Umbrella insurance: can it replace an LLC?

Written on February 6, 2018 by , updated on June 15, 2018

communication“Should I have an LLC for my real estate investment?”

It’s a common question we hear at Landlordology, and one landlords constantly ask in meetups and online forums. The underlying question is: “How do I protect myself from lawsuits?” Here’s some good news. There’s an alternative to an LLC that protects your finances—umbrella insurance. Let’s compare LLCs and umbrella insurance.

What’s an LLC?

An LLC is a limited liability company. Real estate investors set up LLCs to protect themselves from lawsuits, and independent landlords use LLCs to protect themselves from personal lawsuits. For example, a tenant slips on an icy sidewalk and hurts their back. They sue you for their medical expenses. The tenant wins $500,000, but your liability insurance will only cover $100,000. That leaves you personally responsible for the remaining $400,000, if you don’t have an LLC. If you had an LLC, your LLC’s assets would be responsible for the rest.

What does an LLC cost?

Real estate investors question an LLC’s value because of costs and restrictions, and they make taxes are more complicated. So, talk to your tax advisor to make an informed decision about your situation. LLCs cost money to create, and some states charge an annual fee. For example, creating an LLC yourself in Illinois costs $500. It can cost thousands of dollars to go through LegalZoom or an attorney. The annual fee to renew the LLC in Illinois is $250. Check this list of LLC registration fees and renewal fees by state. Often, investors get an LLC for each property for further protection. The costs add up quickly.

Related:  Should landlords set up an LLC for a rental property?

What’s an umbrella insurance policy?

An umbrella insurance policy covers the liability costs above and beyond standard landlord liability insurance. Umbrella insurance policies protect landlords from personal fiscal responsibility in the event of an injury or a lawsuit. The umbrella insurance kicks in when the dwelling insurance meets its max payout. Also, umbrella insurance covers claims that are generally excluded from standard insurance policies like slander, libel, false arrest, malicious prosecution, or mental anguish lawsuits.

Umbrella insurance policies cover more than your rental properties. They also cover personal circumstances. If your dog bites someone at the park, your umbrella insurance can cover the medical costs. Umbrella insurance policies are flexible. One policy covers real estate investments in multiple states, while an LLC only protects assets in the state the LLC is registered.

Landlords should work with their insurance company to better understand their coverage. Loopholes in the policy could prevent the insurance company from paying. Often, insurance companies provide their own legal team to fight lawsuits. Be sure to ask if your insurance company will help you fight a lawsuit. Remember, it is in the insurance company’s best interest to win the lawsuit, too.

Know that in some situations, your tenant’s renters insurance will cover damage to the property and claims from accidents. Consider requiring renters insurance in your lease.

Last, note that you, the landlord, are responsible for costs above the max payout of the policy.

How much does an umbrella insurance policy cost?

Insurance rates vary by location. The average cost is $383 annually for a $1 million policy. Policies go up to $10 million in coverage, which costs about $1,578 annually. Get competitive quotes when choosing an insurance provider. Speak with each company to learn what is and is not included. Often, if you package all your insurance needs with one company, you’ll get a discount. I used the same company for our car, house, and landlord insurance, so we get a decent discount.

An umbrella insurance policy has a deductible to consider. If you lose a lawsuit, you need to pay a deductible before the umbrella policy pays the remaining cost. Depending on the cost of premiums, the deductible varies. For a low annual premium, you will likely have a high deductible.

Keep in mind, the cost of LLCs and umbrella insurance are both tax deductible.

Related: Carry adequate insurance

LLC vs. umbrella insurance

Let’s look at a couple of scenarios.

Scenario 1:  Umbrella insurance

The landlord owns a triplex worth $700,000. A tenant breaks their leg on the property. The tenant sues the landlord for $300,000.

LLC: The LLC has assets of $700,000. The LLC pays the full amount of $300,000.

Umbrella insurance policy ($10,000 deductible/$1,000,000 coverage): The dwelling insurance picks up the liability max. After that, the landlord personally pays $10,000 out of pocket for the deductible. The umbrella policy would pick up the remaining balance plus legal costs.

Result: The landlord would be better off with the umbrella insurance policy. With the LLC, the landlord would lose $300,000. However, with the umbrella policy, the landlord only loses $10,000.

