Buying an Umbrella Policy

An umbrella policy is supplemental insurance, which means that coverage kicks in when your basic policy has paid its limit on your claims.

While you may be confident that you won't face a large claim, an umbrella policy is useful in protecting you from potential financial catastrophe.

Say you have a basic homeowner's insurance policy with $500,000 of coverage for dwelling and property damage. Any amounts that exceed that claim limit would have to be paid by you.

If your $1 million home burns down, you would have to sell some of your assets to help rebuild your home. Worse, if these assets were in tax-advantaged accounts such as IRAs, you'd likely face income taxes and penalties.

If you have a mortgage loan, it's likely that your home is insured for its replacement cost. However, while your home is likely to be fully covered, you may not have the same protection in liability coverage. A liability lawsuit against you could potentially be a major drain on your wealth. That's where an umbrella policy for excess-liability coverage may be useful.

Umbrella insurance is sold as a separate policy from your basic policy. The Insurance Information Institute estimates that $1 million of excess-liability coverage costs between $150 and $300. Each additional $1 million of coverage is less than $100. The larger your basic liability limit, the less excess-liability coverage you need and the lower your premium for excess coverage.

Next, we take a look at how premiums for homeowner's insurance continue to increase.