What is an umbrella policy and why would I need it?

Renters, homeowners, and auto insurance protects you from many financial risks. When you need to replace or repair property—a stolen bike, a soggy carpet, a crumpled fender—insurance helps you to pay the bill. That’s the property part of “property and casualty” insurance.

The casualty part of your coverage is also known as “liability coverage.” It can help you to pay costs when you are liable, or responsible, for someone else’s loss. These losses include damage to their property and injuries that require medical treatment. It also helps to pay your own legal fees.

And those losses to others can rack up big, big bills. Medical care, lost wages, repairing or replacing structures and the items housed inside—your bill for one accident can easily exceed hundreds of thousands of dollars.

Will your insurance cover that? Sure. But only up to the “limits” (i.e., the maximum payment amounts for the different types of coverage, like liability coverage, afforded by your policy). If you have standard auto, homeowners or renters insurance, for example, a standard policy will often cap liability coverage at $500,000 or less.

What if expenses are higher than your insurance will pay? That’s what umbrella coverage is for.

What is umbrella coverage?

An umbrella policy is insurance you add to your auto, homeowners or renters policy to give you extra liability coverage. It sits “on top of” your underlying “base” policy, sort of like an umbrella. Get it?

It protects you in two ways:

An umbrella policy increases the dollar amount of liability coverage on your primary policy. If your renters policy includes $200,000 in liability protection, and you buy a $1 million umbrella policy, you have $1.2 million in total coverage.

In addition to providing you additional coverage beyond the base limits of your policy, umbrella coverage also covers certain “perils,” or events that cause losses, which standard auto, homeowners or renters policies typically do not cover. For example, if you criticize someone in public and are sued for slander, an umbrella policy can help to cover your legal costs. A base auto, homeowners or renters policy alone likely would not.

How much does umbrella coverage cost?

For $1 million in coverage, expect to pay about $150-$200 a year.

Do I really need $1 million in umbrella coverage?

You might. The fact is, accidents happen, and many people do not have adequate health or disability insurance. They may sue you to pay their medical bills, which can add up very quickly. If the liability limits of your base policy are less than your net worth, a smart practice is to “level up” via an umbrella policy, up to your net worth.

Still not convinced? Think about umbrella insurance if you:

Have a pool or a trampoline.

Swimming and gymnastics are a blast, especially for kids and teens. But if anyone gets hurt on your property, you could be sued for medical costs. This is true even if the victims were not invited and you are not home when the accident happens.

Live with a dog.

Even small dogs can send bite victims to the emergency room for stitches. If the wounds are deep, treatment often includes surgery, hospital stays and rehab.

Own rental properties.

If your tenants or their guests are hurt at your rental property, they may sue you to pay for their hospital bills. If they miss work because of their injuries, you may able be required to reimburse them for lost income.

Have a teenaged driver.

Teens take chances. If your young driver is responsible for an accident that seriously injures passengers or other drivers, hospital bills can quickly reach hundreds of thousands of dollars—more than most auto policies will cover.

Want to sleep easier at night.

Accidents happen. So do lawsuits. An umbrella insurance policy can give you $1 million in coverage for about $10 a month. And that is a great deal—whether you rent an apartment or own a house, live alone or with a posse of teen drivers.