Why we spend money on umbrella insurance

First of all, what is an umbrella insurance?

An umbrella insurance policy is extra liability insurance coverage that goes beyond the limits of the insured's homeowners, auto or watercraft insurance. It provides an additional layer of security to those who are at risk of being sued for damages to other people's property or injuries caused to others in an accident. It also protects against libel, vandalism, slander, and invasion of privacy.- Investopedia 

But I do not agree with the following …

The added coverage provided by an umbrella insurance policy is most useful to high net worth individuals who own a lot of assets or very expensive assets and are at significant risk of being sued.

After all, a sizable judgement can claim not only your existing assets, but also your future earnings. 

In order to purchase an umbrella policy, you’re required to have $300K liability coverage in your auto and home insurance. You may think that a $300K settlement is rare, but in fact, it may not be as rare as you think. Here are some examples of umbrella insurance claims. 

Let’s be clear. You do not want to be under uninsured when it comes to personal liability coverage. A serious injury involving significant lost wages and/or lifetime medical care can lead to a catastrophic settlement. 

For our family, we choose to have umbrella coverage for a number of reasons.

#1 Liability coverage Lawsuit seems to be in everyone’s mind when it comes to liability. My friend told me a story. She was babysitting two 5 years old boys in a play date. One of them misfired a toy gun and hit the other’s face. The other boy immediately said, “you’re lucky that you hit my face. If you hit my eyes, I will sue you”. Seriously, that’s a 5 years old!!

#2 Do you drive a car? From the insurance perspective, chances of having claims filed against auto insurance are a lot higher than home insurances. After all, auto vehicles are not a stationary objects and they can be operated at certain speeds, so that totally makes sense. Our umbrella insurance covers all 3 of our cars, our home and our rentals. But if you look closely at the breakdown of the coverage, each additional car increases our premium while our homes and rentals basically are free-riders in the policy. 

#3 Do you have a rental? When we started out having rentals, we would like to set up an LLC to host all of them. I do believe it is a good practice to have an LLC especially if you plan to have multiple rentals under your belt. Due to timings and loan complications, we ended up purchasing the rentals under our own names. Nevertheless, since we do not have the LLC to separate our rentals from our personal assets, we have the umbrella policy to protect ourselves. Is this the best practice? It may not be. But we are comfortable with this level of protection at this moment. After all, an LLC is not going to protect your asset absolutely as the judge can also pierce the veil of LLC during litigation.

#4 Do you have a family depending on you financially? When it comes to settlement over a lawsuit, not only your present asset, your future earning is also at stake. Imagine, you receive a judgement of $750K, and your insurance is maxed out at $250K. You have to cover the remaining $500K, and your future earnings can also be garnished. In this case, your spouse and kids would be the collateral damage in the lawsuit.

#5 Do you have kids? When you have kids, you may be asked to chaperon kids for field trips. Should an unfortunate accident happen, you may be charged with negligence. What if your little one’s BFF accidentally gets injured when coming over for a play date? Yup, most of us can assume that some bruises or even broken arms are parts of normal childhoods. But do the parents of the injured kid think the same way?

#6 Umbrella insurance is actually not that expensive. An umbrella insurance covering two cars and one house with a payout of $1M costs around $150 to $300 annually. For us, we believe it is money well spent.

#7 Legal defense cost When it comes to any sort of lawsuit, the legal fees can be very expensive. Not only that, for most of us who do not have any experience dealing with law firms, finding the right lawyer can also be a daunting task as well. If you have the insurance company liable for the potential settlement, it is simply its best interest to defend you. In addition, if you’re sued, your umbrella policy will cover the defenses cost, regardless if it is your fault or not. On top of that, the defenses fee is in addition to the limit in your liability coverage.

The Final Verdict

Ultimately, it comes down to this final reason for having the umbrella insurance.

#8 Peace of mind We value the peace of mind knowing that we are adequately covered in case we run into unfortunate circumstances. It provides a safety net for our family. For some families, considering the unlikelihood of filing a claim in the umbrella insurance, they may dismiss the idea of having one right away. For us, we always try to prepare for the worst, so the benefits of the umbrella policy outweighs the cost.

And, one last reason which does not apply to us, but apply to a lot of families …

#9 Do you have a dog? If your dog accidentally hurts someone, you may face a lawsuit. Your dog may be really well trained, but accidents happen all the time. And should you take the chance? By the way, this reason is applicable to all kinds of pets that can potentially cause harm to others.

