Call it covering your ass. If you own an automobile, business, or home, liability insurance will protect your assets from lawsuits.

If a court finds you legally liable for causing injuries or property damage, liability insurance will pay your legal bills and claims against you.

That’s why it’s so important to buy more rather than less insurance protection. It’s a firewall between you and possible financial ruin.

But how does liability insurance work, exactly? And how do you know what types you should have?

How Does Liability Insurance Work, and Why Is It Crucial?

We live in a very litigious society. If your actions or the products you make hurt others (guns exempt), those people, their families, or other third parties can seek recourse against you for damages.

That’s why most drivers buy liability insurance to protect against serious accidents, and why employers use it to cover themselves if a worker is injured or killed during business operations.

Manufacturers carry product liability insurance to protect against faulty-product injuries or worse. Meanwhile, doctors carry their own form of liability protection called malpractice insurance just in case a patient dies on the operating table.

But liability insurance also covers those “indirect” accidents on one’s property, like when a utility worker trips over a child’s toy in the front yard and is injured or a customer falls down in your business's parking lot. Lawsuits will surely come. That’s the game.

Accident victims and their lawyers will come after you — and rightfully so.

You’d do the same thing if a loved one was injured or killed by a drunken driver or an exploding hair dryer they just purchased.

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The Most Popular Type of Liability Insurance

When most people think of liability insurance, they think of car insurance. Liability coverage is indeed the bedrock (and most expensive part) of car insurance policies. And since we start driving at age 16 in most of the U.S., it’s likely that the first insurance policy you’ll ever buy will be liability car insurance.

Today, 47 states (New Hampshire, Mississippi, and Virginia not included) and the District of Columbia mandate all motorists purchase this coverage.

Just remember that if somebody ever sues you for causing an accident with injuries, property damage, or worse, most of your assets are at risk — even your future wages. The only asset that’s hands-off in a lawsuit is a retirement account like a 401(k) or individual retirement account (IRA).

How Does Car Insurance Work?

Car insurance policies offer two types of liability coverage: bodily injury and property damage. If you crash your car into and damage another car and its occupants and you’re deemed “at-fault” for causing the accident, your insurance will cover claims against you.

Your coverage extends beyond your car. It also covers you if, say, you hit someone in a crosswalk or if you strike any bystanders or property (collateral damage) during your accident.

Bodily injury coverage pays claims for medical expenses, funeral costs, pain and suffering, and lost wages. If you're sued, your coverage pays your attorney and court costs.

The second component, property damage liability, pays for damages and the economic loss from not being able to use the car until it's repaired or replaced. It also covers pricey valuables damaged or destroyed in the accident.

And if you take out a street lamp or piece of public property, your insurance policy will have you covered.

Keep in mind that your policy doesn’t cover your injuries or car damages. That’s why you need comprehensive collision coverage and medical expenses coverage.

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What Are Popular Types of Liability Insurance for Businesses?

Just as tens of millions of motorists carry liability insurance every day, millions of business owners and their top executive and corporate officers purchase liability insurance to protect against the cost of compensation claims stemming from injury, malpractice, and negligence.

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There are several business-focused insurance plans on the market, illustrating how businesses face constant threats from lawsuits.

As I mentioned before, product liability insurance is one popular plan. But the most popular coverage for businesses, both small and large, is commercial general liability (CGL). This offers broad protection for bodily injury and property damage.

Another must-have plan for businesses is directors and officers liability insurance. It covers the top dogs against, for instance, age or sex discrimination claims made by employees. It also protects company leaders from claims made by suppliers, customers, rivals, government regulators, and shareholders.

And there’s more: The top dogs can also buy professional indemnity insurance. This covers them if they make stupid decisions that cause their business clients to lose lots of money. Businesses also buy insurance to protect themselves should hackers or employees steal from clients.

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What Liabilities Does Homeowners Insurance Cover?

The standard homeowners insurance policy contains a personal liability section that’s similar to your liability car insurance policy. It protects you against lawsuits for injury or property damages that you or family members cause on your property. It also covers any pet-inflicted damage.

If Fido bites your neighbor who has come over for tea and she falls and breaks her hip, your policy will cover her medical bills.

And homeowners insurance sometimes can work hand-in-hand with your car insurance. Say, for example, a tree falls on to your house and car. You’re covered for any damages to your house, but you’ll need to file a claim with your car insurance company for car repairs under your comprehensive coverage policy (which covers acts of God).

You can often get both kinds of insurance through the same company, which might make filing claims easier.

One nice feature of homeowners liability insurance, when compared with car insurance, is that it doesn’t carry a deductible that you must pay out of pocket before your insurance company begins paying claims.

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How Much Insurance Should You Purchase?

The pros say that you should always buy enough insurance coverage to protect your assets, whether you own a $100 million tech company or a 2010 Honda Accord worth $8,000.

When it comes to buying liability insurance, businesses don’t scrimp. They buy what they need, and then some. Business owners and their investors have a lot at stake and a lot to lose if somebody successfully sues them.

That said, most folks starting out in life aren’t running businesses. The insurance they need to worry about is car and homeowners.

For private homes, the standard insurance policy provides basic liability coverage up to $300,000 for injuries and property damages. You can buy more insurance with higher premiums. Remember, you need to buy enough to cover the home’s value and your other assets.

The same thing goes for auto liability insurance, which typically offers coverage ranging from $10,000 to $500,000 per person injured, per accident (bodily damage) and up to $500,000 in property damage coverage (in case you hit a tour bus).

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The What, Why, and How of Liability Insurance: Final Thoughts

Many motorists foolishly pick the minimum coverage requirements, and some don’t even bother. This means that drivers like me and others in New York have to purchase extra insurance to protect ourselves should some underinsured or uninsured schmuck smack into our cars and send us to the hospital.

My recommendation is to buy the maximum. If you need more coverage — like millions of dollars’ worth — you can purchase umbrella insurance. It's sold as a separate policy and covers your house, as well. That said, buying liability insurance with top-notch coverage is one of the best investments we can make.