umbrella policy: additional liability insurance that goes beyond the limits of an insured’s general liability, auto and/or employer’s liability insurance.
Normally an umbrella policy is written to supplement an existing policy (or policies) beyond a $1,000,000 limit. Umbrella policies are purchased for added protection for businesses and even individuals. They are often required by a business’s clients or governmental entities.
Umbrella Pricing Complexity
It is difficult to determine the price of an umbrella policy. Claims less than $1,000,000 are more predictable because they happen with greater frequency than larger, more catastrophic losses. Underwriters are able to statistically calculate average losses for lower-cost claims, so they can then be utilized to establish stable and reliable pricing. Catastrophic losses, on the other hand, are more difficult to predict in terms of frequency and dollar amount. The added uncertainty creates difficulty in establishing the price of an umbrella policy relative to the primary policies that provide limits of less than $1,000,000.
Factors Causing Increased Umbrella Pricing
- Attorney Involvement in Claims – Insurance companies have cited that the percentage of attorney involvement in liability claims has increased from 30 percent in 2007 to approximately 50 percent in 2018. Any time that an attorney is involved in a liability claim, the cost of the claim increases substantially. This has caused claims exceeding $1,000,000 in value to increase accordingly. In addition to the actual payout of money to the claimant, the insurance company pays out substantial legal fees and court costs.
- Increasing Motor Vehicle Accidents – A number of factors have caused motor vehicle accidents to increase nationally. These factors include distracted driving, disintegrating and outdated roadways and infrastructure, and an increasing number of vehicles on the road. The mere increase of motor vehicle accidents provides more opportunities for bodily injury claims to pay out in excess of $1,000,000, which is the catalyst for an umbrella policy to come into play.
- Lawsuit Financing – In recent years, lending institutions have been willing to loan a plaintiff money using the forecasted value of the lawsuit as collateral. This provides the plaintiff money to sustain them while the lawsuit unfolds. This allows the plaintiff to attain a larger settlement, as they are not forced to take a smaller settlement due to their financial needs. Previously, insurance companies were able to settle with claimants at dollar amounts of less than $1,000,000. Lawsuit financing has increased the settlements to more than $1,000,000 which can cause umbrella policy payouts.
- Lawsuit Investing – Lawsuit investing occurs when attorneys attain individual investors who are willing to invest money that is given to the plaintiff up front. The plaintiff is required to continue with the lawsuit to its conclusion. For example, the lawyer’s estimate of the final outcome of the lawsuit is $1,500,000. The investors give the plaintiff/claimant $500,000 beforehand. At the conclusion of the lawsuit, the investors receive their $500,000 investment back in addition to any amounts above the $500,000 derived from the settlement. This is a simplified example, but the net effect of lawsuit investing is to escalate the amount paid out by the insurance company. The insurer previously would have probably settled for $500,000, but the lawsuit investing causes the insurance company to pay much more. Often time, this causes the payment to be in excess of $1,000,000 and involving the umbrella policy.
- Reinsurance – Reinsurance is insurance that is purchased by an insurance company when they are not comfortable holding the full limits of a particular policy. Due to the issues causing liability claims and lawsuits going beyond $1,000,000 with greater frequency, insurance companies have utilized reinsurance more often to protect their assets. The reinsurance company costs are added to the policy premium. The reinsurance underwriters have seen the increase in claims as well, and they have increased their premiums accordingly.
All of the above factors combined with the inherent difficulty in pricing umbrella policies causes insurance underwriters to seek significantly higher premiums or decline to quote entirely.