Don't Let a Smile Be Your Umbrella
Rick Sikorski has come a long way from the days when he was too poor to afford an apartment and slept in a sleeping bag in his tiny personal-training studio. Today, 24 years later, Sikorski's single studio has bloomed into Fitness Together, a franchise business with about 350 locations in the United States, Canada, Costa Rica, Ireland, and Israel, along with a new seven-location massage-therapy franchise. Last year, Sikorski sold 80 percent of Fitness Together to a private equity fund. He'd been rich for years, but now he had cash--$40 million of it. And that meant Sikorski had to think differently about insurance.
When his main asset was the company, business insurance policies covered many of Sikorski's needs. Now that he had money in the bank, he had a new series of headaches and questions. Some were small: Should he raise the deductibles (and hence lower the premiums) on his auto and property policies, now that he could afford to pay cash for small repairs? But there was another, potentially more important concern. Many wealth managers recommend that high net worth individuals buy insurance policies sufficient to cover a multimillion-dollar legal settlement. Sikorski had to decide whether he needed such a policy, and if so, how much coverage he should buy.
Your homeowner, auto, and property policies pay for many legal claims. But you may need the extra protection afforded by what's known as an umbrella policy, which pays for any legal settlement that ordinary insurance doesn't cover. Say your pizza delivery guy slips and falls on your porch and sues you for $2 million. If your homeowner's insurance covers only $1 million, the umbrella policy will kick in and cover the difference. The same applies if you get into a car accident and the other driver sues you for more than your auto insurance will cover. It's an important concern for wealthy individuals, says Kraig Kast, CEO of wealth management firm Atherton Trust in Redwood Shores, California. "You're more likely to have someone sue you if you're driving a new Mercedes than if you're driving a 1992 Saturn," says Kast.
So how big of an umbrella policy do you need? The usual answer is, not the total value of your assets, only the amount you're at risk of losing to a lawsuit. That number is tough to determine, but it has a lot to do with what you do for fun and what other asset protection strategies you use. If you have dangerous hobbies--throwing wild parties, perhaps--you need more coverage than someone who spends most of his time reading mystery novels. Even a house on a lake could be a liability if you invite your neighbors and their kids over for a Fourth of July party. The largest liability policy Kast has ever recommended was $25 million, and that was only once, for a client with no other asset protection strategies. Most of his clients put their properties in a limited liability corporation, which provides protection in case of a lawsuit. For clients with such LLCs, he's never recommended more than $8 million in coverage. That was for a neurologist who owned several apartment buildings and had a net worth of more than $20 million. His malpractice insurance covered the risks associated with his profession, but his secondary job as a landlord also put him at a high risk of being sued.
A policy that large is only necessary if you're at risk of a huge lawsuit. In ordinary slip-and-fall suits, plaintiffs almost always settle for whatever amount is covered by liability insurance, says Tom Baker, a professor at the University of Connecticut Insurance Law Center. That's why Sikorski decided he didn't need much coverage. He bought a $3 million umbrella policy, which will kick in to cover any legal damages that exceed the limits of his other policies. At $1,150 a year, the policy is affordable and practical and gives him peace of mind. "I play ice hockey, and if I were to hurt someone, the umbrella policy would kick in," he says.
When adding liability to your homeowner, auto, and property policies, you could be forgiven for cringing at the total cost, which can be tens of thousands of dollars. But there are ways to keep costs down without cutting back on your coverage. David Moore, owner of Moore Holdings, a New York City-based holding company that owns six businesses, has developed a system for negotiating rates on any kind of business or personal insurance. First, he says, understand that a single broker looking for proposals from a dozen different insurance companies is not truly generating competitive bids. Why? That broker typically has good relationships with one or two companies and the other insurance companies know that they have little chance of earning that broker's--and your--business. As a result, they won't put in the time to give you a serious quote. Bill Montgomery, owner of Insurance Works, an insurance agency in Dayton, Ohio, confirms Moore's view. "Agents typically get the best quotes from the insurance companies they work with all the time," he says. Additionally, no matter how much you love your broker, he or she works on commission and has a strong incentive to keep your premiums high. Brokers generally take 10 to 12 percent of the premiums you pay every year, according to the Insurance Information Institute.
So Moore suggests dividing up the playing field. A few months before your insurance is set to renew, tell your broker you're going to shop for insurance. In writing, give him permission to speak to two or three specific insurance companies and no others. Take a similar request, in writing, to one or two other brokers. By having each broker get proposals from two or three different insurance companies, you're inviting competition between the insurance companies and between the brokers. "A new broker has an incentive to look at your current insurance coverage with a critical eye, and he or she is very happy to point out gaps in insurance," Moore says. Using his system to shop for insurance last year, Moore saved 30 percent on a package of auto, home, personal property, and general liability policies. Now he pays $22,500, down from about $32,000 two years ago.
You can also boost your coverage without causing premiums to skyrocket by increasing the deductibles on all your insurance policies. Then, use the money you save on premiums to increase your coverage, say from $1 million to $3 million, suggests Stuart E. Lucas, author of Wealth: Grow It, Protect It, Spend It, and Share It. This is particularly sensible for property and auto insurance, Lucas says. Say you get a ding in your car. "The cost of that repair--a few hundred bucks--is not going to destabilize your asset base," he says. "If you're healthy and responsible, you're an ideal candidate to self-insure for noncatastrophic events."
That strategy makes sense for Sikorski. After selling his business, he increased the annual deductibles on both of his $2 million homes to $5,000 each, which saved him 12.5 percent on premiums. He boosted his auto deductibles to $1,000, which cut his premiums by 5 percent--no small sum considering he insures two Hummers and a Porsche. "I'm assuming a much higher risk than I did back then, because then I didn't have any extra money if something went wrong," he says. "But why pay those extra premiums?"