Understanding Umbrella Policies and Why to Buy Commercial Coverage

by Shawn Woedl

The umbrella liability policy. One of the most misunderstood concepts in insurance for real estate investors. Even among insurance professionals, how best to structure property and liability insurance for rental properties can be misrepresented, leaving landlords exposed to huge financial risks.

What is an Umbrella?

An umbrella insurance policy is additional liability insurance coverage that goes beyond the limits of your liability insurance, providing an additional layer of coverage to those at risk of being sued. This means that you are required to hold an underlying (or primary) liability policy, the limits of which must be exhausted in the event of damages or a lawsuit before the umbrella coverage kicks in.

Some agents unfamiliar with real estate investing may advise a client to add their rental property as an asset under their personal homeowner’s policy, and purchase a personal umbrella to extend the limit of coverage. Here are two reasons this is not a good idea:

If you own the rental property under an entity other than your personal name (such as an LLC), the personal umbrella offers limited or no protection for that entity’s asset. Many personal umbrella policies contain a “business pursuit” exclusion, which could exclude damages or lawsuits on a rental property because it produces income.

Treat rental properties as the business that they are, which means it is more appropriate to cover them with commercial insurance policies. Policies developed for landlords typically provide higher premises liability limits, loss of rental income coverage, and allow you to buy back coverage to combat the “Total Pollution Exclusion” seen in personal lines. Look no further than carbon monoxide for a reason to avoid that exclusion.

On a homeowner’s liability policy, you will also likely be subject to a canine bite exclusion of the top 12-14 vicious dog breeds, or a full exclusion. A commercial liability policy will often include this coverage with no breed exclusions. Even if you have a clause in your lease against pets or specific breeds, unfortunately tenants don’t always follow through. Unless you are dropping in on a regular basis to confirm there is no pit bull on the premises, for instance, you could unknowingly be at risk.

Commercial Umbrella Policy

On a commercial liability policy form, most limits of coverage start at $1,000,000 per occurrence with a $2,000,000 annual aggregate. This already puts you at a greater included coverage limit than the typical $300,000 on a homeowner’s policy. This is often sufficient to cover your business assets (and isolate your personal assets) in case of a lawsuit by a tenant. But for those with a larger portfolio of properties, or who will sleep better at night knowing they have additional coverage limits, you may invest in a commercial umbrella policy. We always recommend you have as much liability coverage as you can afford, but talk to your agent about what makes sense for your business.

Excess vs Umbrella

While the terms “excess” and “umbrella” are often used interchangeably and they operate in the same way, they are not the same. An Excess Liability policy provides an increased limit over just one specific line of coverage. In the case of a landlord, that is likely your Premises Liability. And your umbrella can blanket multiple locations. An Umbrella policy, while costlier, gives you more flexibility to be able to extend limits over multiple Liability policies (Professional Liability, commercial auto, Errors & Omissions, etc).

Just remember, the umbrella policy “follows” the underlying liability policy. Match personal to personal and commercial to commercial. And typically, anything excluded within your underlying policy is also excluded from your umbrella.

So here’s how this often times works in practice if you have a commercial liability policy with a $1 million per occurrence limit, and a commercial umbrella policy with a $3 million limit. A fire ignites at one of your duplexes, resulting in the death of a tenant. The family sues you for negligence and the judge awards them a $2.5 million judgement. Your underlying commercial liability policy pays out the first $1 million, then your umbrella policy covers the remaining $1.5 million, and your included coverage extends to legal defense fees. If you did not have the umbrella policy, your business assets would be responsible for the additional $1.5 million, but your personal assets (personal home, retirement account, savings, etc.) would still be protected.

In Conclusion

As your investment business grows, it is important that you work with an insurance agent who knows the ins and outs of your needs as an investor. Don’t put your personal or business assets at risk because you got some well-intentioned, but detrimental advice. Commercial policies may cost a bit more up front, but they provide you coverage that is more appropriate for your business.