If you commit a negligent act that results in injury to a third party, liability insurance can be a financial lifesaver. Liability insurance will cover the injury costs and provide additional coverage if the party decides to pursue litigation against you. Determining how much coverage you should carry requires a fairly straightforward mathematical calculation.
You may need a variety of liability insurance types. Nearly every state requires vehicle owners to carry at least a minimum amount of coverage, and if you own a home, you'll want liability insurance to protect you in case a visitor is injured due to a fall or other mishap. If you own a business, liability coverage protects against the negligent acts of you or your employees or harm caused by your products. Professionals such as doctors and lawyers need coverage against possible errors or omissions during their practice.
According to the SmartMoney website, the amount of liability coverage you carry should equal or exceed your net worth, which is calculated by subtracting the value of your liabilities from your total assets. Your assets can include the total of your salary, the amount of equity you have in your home, your investments, valuable items such as jewelry and real estate, and the value of a business. Liabilities generally include any outstanding debt obligations.
The purpose of insuring your entire net worth is to ensure you can keep everything you own, even if you are successfully sued for a negligent act. Otherwise, you would be forced to pay any amount not covered by insurance out of your own pocket. The higher your net worth, the more attractive a lawsuit target you may be, which further increases the need to carry as much liability insurance as possible.
In some cases, your available liability coverage may be inadequate. A standard homeowners insurance policy, for instance, may only offer a maximum of $300,000 in liability coverage. One way to provide additional coverage is to purchase an umbrella liability policy, which offers relatively inexpensive protection in $1 million increments. A personal umbrella provides excess coverage over your home and auto policies, while a commercial umbrella will protect your business assets. To qualify for an umbrella policy, you generally must be free of previous large liability claims and not be a high-profile figure such as a politician or professional athlete.