Scenario 2: LLC

This unfortunate situation happened in Oakland, California. A landlord rented out a warehouse as an event and residential space. A fire ignited at the warehouse, killing 36 people. Prosecutors sued the owner and leaseholder for “negligently ignoring safety hazards.” Insurance paid out $3 million to the owner for the fire. However, 31 of the 36 victim’s families sued over the fire.

We don’t know yet how much the families will win. Let’s say they win $20 million.

LLC: The judgment is $20 million. The value of the warehouse is $3 million. The landlord loses the warehouse and insurance payout. The total monetary loss is $6 million.

Umbrella Insurance Policy ($10,000 deductible/$3,000,000 coverage): The landlord goes bankrupt, losing $20 million.

Result: The landlord is better off with an LLC, which shields them from personal bankruptcy.

Ultimately, landlords should make a decision based on their own real estate portfolio. An umbrella insurance policy is generally the better financial choice for most small portfolio holders. However, everyone’s situation is different.

Look at your personal financial situation and real estate portfolio. Make a decision that won’t eat away your profits, while lessening your risk for bankruptcy.

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16 CommentsLeave a Comment

  • Karen

    Perhaps umbrella policy along with LLC is the best way to go?

    • Sarah Block

      It’s an option if you want to be extra safe.

      • Francis R Altenhofen

        Salrah, In you r Scenario #1, you say that the tenant sues for $300k (see below). Why does the LLC pay “the full amount of $700,000”?

        Scenario 1: Umbrella insurance
        The landlord owns a triplex worth $700,000. A tenant breaks their leg on the property. The tenant sues the landlord for $300,000.

        LLC: The LLC has assets of $700,000. The LLC pays the full amount of $700,000.

    • mike

      10 properties with 10 llc and 10 bank accounts and excess net profit cash sweeping off to a house account is a ton of work. Not to mention the annual filing fee which in ma is 500 per even with that separation for each property there is no guarantee some slick attorney wont find a way to pierce. I am leaning toward a bigger umbrella policy . amazing there is no clear criteria for going one way or the other as a way to reduce risk

    • phil wallace

      I have approx.20 rental units in Greater Boston area.I have all the properties in one LLC.Just open a new divide them up.My question is say someone get hurt and sues the LLC and there are 5 houses in there,are they all venerable to the person who is suing the LLC or just that house they got hurt in..if this was a 20 unit development you only would need 1 LLC but these are individual houses and in my state would cost me approx.,$4000 a year in LLC fees to have 8 LLC for 8 properties. I’m going to get an umbrella Business policy to cover the LLC’s for more protection.and a personal umbrella policy for my primary home and vehicles.Have I covered myself enough.Are there still ways to sue The LLC’s and me person.Thank

  • Jenny Chien

    It’s all about liability. LLC does not quite provide as much protection as people think it does. As for real estate investing, there are just so many ways to incur liability. Overall, this is a good read. Thanks!

  • Celticbyrd

    I have been turned down by several companies for Umbrella coverage because I own too many rentals they say. What companies offer coverage to those with 19 or more rentals

    • Steve Mack

      I own 20 rentals within 9 buildings. This is a great topic for me to research. My state only requires a $20 anual fee to keep an LLC in place. The attorney is saying I should combine an LLC and a Trust as a package deal. I have a million dolllar Umbrella, but since I have that many rentals, it is the commercial type. It covers my personal autos, wife, son and dog(ha). It costs almost $700 a year. I’m tempted to increase the umbrella amount as opposed to an LLC. My accountant tells me LLCs can be a taxing, pardon the pun, but suggests I stick with an umbrella. Am I doing the right thing?

    • Steve Mack

      In reply to Celticbyrd, my rentals are with a place out of North Dakota called Concord Agency if I am allowed to give out info like that. I was with their residential umbrella but am now in the commercial side because of having 20 rentals like yourself. You can probably google their name, but they are a third party to another Insurance Company called US Liability Ins Company out of Wayne, PA

  • Rich

    I own 1 duplex property worth less than 50K. Would an LLC or Umbrella Insurance be worth the value to protect liability?

  • Johnson

    I have 2 properties in Buffalo, NY.
    One of them I live in upstairs and the apartment is downstairs.
    Is a LLC worth it or would an umbrella property be better?

  • GuQin

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  • John F HEBERT

    Why not just get both an LLC and Umbrella Insurance? Then you’re set.

  • Jamie Silvers

    Series LLC if your state allows them…then have an umbrella to cover the Llc and a separate one for personal.

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