When shopping for car insurance, what’s the most important coverage you look for? What’s the main thing you’re trying to protect? If you had asked me this question a few years ago I would have said collision and comprehensive. After all, that’s why you buy car insurance, right? To protect your investment in case you crash it or it gets stolen. Wrong! Well, sort of.
While protecting your investment is important, I’d argue that it is not the most important thing, especially when it comes to car insurance. Rather, protecting yourself from the liabilities you’re exposed to while driving a motor vehicle is. All it takes is one accident and you might find yourself on the wrong side of a lawsuit that could potentially cost you multiples of the value of your car. Or even worse, completely wipe you out.
That’s why liability coverage is the most important coverage you can add to your auto insurance policy. It helps protect you from financial catastrophe. Let’s dive a little bit deeper.
What is Liability Insurance?
Liability insurance pays for expenses resulting from injuries you caused to others. It also pays for damages you caused to other people’s properties.
For example, let’s suppose you cause a car accident on your way to the mall. The other car is totaled and the driver was sent to the hospital. You might be found liable for all expenses you incurred to the other person, such as the cost of replacing the totaled car, medical bills, legal bills, among others.
That’s when liability insurance kicks in. The insurance will pay for all these expenses, up to the limits established on your policy.
What Does Liability Insurance Cover?
Liability insurance is usually split into two different types of coverage: bodily injury and property damage liability coverage. Let’s take a look at each one of them.
Bodily injury liability coverage kicks in when you injure someone in a car accident. It will typically pay for expenses related to the injury you caused to others during an accident. The following are some examples of covered expenses.
- Medical Expenses: Doctors and hospital bills. Rehabilitation therapy costs such as physical therapy. Equipment such as wheelchairs. These are among the most common medical expenses the insurance will pay for. In the case of death, insurance will help pay for the funeral costs as well;
- Legal Fees: if the other party involved in the accident sues you, the insurance will pay for your legal defense cost, which can be quite substantial;
- Loss of Income: If the injured party becomes incapacitated to work and earn an income for some time, the insurance may pay part or all of their lost income for the period;
- Pain and Suffering: An accident can have lasting consequences that negatively affect the person’s life for years to come, or even forever. They might seek compensation for such suffering. Bodily injury insurance can help pay for these expenses.
Property damages liability coverage will help pay for damages you caused to other people’s properties, such as a car totaled in an accident you caused
It also covers personal items inside the vehicle involved in the accident, such as laptops or anything of value that gets damaged.
What Does Liability Insurance Not Cover?
Liability insurance is intended to cover expenses you caused to others, not to yourself. If your car gets destroyed in an accident you caused and you end up in the hospital with a large medical bill, liability insurance will not help you.
In this case, you will have to resort to your other insurances, assuming you have them. Your collision auto insurance will pay for the damages on your car, and your health insurance will take care of the medical bills.
Do I Need To Have Liability Insurance?
In short, yes. You are required by law to have auto liability insurance in virtually all states. The two exceptions are New Hampshire and Virginia. Keep in mind that while you don’t have to have insurance in these states, you still have to pay for any damages you may cause. So, do yourself a favor and get it anyway.
It’s funny that for the longest time I thought the auto insurance requirement meant that you had to have collision / comprehensive insurance. Instead, what you need is liability insurance only. At the end of the day, the state couldn’t care less if you total your car and then don’t have the money to replace it.
What Are The Liability Coverage Limits?
The thing with liability insurance, and all insurances for that matter, is that it will not always pick up the entire tab. There are limits to how much the insurance company will pay in the event of an accident. If you owe more than the limits of your policy, you’ll have to pay for the difference out of your pocket.
These limits are determined by your insurance policy and they come in two different forms: split and single limits.
- Split Coverage Limits: A policy with split coverage limits has three separate limits usually represented in the following format: 25/50/15. In this case, it means this policy will pay a maximum of $25,000 per person for bodily injuries, but not more than $50,000 combined for all persons involved. It will also pay a maximum of $15,000 in property damages. One downside of this type of limit is that depending on what the damage was, you might run out of limit on one category while having an unused limit in another category.
- Combined Coverage Limits: This type of policy has just one global limit, for example, $100,000. In this case, the insurance will pay up to this amount to cover the costs related to the accident. It does so regardless of whether they were bodily injuries or property damages. This type of coverage is much more flexible and ensures you will be able to use your entire limit.
How Much Liability Insurance Do I Need?
This is the most important question you should be asking. In fact, this is the main reason I decided to write this article. So, how much liability insurance should you really have?
Let’s start with what is required by law. Each state defines a minimum liability coverage amount that you have to have to legally drive in that state. If you are caught driving without at least the minimum coverage, you could get fined. You could also have your driver’s license temporarily suspended and your car impounded. In certain states, you could even face jail time.
Now, here’s one caveat. More often than not, having only the state minimum coverage is a very bad idea. Sure, you’re meeting the legal requirements but you could also be setting yourself up for financial disaster should the worst happen.
Why Is Having the State Minimum Usually A Very Bad Idea?
While the state minimums provide you with some level of coverage, the limits are usually relatively low. Let’s take Arizona as an example.
As I’m writing this article, the minimum coverage requirement in Arizona is 25/50/15. This translates to $25,000 for bodily injuries per person, $50,000 for bodily injuries per accident, and $15,000 for property damages. If you compare this against the average cost of an accident, you can even argue that it provides somewhat decent coverage.
