How Liability Insurance Works


If you cause a car accident, your liability insurance will pay for the damage you do to the other person's car. See more car safety pictures.
©iStockphoto.com/diane555

It's no secret we live in a litigious society. People are only too happy to run down to their lawyers' offices and file lawsuits if they even remotely feel they've been wronged. So it's critical to protect yourself through liability insurance. Actually, liability insurance is any insurance you purchase to protect others against something you do -- hit and damage their cars, for example, or create a product they purchase that inadvertently results in an injury. So really, you're protecting others and yourself.

Because so many things can go wrong in our lives, there are many types of liability insurance. Here are a few of the more popular types, some of which are only applicable in a business setting:

  • General liability: Covers bodily injury and property damage to others from an accident you cause.
  • Directors and officers: Protects people against financial loss and injury caused by "wrongful" acts you committed, typically making poor management or governing decisions.
  • Professional liability: Guards against any injuries another person receives due to your negligence in the way you provided a professional service, or by your failure to maintain professional standards. (For example, if you're a CPA who gave out bad advice that resulted in a hefty IRS penalty for your client.) Depending on your profession, this type of liability insurance may have another name; physicians, for example, call it medical malpractice insurance.
  • Umbrella: Also called excess liability, umbrella insurance provides additional coverage for your home, auto and boat in the event a claim costs more than your homeowners, auto or boat insurance can cover. So if you cause a terrible car accident and the resulting claim exceeds the limits of your auto insurance, your umbrella will kick in to pay the rest of the bill.
  • Product liability: Protects people from injuries caused by something you produce.
  • Liquor liability. Covers bodily injury and property damage to others specifically because you had some role in contributing to the intoxication of another [source: Szerlip].

The two most common types of liability insurance from the above list are probably umbrella and general. People who have assets to protect usually purchase umbrella coverage, because if you're sued after a major accident and don't have enough protection, you can be forced to cash in your assets and maybe even give up some of your future earnings. General liability pertains to bodily injury and property damage that someone suffers due to your negligence, whether in your car, home or business. The most common type of general liability insurance is probably general auto liability, which most people are required to carry. Read on to find out more about this common coverage.

Liability Auto Insurance Coverage

Of course you're a good driver. We all are, aren't we? I'm sure you've never chatted on your cell phone while driving, or ate, or applied make-up, or texted or simply were distracted. But even driving aces can cause a crash, and that's when liability auto insurance is critical. If you cause an auto accident, whether it's a mere fender-bender or a catastrophic crash, your liability insurance will pay for the damage you caused to the other person's car, plus any property you may have wrecked as your cars were bumping around. It will also pay for any injuries the other person received, along with their lost wages and their pain and suffering. If someone died in the accident, your liability insurance will also cover funeral expenses, plus legal bills if you're sued [sources: Progressive Commercial, Allstate]. All in all, pretty important stuff.

Liability auto insurance is considered so important, it's required in every state except New Hampshire. The amount of coverage required varies by state. Insurance companies usually offer coverage in a three-part package, such as 25/50/25. The first number always refers to the coverage for bodily injuries you caused to one person, in thousands; the second number to bodily injuries you caused to all people in the accident; and the third figure to property damage. So purchasing 25/50/25 coverage means your policy would pay up to $25,000 for one person's injuries, up to $50,000 for everyone's injuries added together and up to $25,000 for any property damage [sources: Progressive Commercial, Reed].

It's wise to purchase as much liability insurance as you can afford, because if you happen to cause a serious auto accident, medical bills in particular can be astronomical and wipe out your savings and assets. Take the 25/50/25 coverage mentioned above. That's considered fairly bare-bones coverage; experts recommend $100,000 and $300,000 for bodily injury coverage for one and all people, respectively [source: Reed]. It's easy to see why. If you slammed into a car carrying a family of five, their combined injuries could easily result in medical bills that far exceed your $50,000 limit, not to mention the costs for lost wages, funerals, pain and suffering, and, of course, the nearly-inevitable lawsuit that would result.

The Limits of Liability Auto Insurance

Umbrella insurance provides additional coverage for your home, auto and boat.
Umbrella insurance provides additional coverage for your home, auto and boat.
©iStockphoto.com/JulNichols

As critical as it is to carry adequate liability auto insurance, it's not some magic cure-all. Don't forget that it doesn't cover any damage to your vehicle or property, or any bodily injuries you suffer. It's strictly for damage and injuries to others and their property. That's why most drivers also purchase additional auto insurance coverage such as collision, which does cover damage to your own vehicle, and personal injury protection, or PIP, which covers your own injuries, lost wages and other associated costs.

PIP is required in Delaware, Florida, Hawaii, Kansas, Kentucky, Massachusetts, Michigan, Minnesota, New Jersey, New York, North Dakota, Oregon, Pennsylvania and Utah; in Arkansas and Maryland it's not mandatory, but you have to reject it in writing if you don't want it. If you live in a state where PIP isn't mandatory, remember to check over your health insurance before you purchase PIP (or a similar insurance called medical payments). If you've got great health coverage, you may be able to either skip PIP/medical payments, or just purchase the minimum amount available [source: Reed].

The other caveat when it comes to liability auto insurance is that even if you purchase the most that's available (generally $250,000 per person, $500,000 for all), you can still come up short if you're in a serious accident. That's why it's a good idea to also carry umbrella insurance if you're able to swing it. Also called excess liability insurance, umbrella insurance provides additional general liability coverage to your home, auto and boat. Because of this, it's only available to people who have their homeowners, auto and boat coverage with the same insurer [source: Travelers].

Here's how it works: Let's say you cause a serious auto accident, and the resulting bills are $300,000 more than your auto liability insurance can pay. No worries; simply tap into your umbrella insurance, which covers the rest. (That's how it gets its name, incidentally -- you're supposed to think of this coverage as a giant umbrella opened up over your car, home and boat, shielding them from harm.) Umbrella coverage is generally available in increments of $1 million, up to $5 million.

The bottom line is, nobody really likes to pay for insurance. It's expensive, and you may never get a penny back from what you pay in. But when you start grumbling the next time you read your bill, just remember this: Nobody struck by disaster ever regrets being prepared.

Author's Note

Let's be honest. Insurance is not an exciting topic. And sometimes it gets pretty difficult to understand. But once you grasp the basics -- even on more complicated topics like liability insurance -- it's not that hard. Maybe you'll even admit to yourself it's a pretty important subject. And that you really need to stay on top of it. And that you'll start paying more attention to any notices that come from your insurance company. And that you'll sit down with your spouse/partner to review your coverage every year, instead of saying, "You just deal with it." And ... Ahem. Well. I guess I know what resolutions I'll be working on this year.

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Sources

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