The umbrella liability policy is one of the most confusing concepts in real estate investor insurance. Worse, some insurance agents misrepresent how to structure rental property and liability insurance, leaving landlords vulnerable to large financial risks.

What's an umbrella?

An umbrella policy provides additional coverage for those who are at risk of being sued. You must have an underlying (or primary), liability policy, whose limits must be exhausted (in the event of damages or a lawsuit before the umbrella coverage kicks in). Umbrella coverage only covers liability risks. It does not provide protection for property. As premises liability losses can be caused by a slip and fall or wrongful death, the umbrella policy is there to cover any shortfall due to existing liability policy limits.

Agents who are not familiar with real estate investing might advise clients to insure their rental properties on a personal dwelling insurance policy. This policy typically has a $300,000.- $500,000 limit. To increase their liability limits, they can also purchase a personal umbrella that extends the coverage to their investment property's dwelling policy as well as their homeowner's policy. There are many reasons why this might not be a good idea.

1. The personal umbrella does not protect the asset of a rental property if it is owned by someone other than you (e.g. an LLC).

2. A lot of personal umbrella policies include a "business pursuit exclusion", which can exclude damages and lawsuits against rental properties that generate income.

3. Many insurers limit the number of dwelling policies an individual can have. If you keep buying investment properties, your insurance company will not allow you to increase your coverage.

4. It can be detrimental to tie personal assets to business assets.

Per Shawn Woedl, CEO and President of NREIG, (where this article was originally posted): "Policies designed for landlords often provide higher premises liability limits and loss of rental income coverage. They also allow you to buy back coverage to fight the "Total Pollution Exclusion" found in personal lines policies." Carbon monoxide is a good example of how to avoid this exclusion.

You will likely also be exempted from coverage for dog bites on a homeowner's policy or dwelling liability policy. This coverage is often included in commercial liability policies. Tenants don't always comply with any clauses in their lease against pets or certain breeds. You could be in danger if you don't check the premises on a regular basis.

Commercial Liability Policy

Most commercial liability policies have a $1,000,000 per occurrence limit and a $2,000,000 annual aggregate to cover each individual location. This gives you a higher included coverage limit than the $300,000-$500,000 homeowner's policy or dwelling policy. In the event of a tenant's lawsuit, this is usually enough to protect your business assets and your personal assets. Many carriers will offer higher limits to the underlying policy which can reduce the need for an umbrella. Commercial umbrella policies may be a better option for you if you have more properties or are able to sleep easier knowing that they have additional coverage. There is no right or wrong way to determine how much liability coverage you need. Talk to your agent about the best options for your company.

Excess vs Umbrella

Although the terms "excess" and "umbrella", are often interchangeable and work in the same manner, they are different. An Excess liability policy offers a greater limit than a single line of coverage. If you are a landlord, it is most likely added to your Premises Liability. Although an umbrella policy is more expensive, it allows you to have greater flexibility in extending limits to multiple Liability policies (professional liability, commercial auto, errors & omissions, etc). Your umbrella can also blanket multiple locations.

Remember that the umbrella policy "follows the underlying liability insurance policy." You can match a commercial policy with a commercial umbrella policy or a personal liability policy with personal lines. You will usually also be exempt from your umbrella if it is not covered by your underlying policy.

Here's how it works in practice: A commercial liability policy with a $1,000,000 per occurrence limit and a commercial umbrella insurance policy with a limit of $3 million. Tenant's death results from a fire at one of your duplexes. Your family sues for negligence. The judge grants them $2.5 million judgment. Your underlying commercial liability policy pays the first $1,000,000, then your umbrella insurance covers the $1.5 million and your included coverage includes legal defense fees. Your business assets would pay the $1.5 million additional, while your personal assets (such as your home, retirement accounts, savings, etc.) would be responsible. You could be exempted from the lawsuit.

Your Insurance Agent Matters

It is crucial that you have an agent who understands the needs of real estate investors as your investment or property development business expands. You should not put your business and personal assets at risk by getting sub par coverage from an inexperienced insurance agent. Although commercial policies are more expensive upfront, they offer more coverage that is absolutely needed for your business to be properly protected. Connect now with a Pearson Wallace Insurance agent who will analyze your current policy at no cost to see if you have adequate coverage.