How does an umbrella insurance policy work?

First of all, umbrella insurance is a type of liability insurance, which means it provides protection if you are sued or found liable for things like:

• Causing injury
• Causing property damage
• Libel or slander (learn more about Liability Risks on Social Media)
• Other personal injuries

An umbrella insurance policy gives you coverage that kicks in when the coverage from your primary liability insurance policies falls short. If someone gets injured on your front steps or you cause serious property damage in a car accident, your homeowners or auto insurance policy might not fully cover your losses. If it doesn't, your umbrella policy (if you have one) will pay for the excess damages.

Your primary liability policies can fall short mainly in two ways: limits and coverages.

Limits are one of the biggest reasons people choose to buy umbrella insurance. Often, your primary policy will provide you some protection, but it will be quite limited. For most homeowners policies, the insurance limit is $1 million for a personal liability claim. That's the maximum your insurance company will pay out if you file a liability claim. The typical limit for auto liability coverage varies across jurisdictions, ranging between $200,000 and $5 million.

Depending on your level of wealth, risk tolerance, and whether you live in a particularly litigious area, those limits might not be enough. If you think you need more, look into getting an umbrella insurance to increase your coverage limit (find out Why You Need a Lot of Liability Coverage - Even if You're Law Abiding).

Coverage is another important factor. All liability policies have exclusions. For many people, that's not a big deal, but if you look over your liability policies and aren't comfortable being on the hook for some of the perils that are excluded, you can get an umbrella policy to fill in those deficits.

That being said, it's not a perfect solution. Umbrella policies have some exclusions as well. So be sure to carefully review your options and the way the policies are worded to know whether you are adequately protected.