpensive way to protect your finances from devastating lawsuits. And given the risks, those with higher incomes should have at least $2 million in excess liability coverage, and for those with rental property, the amount should be increased to $3 million to $5 million.
One of the benefits of having an excess liability policy is that because the insurance company’s money is at risk when you are sued, it will want to protect that money with its own legal team, possibly a better legal team than you could afford on your own.
While the risk of being sued may be remote, don’t make the mistake of treating the unlikely as impossible. An umbrella policy is a relatively inexpensive way to prevent a catastrophic loss that can devastate an otherwise well-thought-out financial plan. If you don’t currently have a policy, or have one that is not at least equal to the value of your assets, now is the time to act. It might also be a wake-up call to have a complete review of all your insurance needs, from life to disability to longevity to long-term care.
If your financial advisor isn’t helping you address these issues, perhaps it’s time to seek another advisor.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.
More Tax Planning Topics >