Lawsuit Risk and the Insurance Layer

The most likely way an ordinary household loses a large sum to a lawsuit is not a dramatic business dispute. It is a car accident, a fall on a staircase, a dog bite, or a teenager behind the wheel. Insurance, not clever legal structures, is the first and strongest defence against those claims, because it pays both the judgment and the lawyers. This chapter helps you find where your exposure comes from, read the liability limits you already have, and decide whether an umbrella policy or professional coverage is worth its cost.

Where personal liability comes from

Most claims against individuals come from a short list of everyday activities:

• Driving. An accident that injures someone is the largest common liability. Medical bills, lost wages and pain and suffering can far exceed the minimum liability limits that states require, and those minimums are low in many states.
• Your home and property. Guests who slip, a pool, a trampoline, a dog with a bite history, a tree that falls on a neighbour's house.
• Teen and young adult drivers on your policy, whose accidents can lead to claims against the parents who own the car.
• Rental property. Tenants and their guests can sue the owner over injuries and conditions.
• Volunteer and board roles. Serving on a nonprofit or homeowners association board can draw you into claims against the organisation.
• Words. Posts, reviews and emails can lead to defamation claims.
• Work. Doctors, lawyers, accountants, engineers, financial advisers, contractors and business owners face claims from clients, patients and employees that personal policies exclude.

You cannot remove these risks, but you can see which apply to you and match coverage to them. A household with two cars, a teen driver, a pool and a rental unit has a very different profile from a single renter who takes the train.

Read the limits you already have

Your auto and homeowners or renters policies each contain liability coverage. The declarations page states the limits.

Auto liability is often shown as three numbers separated by slashes: bodily injury per person, bodily injury per accident, and property damage, all in thousands of dollars. Many states' required minimums would be exhausted by a single hospital stay. Insurers commonly sell much higher limits, and the extra cost is often modest because the most expensive part of the premium covers the first layer of claims, which are the most frequent.

Homeowners and renters liability covers injuries and damage you cause, at home or away, other than with a car. It usually also includes a small amount of medical payments coverage that pays a guest's minor medical bills without a lawsuit.

Defence costs. In most personal auto and homeowners policies, the insurer must hire and pay a lawyer to defend you, and those costs are usually paid in addition to the limit. A lawsuit can cost a great deal to defend even when you win, so this is part of what you buy. Check the wording of your policy, because some policies count defence costs against the limit.

The umbrella policy

An umbrella policy adds liability coverage on top of your auto and home policies. It pays once their limits are used up, and it often covers some claims those policies exclude, such as libel and slander. Insurers sell umbrellas in round amounts and require you to carry certain minimum limits on the underlying policies first, so buying one often means raising your auto and home liability too.

Here is the arithmetic of the choice. Suppose an umbrella costs $40 a month; quotes vary with your cars, drivers, home and state, so treat that as an illustration and get your own price.

At that price the policy costs $480 a year and $9,600 over 20 years. Compare that with one claim that goes beyond your underlying limits and is not covered. A judgment is a debt that typically earns interest until paid, and creditors can collect from exposed assets and part of your wages. If an uncovered judgment had to be paid off over ten years at an assumed 6.0% interest, it would look like this:

That is about $5,551 a month for 10 years, with $166,123 of interest on top of the judgment itself. Post-judgment interest rates are set by state law or, in federal court, by Treasury yields, so the real figure depends on where the case is decided. The point is not the exact number. It is that two decades of premiums cost a small fraction of one uninsured claim.

How much coverage? There is no formula from a regulator. Common rules of thumb set the umbrella at least equal to your net worth, or to the assets a creditor could reach after the exemptions in chapter 1. Those with higher earnings, more drivers, or a visible public profile often buy more, because future wages can also be garnished. The net worth by age benchmark is a quick way to total what you own before you ask for quotes.

Umbrellas have limits of their own. They generally exclude business and professional activities, intentional acts, and claims between members of your household. Some exclude certain dog breeds, watercraft or rental units unless you schedule them.

Coverage for work and business

Personal policies stop at the door of your job or business, so work risk needs its own coverage.

• Professional liability (malpractice for clinicians, errors and omissions for other professionals) pays claims that your advice or work harmed a client. Many policies are written on a claims-made basis: they cover claims made while the policy is in force. When you retire or change employers, an extended reporting endorsement, often called tail coverage, keeps old work covered. Find out whether your employer provides tail coverage before you leave.
• General liability for a business covers injuries and property damage at your premises or caused by your operations.
• Directors and officers (D&O) insurance protects board members. Before joining any board, including a nonprofit or homeowners association, ask whether it carries D&O coverage and whether the organisation will indemnify you.
• Employment practices liability covers claims from employees, such as discrimination or wrongful termination, for anyone who employs people.

An entity such as an LLC or professional corporation protects your personal assets from the business's debts and from claims about other people's work, but it does not protect you from your own professional negligence. Insurance is what covers that.

Behaviour that keeps claims small

Insurance pays claims; behaviour prevents them. A few habits matter more than any legal structure:

• Keep cars and drivers safe, and think carefully before titling a car in a parent's name for an adult child who drives it.
• Fix hazards on property you own, and keep records of repairs.
• Use written contracts in business, and avoid personally guaranteeing business debts unless you understand what you are signing.
• Keep business and personal money in separate accounts.
• Report every incident to your insurer promptly. Late notice is a common reason a claim is denied.