What is an umbrella policy, and why are they important? An umbrella policy is a second policy on top of your underlying policy. What it does is it spreads the cost out and makes both policies a little bit cheaper. It’s actually a really nice part of insurance.
The best way to explain an umbrella policy is in the context of an auto accident. Say that you’re driving and you’re rear-ended by somebody who has $25,000 in underlying liability coverage and then $100,000 in umbrella policy. Say that you have $100,000 of damages. The $25,000 would be taken out of the liability policy, and then what’s leftover, the $75,000, will be covered by the umbrella policy.
The reason why that’s cheaper is that the underlying policy will only have to pay up to $25,000 and the umbrella policy only has to pay in the unlikely event that the person causes damages upwards of $25,000. The costs are spread around.