# Liability Insurance: What It Is, How It Works, Major Types

![Liability Insurance: An insurance product that provides protection against claims resulting from injuries and damage to other people or property.](https://www.investopedia.com/thmb/ref1gQq7CNxxKl4S_2BdaWIHku0=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/liability_insurance.asp-final-5047623e88434455a627aabe9ab2bba0.png)

*— Investopedia / Ryan Oakley*

## What Is Liability Insurance?

Liability insurance shields individuals and businesses from claims arising from injuries and damage caused to people or property. This form of protection is vital for anyone who can be held legally accountable. Liability insurance policies take care of legal expenses and payouts when an insured party is found responsible, though these policies typically do not cover intentional damage or contractual liabilities. Unique among insurance types, liability policies are designed to compensate third parties rather than policyholders.

### Key Takeaway

*   Liability insurance protects the insured from claims due to injury or damage to people or property, covering legal costs and payouts if found legally liable.
*   It pays third parties, not policyholders, and does not cover intentional damage or contractual liabilities.
*   Various types, including personal and business liability insurance, cover individuals and companies against different risks and potential lawsuits.
*   Umbrella insurance provides additional coverage beyond standard home, auto, and watercraft policies, typically in increments of $500,000 or $1 million.
*   Backdated liability insurance covers claims that occurred before the policy was purchased, though it's generally only available to businesses.

## Understanding the Mechanics of Liability Insurance

[Liability](https://www.investopedia.com/terms/l/liability.asp) insurance is crucial for those responsible for injuries to others or for damaging another person's [property](https://www.investopedia.com/terms/p/property.asp). As such, liability insurance is also called [third-party insurance](https://www.investopedia.com/terms/t/third-party-insurance.asp). Liability insurance does not cover intentional or criminal acts, even if the insured party is found legally responsible. Policies are taken out by anyone who owns a business, drives a car, practices medicine or law—basically anyone who can be sued for damages and/or injuries. These policies protect the insured and third parties who might be injured due to the policyholder's unintentional negligence.

> **Important**
>
> Liability insurance is also called third-party insurance.

For instance, most states require that vehicle owners have liability insurance under their automotive insurance policies to cover injury to other people and property in the event of accidents. A product manufacturer may purchase product liability insurance to cover them if a product is faulty and causes damage to the purchasers or another third party. Business owners may purchase liability insurance that covers them if an employee is injured during business operations. The decisions doctors and surgeons make while on the job also require liability insurance policies.

## Special Considerations for Liability Insurance Coverage

[High-net-worth individuals](https://www.investopedia.com/terms/h/hnwi.asp) often buy personal liability insurance, but it's recommended for anyone whose [net worth](https://www.investopedia.com/terms/n/networth.asp) surpasses their home or auto insurance limits.

Many find extra insurance costly, but most providers offer discounts for bundled packages. Personal liability insurance is secondary, often needing specific limits on home and auto policies, which can increase costs.

> **Fast Fact**
>
> The global liability insurance market size was valued at more than $25 billion in 2021, and is expected to reach $433 billion by 2031.

Commercial general liability insurance covers most legal issues, but not lawsuits against directors and officers or against errors and omissions. Companies require special policies for these cases, including:

*   **Errors and Omissions Liability Insurance (E&O):** An [errors and omissions liability insurance](https://www.investopedia.com/terms/e/errors-omissions-insurance.asp) policy covers lawsuits arising from negligent professional services or failing to perform professional duties. Lawyers, [accountants](https://www.investopedia.com/terms/a/accountant.asp), architects, engineers, or any business providing a service to a client for a fee should purchase this form of insurance. An E&O policy does not cover criminal prosecution, fraudulent or dishonest acts, or claims against bodily injury. The insured, however, is covered for attorney fees, court costs, and any settlements up to the amount specified by the insurance contract.
*   **Directors and Officers (D&O) Insurance:** This type of policy protects directors and officers of large companies against legal judgments and costs arising from unlawful acts, erroneous investment decisions, failure to maintain property, releasing confidential information, hiring and firing decisions, [conflicts of interest](https://www.investopedia.com/terms/c/conflict-of-interest.asp), [gross negligence](https://www.investopedia.com/terms/w/wanton-disregard.asp), and other errors. Most D&O policies exclude coverage for [fraud](https://www.investopedia.com/terms/f/fraud.asp) or other criminal acts. [Premiums](https://www.investopedia.com/terms/p/premium.asp) depend on the company, its location, industry type, and loss experience.

