Setting Liability Limits

At some point in purchasing insurance, everyone has to choose a limit of liability. Even in personal auto insurance you have to choose a limit. Some people take "state minimum" or they ask the insurance agent to tell them what they need. And for many people, I can understand why this happens. Most people don't have a good handle on what a limit of liability is or why they should care. The limit of liability is the most the insurance company will pay to a claimant on behalf of the insured. It may or may not limit the cost of legal defense as well.

So why does it matter? When the insurance company pays the policy limit, it doesn't magically make the insured not liable for additional losses. For example, someone is insured in a fatal car crash, and the insurance company pays the policy limit of $50,000 to the deceased's spouse. That does not end the claim, the family is free to sue, and may receive a judgement well in excess of $50,000. They could then place liens on property and garnish wages until the judgement is paid.

However, most plaintiffs only want to bring a suit if they think that they can recover something. Which is why when someone driving a cheap car without insurance and damages your car, your insurance company may not pursue the driver. The insurance company doesn't think that they will be successful in extracting any money from the guilty party. There is likely nothing to take. Those with nothing to protect are generally judgement proof, and only carry what the law requires, at most.

So, how does one set a liability limit? I advise my clients to take three items into account.

1. What is the maximum probable loss?

2. How much insurance do I need to protect my assets?

3. What is reasonable and customary for others in the same position?

For example, Jim runs a medium size seafood wholesaler. He owns his building and has business assets of about $750,000 including fixtures, inventory, cash and receivables. Wholesalers similar to Jim carry at least $1,000,000 in general liability, and some carry as much as $5,000,000. A maximum probable loss is somewhat more than $1,000,000 (think salmonella poisoning). Jim wants to protect his assets, and make sure that no one incident can end his business. I would most likely recommend a $2,000,000 limit of liability. This balances the exposure, his assets to protect, and the practices of other similarly situated businesses.

So $2,000,000 is going to cost twice as much as $1,000,000, right? Actually, $2,000,000 won't cost that much more than $1,000,000. In many cases the second million of coverage will cost as little as 20% as the cost of the first. This is because losses under $1,000,000 are generally more likely than losses between $1-$2 million.

There are a number of pieces to balance, but as an informed consumer, you don't have to let someone else choose for you.