Insurance analysis is the process by which an individual assesses their risks related to a loss of income due to:
- a premature death;
- a disability; or
- a critical illness
and then quantifies the capital needed to bridge the gap between personal resources and the potential need.
What is insurance?
Insurance is one of the four risk management strategies to deal with the risk of financial loss. These strategies are:
- Risk avoidance;
- Risk reduction;
- Risk retention; and
- Risk transfer (use of insurance)
The first strategies are self-explanatory in that a person can try not expose themselves to the risk in the first place; or they can take steps to reduce the probability or severity of the risk; or they can simply accept the consequences if the risk is realized (self-insure).
The fourth strategy is risk transfer, which means finding someone else who is willing to assume the consequences if the risk is realized. In its simplest form then, insurance is a risk transfer strategy whereby a person contracts with an insurer to protect against a risk in exchange for a premium.
Why is insurance analysis important?
Proper analysis is important to ensure that you have the correct type and amounts of insurance for your needs and to ensure that you are not paying too much for that insurance.
The decision to buy insurance to protect against a certain risk is most often based on some determination that your personal resources are not sufficient to protect from the resulting financial loss. Therefore, an insurance analysis is the only way to properly assess your financial situation to determine how much of the risk that you can assume, and how much of it should be transferred to an insurance company.
How do you know how much coverage to buy?
Only with a proper insurance analysis will you be assured that you are purchasing the right amount of coverage. Determining the need is only the first step – the analysis will also help you identify the right kind of insurance based on your budget and your preferences. This analysis will also tie in with the stage in your life cycle. In the end, you do not want to buy too little coverage, but you also do not want to buy more coverage than you need.
A comprehensive insurance analysis will also ensure that your greatest risks are covered first. While it is true that most people own some form of life insurance to protect against the risk of dying too soon, it is equally true that very few people are protected against the risk of becoming disabled or critically ill. The loss of income due to a disability or critical illness is one of the leading causes of bankruptcies.
Even further, for seniors, there is a high probability that they will require some form of nursing care. In current years we have seen the proliferation of these costs which will make this care prohibitively expensive, and even unavailable, to most people.
As most small business owners, and all taxpayers, have seen in the past 12-24 months, there can be substantial uncertainty with respect to our tax laws, and rates, changing in Canada. It is worthy to note that the proceeds from most types of insurance are exempt from taxes.
Although there was some tax reform in 2016 that limited some of the benefits with respect to permanent life insurance, it has been decades since the last major tax reform related to insurance. Today, as in the past, certain types of insurance, especially life insurance, can be used within corporations to offer tax-sheltering and deferral opportunities.
There are many strategies that can help you reduce or avoid the tax burden on your estate after you pass away, and a SPARK financial consultant can help you figure out which ones makes sense for your situation.
Types of insurance
To protect you and your family there are several general types of insurance products to meet your needs. In addition, there are often dozens of product choices within each general category from a myriad of insurance companies. The most basic categories of insurance relate to:
- Term life insurance;
- Permanent life insurance;
- Disability insurance;
- Critical illness insurance;
- Long-term care insurance;
- Health and dental insurance;
- Travel insurance; and
- Group insurance (through employment)
Many of these products can also be combined in the form of riders, i.e. a critical illness rider may be purchased on a term life insurance policy. Other common riders include paid-up additions, accidental death & dismemberment, guaranteed insurability, waiver of premium, and return of premium benefits.
Ask your qualified SPARK insurance specialist for more details about any of these products and benefits.
Inhibitions to insurance analysis
Many people avoid addressing their insurance needs because they think it is expensive and not relevant in the present. It is seemingly easier to respond to problems in the present and it is often much more difficult to look ahead, especially for situations that we would prefer not to think about. But, in one of the situations identified earlier, loss of life, disability, or critical illness, I can assure you that it is much easier to think about those situations in the present than it is during the moment that it happens.
Insurance is a form of risk management and nobody can force you to adopt that mindset. It is a personal choice that you must make on your own. It requires initiative and a sense of responsibility. You need to ask yourself “what if?”.
What is needed to start the process for insurance analysis?
It is usually recommended that we start the process by:
- assessing the family dynamics (i.e. spouse, children, ex-spouse, disabilities and court ordered insurance);
- assessing the employment situation (i.e. employee, future income potential, job stability, group benefits, self-employed, incorporated, partnership, time to retirement, and retirement income sources);
- assessing the current financial situation (i.e. asset analysis, debts, tax liability on death, and determining available cash flow);
- assessing existing insurance (i.e. individual, business, group, and government benefits); and
- assessing the client’s priorities in the event of death, disability or critical illness (i.e. family lifestyle, final expenses, and future plans such as post-secondary education or weddings for children, family legacies and philanthropy)