But what happens if you get involved in a not-so-average car accident? Imagine you crash and destroy a brand new car that costs $45,000. Your insurance will pay $15,000 and you will have to cover the remaining $30,000 out of pocket. And, what if the accident leaves a person with a permanent disability, at an average cost of $98,000? Or even worse, what if you kill someone, at an average cost of $1,704,000? Sure enough that $25,000 your insurance will pay sounds pretty low now, doesn’t it?
As you can see, the minimum coverage in Arizona will protect you from having to pay a maximum of $65,000. Depending on the accident and the number of people involved, this protection can be as low as only $25,000! Anything above it, they will come after you. These figures are not all that different in other states. While it’s better than nothing, let’s be honest, that’s ridiculously low.
If you’re still not convinced of the dangers of not having enough insurance, let’s take a look at a couple of real-world accidents and their outcomes.
- A driver was hit by another car in an intersection in what appeared to be a minor accident. The driver had extensive arthritis on the left hip and as a direct result of the accident, had to undergo a full hip replacement. The case was settled for $310,000.
- Another driver had to go through surgery to treat a few herniated discs after being rear-ended by another driver and became unable to go back to work. The case was settled for $1,100,000.
These two, apparently mild, accidents resulted in large settlements. Way above the state minimums. You could argue that these are extreme cases, and I’d agree with you. The odds of this happening are low. But the point here is: it can happen.
To me, that’s the main reason to buy insurance. Not to protect you from mundane, higher probability, lower-cost things. But to be there if that unlikely event happens, and protect you from having your life ruined.
What Is at Stake?
As stated before, if you receive a judgment against you for an amount that’s higher than the limits of your insurance policy, you will have to come up with the remaining amount out of your pocket. But what if you don’t have the cash to pay for it? Well, they will come after your assets.
Here are a few examples of things that you could lose in an accident-related lawsuit:
- Bank accounts;
- Investment accounts (your life savings!);
- Rental properties;
- Primary residence, minus the homestead exemption;
- Other homes you may own;
- Cars, minus the state exemption;
- Wages, up to a certain percentage;
- Assets owned by your spouse, if you live in a community property state;
- In extreme cases, personal properties that are not protected by an exemption.
Basically, almost anything you worked so hard to build can be seized to satisfy a judgment. If you don’t have enough assets, your wages can be garnished until all your debt is satisfied.
Depending on the severity of your case, you could end up having to file for bankruptcy. This will erase most debts but will have long-lasting side effects, including severely damaging your credit score for several years.
There are some exceptions, however.
A portion of the equity on your primary residence is usually protected by a homestead exemption, which varies by state. Some states exempt the entire value of your home, while others exempt little to nothing.
In Arizona, for example, up to $150,000 is protected by the homestead exemption. That means if your home is seized to satisfy a judgment, you get to keep up to $150,000 of the equity you own.
Cars have similar protection, which also varies by state. In Arizona, up to $6,000 of the value of your car is protected from seizure.
Retirement accounts under ERISA, such as 401(k) and 403(b), are generally protected by federal law and usually cannot be touched in a lawsuit. That is true regardless of how much money you have in them. Individual retirement accounts, such as IRAs, are not protected on the federal level but are usually protected on the state level.
Ok, I Get It. So, How Much Do I Really Need Then?
There’s no definitive answer here. Dave Ramsey, for example, suggests that you have at least $500,000 in liability coverage. Others suggest you have enough coverage to protect your entire net worth, or at least enough to protect the assets you have at risk.
At the end of the day, this is a very personal decision. You have to look at your situation and determine how much insurance is enough for you. Are you a renter and most of your assets are in retirement accounts? You probably don’t need all that much. Own your house outright and have a fat brokerage account? You’d better get some decent coverage.
I’m in the camp of having enough to protect your entire net worth, for extra peace of mind.
What if I Need More Than the Maximum Available Through My Auto Insurance Company?
Most auto insurance companies have a cap on how much liability coverage they offer. It’s usually around $500,000. Depending on how much you are worth, this might not be enough to give you proper protection. In this case, you should consider adding an umbrella insurance on top of your auto liability insurance.
Umbrella insurance is a type of liability insurance that effectively extends the liability coverage of your auto (and others) insurance. Coverage generally starts at $1,000,000 but can go as high as $10,000,000.
For example, let’s imagine someone sues you for $1,000,000. You have $500,000 auto liability insurance plus a $1,000,000 umbrella policy. In this scenario, your auto insurance will pay up to the limit of the policy, $500,000. Your umbrella policy will pay for the rest of it.
One last thing to keep in mind. Liability insurance is not a magic thing that will 100% shield you from any lawsuits. Someone can actually sue you beyond the limits of all of your policies and take your assets anyway, even with proper insurance coverage. The likelihood of this happening? Slim to none. But still, that is a possibility and I just wanted to throw it out there.
The Bottom Line
Do not skimp on your auto liability insurance! If all you have is your state’s minimum coverage, you should seriously revisit it. With such small coverage required by most states, it doesn’t take much for you to find yourself having to pony up large sums of cash to pay for an accident.
It doesn’t even cost all that much. I pay less than $1,000/year (liability premiums only) for the maximum liability coverage my carrier offers, for two cars, plus an umbrella policy. To me, not getting decent coverage is just not worth the risk.
And as usual, if you want to review your current insurance situation, consult with a professional. Call your insurance agent/broker (you have one, right?) and they should be able to go over your policies and make any necessary adjustments.