The basement we plan to finish as a studio with full bath and kitchenette, "apartment"/Mother-in-law suite so that we can rent it out and house hack. 

One lawsuit can easily wipe out everything I have.  

I'm also very interested on how it works and how vulnerable it is when it comes to lawsuit.

Unfortunately, there are times when both the LLC and the individuals can be sued in Texas (it's referred to as "stacking lawsuits"). 

Another issue with not sticking to your screening criteria is that if you reject one person and then are flexible on another for a similar issue like income, you could be opening yourself up to a FHA complaint and lawsuit. 

Worthless lawsuit, they won’t see a dime.

If I were faced with a liability lawsuit and I could only have one of these  (LLC or umbrella liability insurance) I would go with the insurance. every. time.So if you go with an LLC, just get the insurance anyway!

Going to purchase small multi family or residence with in-law suite to house hack.

We would like something else, probably 1 million to start, that would help protect us from other potential lawsuits (unlawful evictions, injury, death, etc)I'm unsure which type of policy would be best to blanket cover our on LLC and would allow us to increase our coverage as the portfolio of properties increase.

Your "friend" is also running the risk of damage to "his" tenant, which would result in lawsuits (and attorney's fees) and damages payable to the tenant.