Insurance plays a key role in the financial success of a lot of people. With so many unknown and potentially catastrophic variables in someone’s life, there are many different types of insurance coverage depending on the needs and circumstances.

In the past, the insurance industry has occasionally gotten a bad wrap for pushy sales tactics. This is in part due to the potential for large commissions on the sale of insurance products. It has often been the case where an agent has sold a policy that is unsuitable, or too expensive just to secure the commission.

However, the larger risk is the potential to be underinsured. This happens when there is not enough insurance in place, or none at all. Insurance can get complicated and extremely expensive. Make sure that you find yourself a reputable and trustworthy insurance agent. If you are unsure of the advice, never be afraid to get a second or third opinion and compare the advice and your options.

In the past couple of weeks, we have been focusing on inflation. This week, we want to continue the trend by looking at how inflation affects your insurance coverage. See past week’s articles below:

• Inflation is Officially Here!
• How Will Inflation Affect Your Retirement Income?
• Inflation and The Cost of Education

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Insurance Basics

In most situations that you will find yourself in, where you think it might be nice to have insurance, there is probably an insurance product available. Granted, it might be quite costly. A couple of the main categories of insurance include; life insurance, disability insurance, critical illness insurance, and accident and sickness insurance. There is also other insurance many will have, such as property insurance, liability insurance, travel insurance, etc.

In addition to the general types of insurance, there is also what is called “riders” that can be added onto an insurance policy. A rider is an optional addition that you can purchase to make your coverage more valuable in one way or another. You could have a rider that allows you to increase coverage in the future. A rider could repay your premiums in the event that no claim is ever made. Another rider could be used to pay the premiums if you were to ever become disabled. This barely scratches the surface. There are many options available.

We want to focus on the life insurance aspect, however, the overarching principles will generally apply to all types of insurance.

There are many reasons that a person would get insurance; to cover off debts or provide for beneficiaries in the case of their demise, to maintain a lifestyle, to help cover costs of illness, estate equalization purposes, business transitions, buy-sell agreements, accident coverage, etc.

In the end, with insurance, you are paying money now, to have access to a fixed amount of capital later, if a particular unfortunate event were to happen. If an event that is covered by your insurance policy happens, the insurance company will pay out the benefit.

Inflation

If you have read any of our previous articles, you should have a good grasp on inflation. Inflation is defined as the declining purchasing power of a currency over time. Another way to look at it is the gradual increase in the price of goods and services relative to a currency. Inflation is measured using the Consumer Price Index (CPI). The CPI is a basket of goods and services that are tracked by Statistics Canada.

If a loaf of bread costs $2 today, and we have a sustained 2% inflation, in 10 years it will cost $2.43. If instead, we have higher sustained inflation of 5%, in 10 years it will cost $3.26. You may be thinking to yourself, that isn’t that bad. At the end of the day, it’s still only $3.26. But what happens if you do this with larger amounts over longer time horizons? The effects will become more pronounced and if your purchasing power doesn’t keep pace with inflation, that loaf of bread will use up a large portion of your income.

The same is true with insurance. Many types of insurance policies will have a fixed benefit. This means that when you purchase a policy you have to take inflation estimates into account so that in later years the benefit paid still covers what it is needed to cover. If inflation is higher than you projected eventually the benefit may not cover your needs.

Above we mentioned the concept of “riders”. Some insurance policies will also your to purchase a rider that helps protect against the affects of inflation. However, there is usually a cap to how much inflation it will cover.

Insurance and Inflation Example #1

An insurance analysis was done on an individual and it was determined that they need $1,000,000 of life insurance coverage. Their were two main reasons for the insurance. They had a mortgage that would be paid off in 20 years, and in the event of their passing they wanted to ensure that there was money available for their spouse and children.

This person decided to buy a $1,000,000 term-20 life insurance policy. If they died in the near future it was more than enough coverage. Assuming a healthy 2% inflation rate, $1,000,000 was the exact amount needed in 20 years (using a time value of money calculation this means the coverage needed now is ~$673,000).

You can probably see where this is headed already. Unfortunately, the insured individual passed away 18 years after taking out the life insurance policy. They still lived in the same house, had the same amount of children, etc. For all intents and purposes, their lifestyle was identical to 18 years prior and so too were their insurance needs. If inflation was constant at 2% over that 18 years, the insured would have needed $961,000.

However, over those 18 years inflation ran hot. The economy fell on some tough times, interest were kept low and governments were printing and spending money like never seen before. Because of that, inflation average 5% over those 18 years. That $1 million of coverage is no longer enough.

That $673,000 original coverage needed has now grown to $1,619,500 over the 18 years. The payout from the insurance company will leave a gap of more than $619,000.

Conclusion

It is important to review your insurance policies on a semi-regular basis. This is even more important in an economic environment where inflation is running hot. The last thing you want is to be underinsured when you find yourself in a bad set of circumstances. Insurance plays a large role in buy-sell agreements, the financial stability of families, and many more situations. You do not want to find yourself financially insecure, or leave your loved ones behind with financial instability.

Be sure to reach out to your trusted financial professionals to ensure you are in a good place when it comes to insurance. It is better to be insured and not need it than to be uninsured and need it. Lastly, do not wait until an unforeseen circumstance hits to get insurance. If you do that, the cost of insurance could likely be way more expensive and there is even the chance that you would be uninsurable.

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