Think twice before becoming a landlord

Yes, the rumor is spot-on. Being a landlord is no fun at all. There are endless sources of troubles, such as …

  • bad tenants: those who do not pay rent on time, or even worse, who trash your house.
  • contractors: good contractors are hard to come by. Their schedules are always full, and matching their schedule with your tenant can be a daunting job.
  • insurance companies: they are particularly picky on rentals.
  • city/county/state regulation on rentals and building code: these regulations can change at anytime, and you have only one choice which is to comply.
  • neighbors of your rentals: in general, people do not like rentals next to their homes.
  • a new set of tax code: even if you outsource your tax, you should still know the tax code so that you can review your tax return. After all, you are ultimately responsible for everything on your tax form.

Before committing to be a landlord, ask yourself the followings.

#1 Does your potential rental actually have a positive cash flow?

My accountant once said, “oh you are doing pretty well, as you are actually making money out of your house”. Surprisingly, a lot of landlords are putting money into their rentals every month to keep it going!! This is particularly true in the case of condos due to the high condo fee. Do not fool yourself that you’re having a sound investment if your rental does not produce a positive cash flow unless you have strong conviction that your rental will be appreciated at a very good pace in the next couple of years. Your house can have many things going wrong as you can’t possibly imagine. That involves not only financial resources, but also your time. So ask yourself, is your rental really worth your time and financial resources? Can you actually come out ahead by investing in an index fund?

#2 Will you self-manage the property or outsource that to the property management?

You can hire property management company / real estate agent to manage the property. I did not because of the hefty 5 – 10% management fee. If you plan to purchase multiple properties, it’s best that you get your hands dirty to the nuts and bolts of managing tenants and building relationship with contractors to fix your house.

To ease the stress of self-management, there are things you can do before your tenants move in to avoid the potential endless phone calls from your tenants:

  • properly inspect your property and fix the issues
  • deal with all the county/city/state rental requirements, i.e. rental license, lead paint inspection if any
  • carefully screen your tenants. A good credit score can only tell so much. Meet your potential tenant and get a feel of how decent this person is. My agent somehow has good intuition, so I always ask him to screen tenants for me.
  • spell out tenant’s responsibilities clearly in the contract, i.e. lawn maintenance.

Rest assured. Most tenants are reasonable human beings. They usually do not call you in the middle of the nights. Think about it; they are also afraid running into a slumlord. So treat them nicely, and in general, they will do the same to you and your property.

#3 Do you have an emergency fund for renovations and repairs in the house?

As a landlord, you will run into fixing houses a lot more than you may expect. Do not rely on the number of times you have to fix something at your  home as the guideline on how often your tenant will call you. Fixing houses is not cheap. The rentals I have are built in the 1960s era. They are solidly built compared to a lot of new houses these days. However, since they are old houses, and the maintenance were somewhat neglected during the time the houses were foreclosed or under short sale, so in the past couple years, I did a lot of repairs and renovations.

Here is a brief summary of what I have done in the last couple years.

  • New water heater and HVAC system. The water heater runs about $1,000 each and the whole new HVAC system is at $5,000.
  • My rental had sewage backup issue to the basement. I got a plumber to snake it twice, and each snake costed $400 to $500. Eventually, it was determined that the sewage pipe somehow was broken up in the middle of the front yard, and hence the sewage backed up to the house. The pipe was buried 15 ft below. This whole project set me back another $5,500.
  • A total renovation of a basement was $20,000.
  • I also installed new windows and put on a new roof.
  • Cutting down dying trees was expensive too.
  • Other miscellaneous issues, i.e. replacing thermostat, changing carpets and appliances.

To summarize, BE PREPARED.

The Final Verdict

A lot of people look at rentals with a pair of rose-colored glasses. Wow, you are having income without doing much every month. Yes, there is an income. But, the without doing much part may not be true all the time. There can be a lot work in managing the rental. Don’t get me wrong. Financially, it can be a sound and great investment, and it is a great diversification in your financial portfolio. But the nuts and bolts dealing with the on-going management can be daunting and challenging. Run the numbers and make sure that you have a good idea on the potential return as well as the various repairs that may come with your rental. Then, you can finally answer the question: is it worth it to be a landlord?