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How to Insure Your Income: Defense Costs Covered

A third major benefit of personal umbrella coverage is that the contract provides for payment of defense costs. When you are accused of being liable for damages to someone else and are taken to court over it, legal costs will be incurred by the accused, even if the suit is totally groundless and ends in the accused's favor. Fortunately, most underlying liability policies provide coverage for defense costs, whether or not the suit is groundless. Also, these costs are paid in addition to the available limits of liability (in other words, the entire liability policy limits are available to pay damages).

Actually, the insurance company does much more than simply pay defense costs when a suit is brought against an insured. The insurer not only assumes the cost for defending a claim, it also has a duty to defend the claim or suit.

In other words, the insurance company steps in and provides the defense and does so at its own expense. However, the insurance company's duty to defend ends when it has paid or offered to pay its maximum limit of liability.

Most personal umbrella policies also agree to provide a defense and to pay defense costs in this way. This can be very important in various situations where a defense by an underlying insurer may not be provided or may not be available.

Suppose you have a homeowners policy providing $100,000 of personal liability coverage and $1 million of personal umbrella coverage. One day, your pit bull terrier bites and severely injures a visiting child, and the child's parents sue for $500,000.

If the underlying insurer believes a defense may be successful, it may defend the claim to conclusion, regardless of the outcome. Perhaps there will be no liability. Perhaps any liability awarded will be less than the homeowners policy limit. Perhaps the award will exceed that limit. The umbrella insurer observes but does not participate in the defense. It will, however, pay its share of any award in excess of the $100,000 homeowners limit.

The underlying insurer might not have to provide a defense. If it believes a successful defense is doubtful, and that any settlement is going to exceed its policy limit, it might immediately offer to pay its $100,000 limit and avoid defense costs (its obligation ends when it exhausts its limit). You no longer have the underlying insurer defending its claim.

The personal umbrella becomes very valuable at this point for two reasons: First, the umbrella company will step in and defend the remainder of the claim; second, the umbrella's liability limit can make up the remaining $400,000 if the child's parents win their entire demand.

An underlying defense might not be available when a loss occurs. Generally, this occurs when a loss is not covered by an underlying policy, but is covered by the personal umbrella on a drop down basis. Obviously, if a situation is not covered by one of the underlying policies, there is no underlying insurer to provide a defense of the claim.

Example: Cal has a homeowners policy, but it is not endorsed to provide personal injury coverage. Cal is sued by someone for slander. There is no coverage for this claim under the homeowners policy -- that insurance company is not obligated to provide a defense or pay defense costs. In this case, the personal umbrella company will step in and provide a defense, pay the defense costs and provide drop down personal injury coverage for damages that may be awarded in addition to the defense costs.

Even if you have umbrella coverage, you need to be careful about defense costs. Many policies do cover defense costs in addition to the limit of liability. But be aware that under the terms of some personal umbrellas, defense costs are included in the policy limit and are not additional coverage!

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