Are You Underinsured for Life Insurance?¹

Understanding underinsurance

Underinsurance happens when your coverage is not sufficient for meeting your dependents’ needs after you pass away. A 2024 study from LIMRA and Life Happens revealed that nearly one-third of Canadians¹ have coverage gaps in their life insurance.

Why might someone be underinsured?

There are many reasons someone could be underinsured. Common reasons include:

• Your family has grown
• Your partner is not insured
• You only have group life insurance through your employer
• Your income has increased
• You have outstanding debts
• Your financial goals have evolved
• The cost of living has risen

Often, more pressing financial obligations can make it hard for families and individuals to justify another expense. But addressing underinsurance can help avoid financial hardships. It can provide the necessary coverage in case something happens to you.

If you think you may be underinsured, getting a quote from Canada Protection Plan can help you find solutions. You can assess your finances, consider what your dependents may need and identify which type of coverage is best.

Factors contributing to underinsurance

Lack of knowledge or misconceptions about life insurance

Understanding how life insurance works helps you choose a policy that suits you. However, some policies can seem complex. People who are unfamiliar with life insurance may not fully understand what a policy covers. Because of this, they could underestimate their coverage needs and may purchase inadequate policies.

It helps to know about the different types of insurance and how they work. Term life insurance offers coverage for a fixed period (e.g., 10, 20 or 30 years) and is generally more affordable. Permanent life insurance provides lifetime coverage and may include a cash value component.

Unfortunately, many people are unaware of these differences and may choose policies that do not always align with their long-term goals.

Policy riders, which are additional benefits you can use to customize and enhance your coverage, are also overlooked. Add-ons like critical illness riders provide a lump sum payment if you are diagnosed with a specific critical illness. If you aren’t aware of how to get the most out of your life insurance, you could miss out on an effective way to tailor your coverage for a specific need.

Procrastination

Some people avoid getting life insurance because they think they don’t need it. But it’s easy to fall into the ‘it won’t happen to me’ mindset. Life insurance can be an effective tool at any age, so just because you’re young or don’t own a house doesn’t mean you can’t benefit from coverage.

Similarly, other people may believe that their workplace-provided coverage is sufficient. However, coverage provided by employers  may not cover all your financial needs.

Financial constraints

Budget constraints or other financial priorities may put people off buying life insurance. They’d rather focus on immediate financial obligations, such as paying off student loans or saving for a down payment. These goals make life insurance a lower priority.

While it might be an additional expense, life insurance can provide a safety net for your loved ones if you pass away. Furthermore, securing a policy now means the premiums will, typically, be more affordable compared to buying later.

Changes in life circumstances

Life insurance is not a ‘set and forget’ kind of deal. Your coverage needs can shift throughout your life. You might get married, have a child or take on a hefty loan. If you don’t adjust your policy to reflect these changes, you might end up underinsured.

If you already have life insurance and have experienced significant changes in your life, it’s worth speaking to your advisor to see how they can help match your coverage to your needs.

Misaligned policy choices

Selecting an insufficient policy means you’ll be left with inadequate coverage. For example, a term life insurance policy expiring when you’re 60 may initially seem sensible but fails to consider potential ongoing financial obligations, like a mortgage or additional retirement spending. In this case, permanent life insurance may be more suitable. It’s always a good idea to speak to your advisor to determine which policy best aligns with your current (and future) needs.

Consequences of underinsurance

Inadequate financial protection for loved ones

Imagine a family where one parent is the primary income earner and one takes care of the kids. If the primary earner passes away and the insurance payout isn’t enough to cover the mortgage, education costs and childcare, the family might have to make significant adjustments.

This is why choosing the right coverage amount is crucial. If it falls short of meeting the financial needs of your dependents, they may struggle to maintain their standard of living.

Increased financial stress

If the life insurance payout does not cover all your loved ones’ expenses, they may have to take out loans or rely on credit cards to cover expenses. This can create a cycle of debt that is difficult to escape. Furthermore, accumulating debt can negatively affect your credit score. It could be more difficult (and expensive) to borrow money in the future for your mortgage or car.

Impact on the policyholder’s legacy

When the financial protection is inadequate, the surviving loved ones may face tough financial decisions. They may be forced to make sacrifices they wouldn’t have had to consider otherwise. They might have to sell a family home, delay educational pursuits or forego starting a business.

Solutions for underinsurance

Assess coverage needs regularly

Make it a habit to review your life insurance coverage annually. List all your current financial obligations, including mortgages, loans and any other debts.

Think about your family’s future financial needs, such as your children’s education or your retirement. Compare this with your current coverage and savings to find any gaps.

You may need to consider how much of your income will need replacing to maintain your family’s standard of living. The general advice is to get coverage that is seven to ten times your annual income.² In certain situations, you may need to combine your current coverage with additional policies or riders.

You should also review your coverage whenever you go through a significant life event. These events can include:

• Getting married
• Having a child
• Buying a property
• Taking on substantial debt

Consider permanent life insurance

Permanent life insurance policies offer coverage for the rest of your life. They include added financial benefits like tax advantages and cash value accumulation. Although these policies typically have higher premiums compared to term life insurance, they can provide more comprehensive long-term financial protection. Additionally, the death benefit provided to your beneficiaries is generally tax-free, so it’s an efficient way to transfer wealth to the next generation.

Sources

¹ https://www.limra.com/en/newsroom/industry-trends/2024/nearly-one-third-of-canadian-adults-report-living-with-a-life-insurance-coverage-gap/ (2024)

² https://itools-ioutils.fcac-acfc.gc.ca/yft-vof/eng/insurance-2-4.aspx (2024)

Footnotes

^TM Foresters and Canada Protection Plan (CPP), and their employees and life insurance representatives, do not provide, on Foresters behalf, financial, estate, legal or tax advice. The information given here is merely a summary of our understanding of current laws and regulations. Clients and prospective purchasers should consult their financial, estate, tax or legal advisor regarding their situation.