How much liability insurance is enough?

LM asks:

My husband and I have close to $2 million in assets (including our home). Currently, we have a million dollar umbrella policy. However a recent NY Times article said people can also sue for future earnings which prompted me to add to our policy. Is a $2 million dollar umbrella overkill? The additional coverage would cost $200 per year.

A Personal Excess Liability Policy (PELP) in the amount of $2M would definitely not be over-kill in your situation. In fact, I would probably go higher - to $3M or possibly even $5M if you could get it. As you have determined, these policies are very affordable. Generally, a $1M policy would cost somewhere in the neighborhood of $200 to $300 per year. You can add additional $1M increments for about $100 per million.

PELP's, more commonly known as "Umbrella" policies, are an important part of your financial security and it is surprising how few people carry these policies. Umbrella policies ride on top of your existing homeowners and auto policies. If you are involved in a serious car accident or a relative or friend is injured at your home, any judgments against you will first be paid by your homeowners insurance or your car insurance. If the judgment exceeds the limits on these policies, an Umbrella policy would kick in and cover the rest. This is important because judgments of $2M to $10M are not uncommon and most people have only $300,000 to $500,000 of liability coverage under their auto and homeowners policies. If you don't have an Umbrella policy and you face a $2M judgment, your assets will be taken to satisfy the judgment and your future earnings could be attached as well.

How much coverage is appropriate? I usually start with a person's current net worth and build up from there. If you have a net worth of $2M but your assets are growing rapidly, you need to think about what your net worth will be in 2 or 3 years. Plus, you need to consider your other "risk" factors: do you live in a wealthy town? do you entertain frequently? are there a lot people coming and going from your home? do you have a swimming pool? If you answered yes to any of these questions, you should add additional coverage.

One other point that many people don't know: if you have a trampoline at your home, you might not be able to obtain umbrella insurance or you might be issued a policy that excludes any injuries sustained on the trampoline. Trampolines are bad news all around and they are a huge liability. Other factors that can impact whether or not you can obtain umbrella coverage include your driving record (too many accidents or tickets may result in no coverage or cancellation of existing coverage) and your credit history.