When we discuss the asset allocation and investing of your accounts, often a big component of what we think about and weigh has to do with risk management, and risk vs. return tradeoffs. The same principle applies when approaching, analyzing and monitoring your financial plan. Individuals and companies have a few options when it comes to how to handle risk; we can retain the risk, try to avoid the risk, or we can transfer the risk to another party.
How we handle each risk often comes down to the probability and severity of the risk, in addition to our comfort and ability to bear each risk - just like with investing. If any risk has a high probability of occurring and a high severity (financial or otherwise) if it does occur, many individuals choose to transfer that risk to another party. The primary example of this risk transfer is your auto insurance. The probability of getting in an auto accident at some point in your life is remarkably high, the financial and/or health burden (the severity) can also be high. The entire insurance industry was created to handle these risk transfers in various forms.
And, while the details of your current auto insurance or umbrella policies are likely farthest from your thoughts given the interesting times we’re living through in 2020, there’s good reason to revisit your policies and ensure you are familiar with your coverage amounts – with how much risk you are transferring.
Personal Auto Policy
As a refresher, your Auto Insurance is generally made up of a few key components:
The main numbers you likely hear when renewing your auto policy have to do with the various maximums of liability coverage your insurance company will pay if you are found to be at fault in causing a loss. These liability limits are most frequently split between the following types:
In California for example, all drivers are required to carry a minimum of $15K/$30K/$5K in coverage. This refers to $15,000 of per person bodily injury, $30,000 total bodily injury liability coverage per accident, and $5,000 in property damage liability coverage, along with an optional uninsured motorist bodily injury coverage of $15,000 and $30,000 per accident minimums.
Each state has its own requirements, and for cost reasons many drivers choose to buy the lowest cost, lowest requirement policies available. If an accident you caused resulted in injuries or damage beyond your purchased coverage level, you may be required to pay the amount(s) above your insurance limits, and/or you may also be sued. While many drivers may choose to have lower coverage limits, individuals with assets like a home, investment accounts and/or a successful career should carefully consider higher coverage amounts. The majority of the coverage level you select has to do with how much your insurance company will pay if you, or a member of your household, is found to be at fault in an accident.
However, what if you are not at fault and the driver who caused the accident only carries California’s minimum insurance requirement of 15/30/5? It’s generally safe to assume most accidents on a freeway likely result in more property damage to a vehicle(s) than that $5,000 property damage coverage required. In this situation, if you, or riders in your vehicle were injured, the underinsured/uninsured motorist coverage from your auto policy steps in past the other driver’s coverage limit to pay for the injuries, up to your policy’s limits. For damages to your vehicle in this accident, if you have collision coverage, your auto policy will usually also step in to cover some of the property damages up to the actual cash value of your vehicle.
Uninsured/underinsured motorist coverage is extremely important and while it is required to be offered by your insurance carrier in California, it is not always automatically included in your auto insurance quote or renewal. Also, some insurance carriers may offer uninsured coverage, but may not include underinsured coverage for individuals who have insurance, but not enough coverage to pay for the full cost of an accident they caused, as in the example above. It is critical to ensure you and your family have proper levels of coverage, particularly if you have young drivers in the home. Your insurance company will usually offer the uninsured/underinsured motorist coverage at the same coverage amounts as your bodily injury per person, and per accident limits. For example, if you have a $250K/$500K/$100K policy, your insurance company would list uninsured/underinsured motorist coverage levels at $250K/$500K.
The optional comprehensive and collision coverages protect from damages to your vehicle from a number of sources, not just the liability protection provided to protect you from others if you are driving and at fault. Your personal auto policy also follows you, not just your insured vehicle if, for instance, you are driving someone else’s car or are driving a vehicle on vacation. If you have comprehensive coverage and something happens to your parked car, such as theft, vandalism, fire, or flood, your insurance generally still protects up to your vehicle’s actual cash value.
It is important to note that coverage and what’s included past the general requirements can vary substantially between insurance carriers. It is always recommended to speak to your insurance agent when renewing your policies, in addition to reading your policy in full, to ensure you know what is or is not covered by your policy. While we are not in the business of selling insurance products at Charlesworth & Rugg, we are happy to look through your policies and share our input to look for potential outsized risks to your overall financial picture.
Any clients who have gone through a financial planning exercise with me have likely heard me touch on umbrella, or excess liability policies, during a call or meeting.
Umbrella policies cover excess liability you could be subject to if you are found to be responsible for certain damages. These policies sit on top of your homeowner and personal auto policies – and kick into gear if you exceed the covered liability limits on your home or auto policies during an accident, or covered liability when you are found to be at fault. For example, if your dependent child is driving a car and manages to cause enough damage to someone else’s property to exceed the $50,000 liability limit for property damage on your $100K/$300K/50K auto insurance, you are responsible for any amounts above your policy’s limits. In this example, if you had an active excess liability policy, your umbrella policy steps in after the $50K mark to cover the amount you owe up to the umbrella policy’s limits.
Umbrella policies cover you, whether you are driving a rental car, in someone else’s building or business, and it also covers libel, slander and related attorney fees. It acts like an umbrella, hence the name, covering additional liability above your home, auto and or renter’s liability policies.
Umbrella policies generally start at $1M in excess liability coverage and increase in increments of $1M. A $1M umbrella policy generally costs between $250 to $400 a year in premiums to cover you up to the face value of the policy. Insurance carriers have minimum requirements for your home and auto liability protections such as $250K/$500K. It can potentially be considered the cheapest, and potentially most valuable insurance you can buy.
If you or a friend or family member, own a home, have accumulated assets in investments accounts, or are a high-income earner, an umbrella policy is an idea to consider carefully as part of your overall risk management strategy.
But how much umbrella coverage should someone have? The amount of coverage is a personal choice and generally determined based on your net worth as well as income level. Policies range from $1MM to $10MM. For example, if a high earning younger couple owns a smaller home, they will probably look at a $1MM policy, but should likely consider placing a $2MM policy or higher depending on their current and expected future income. If you are found to be at fault in an accident that results in a substantial loss to another party, and that party takes it to court, a judgment can even be placed on your future earnings, which can follow you for life.
When we talk about risks that have a potentially high severity, transferring this risk effectively with an umbrella policy can be some of the best dollar for dollar protection for the money spent in your life.