## Exploring Different Types of Liability Insurance Coverage

Business owners are exposed to a range of liabilities, any of which can subject their assets to substantial claims. All business owners need to have an [asset protection plan](https://www.investopedia.com/articles/pf/08/asset-protection-business.asp) in place that's built around available liability insurance coverage.

Here are the main types of liability insurance:

*   **Employer’s liability and [workers' compensation](https://www.investopedia.com/terms/w/workers-compensation.asp)** are mandatory coverage for employers, which protects the business against liabilities arising from injuries or the death of an employee.
*   **Product liability insurance** is for businesses that manufacture products for sale on the general [market](https://www.investopedia.com/terms/m/market.asp). Product liability insurance protects against lawsuits arising from injury or death caused by their products.
*   **[Indemnity insurance](https://www.investopedia.com/terms/i/indemnity_insurance.asp)** provides coverage to protect a business against negligence claims due to financial harm resulting from mistakes or failure to perform.
*   **Director and officer liability coverage** covers a company's [board of directors](https://www.investopedia.com/terms/b/boardofdirectors.asp) or officers against liability if the company should be sued. Some companies provide additional protection to their executive team, even though [corporations](https://www.investopedia.com/terms/c/corporation.asp) generally provide some degree of personal protection to their employees.
*   **[Umbrella liability](https://www.investopedia.com/terms/u/umbrella-personal-liability-policy.asp)** policies are personal liability policies designed to [protect against catastrophic losses](https://www.investopedia.com/terms/w/wrap-up-insurance.asp). Coverage generally kicks in when the liability limits of other insurance are reached.
*   **Commercial liability insurance** is a standard [commercial general liability](https://www.investopedia.com/terms/c/commercial-general-liability-cgl.asp) policy, also known as comprehensive general liability insurance. It provides insurance coverage for lawsuits arising from injury to employees and the public, property damage caused by an employee, as well as injuries suffered by the negligent action of employees. The policy may also cover infringement on intellectual property, [slander](https://www.investopedia.com/terms/s/slander.asp), libel, contractual liability, tenant liability, and employment practices liability.
*   Comprehensive general liability policies are tailor-made for any small or large business, [partnership](https://www.investopedia.com/terms/p/partnership.asp), joint venture, corporation, association, organization, or newly acquired business. Insurance coverage includes bodily injury, property damage, personal and advertising injury, medical payments, and premises and operations liability. Insurers provide coverage for compensatory and general damages for lawsuits but not punitive damages.

## How Does Personal Liability Insurance Differ From Business Liability Insurance?

Personal liability insurance covers individuals against claims resulting from injuries or damage to other people or property experienced on the insured's property or as a result of the insured's actions. [Business liability insurance](https://www.investopedia.com/terms/g/garage-liability-insurance.asp) instead protects the financial interests of companies and business owners from lawsuits or damages resulting from similar accidents, but also extending to product defects, recalls, and so on.

## What Is Umbrella Insurance?

An umbrella insurance policy is additional liability insurance coverage that is purchased and goes beyond the dollar limits of the insured's existing homeowners, auto, or [watercraft insurance](https://www.investopedia.com/terms/w/watercraft-insurance.asp). Umbrella policies tend to be affordable and offered in increments of $500,000 or $1 million.

## What Is Backdated Liability Coverage?

Usually, you must have liability coverage in place when an event happens that results in a claim. [Backdated liability insurance](https://www.investopedia.com/terms/b/backdated-liability-insurance.asp), however, is insurance that provides coverage for a claim that occurred before the insurance policy was purchased. These policies are uncommon and usually available only to businesses.

> **Article Sources**
>
> 1.  Allied Market Research. "[Liability Insurance](https://www.alliedmarketresearch.com/liability-insurance-market-A15352#:~:text=The%20global%20liability%20insurance%20market,5.7%25%20from%202022%20to%202031.)."
>     
> 2.  U.S. Department of Labor. "[Workers Compensation](https://www.dol.gov/general/topic/workcomp)."