Insurance basics: 5 things you should know about insurance

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All of us want financial security for ourselves and for our family. We know that having insurance can help us and that it can contribute to a solid financial plan. Yet many of us don’t really think about insurance. More often than not, we don’t think of risks and for the unexpected to happen (they’re unexpected after all!) so we leave things to chance. It may also be because we don’t know much about insurance and they are much too complicated to pay attention to.

So to start you off, we have broken down some things to the bare minimum. The following is insurance 101 – the five basic things you should know about insurance:

First off, what is insurance?

  • Insurance is a tool to reduce financial loss or hardship.
  • It is a contract between the insured and an insurance provider under which the insured can be paid for certain losses. The insurance provider pools clients’ risks to make payments affordable for the insured (Investopedia).
  • It is protection that can help cover the cost of unexpected events such as theft, illness, property damage, or death.
  • The protection or coverage you receive can be for a limited period of time or throughout your lifetime.

In return for the protection, you pay a premium. Premiums are the amount you pay periodically, depending on the type of insurance and what is stated in your policy. The amount of premiums you pay are based on the probability that you will suffer a claimable loss. Other factors that are considered in computing premiums can be the insured’s age, health, lifestyle or family history.

For health, dental, home, and auto insurance policies, the amount of premiums also depends on the deductible. This is the amount of your claim you agree to pay before the insurer pays the rest. Of course, choosing a higher deductible will lessen your premiums because you are agreeing to pay for a larger part of your loss.

How does insurance work?

When people buy insurance, they put their money into a pool with many others. Some of that pool of money helps the policyholders who suffer a hardship in that period. The hardship can be home, auto or business losses. You are covered only for losses written in your contract, not for predictable events.

When a hardship or loss occurs, a claim is made. This is an official request for the insurer to pay for a covered loss. The insured’s agent or broker can assist in claiming benefits. Supporting documents will be required, depending on the type of loss (for example, photographs of an injury or property damage for an accident or property insurance claim, or a death certificate for a life insurance claim) during claims processing or claims investigation.

There are different types of insurance

Life insurance

Life insurance provides payment to the insured’s family and loved ones after the insured’s death. The insured names a person or persons (beneficiary/beneficiaries) who will receive the death benefit as stated in the policy. The proceeds or death benefit are tax-free.

There are two types of life insurance:

  1. Term –provides coverage for a specific amount of time. If the insured dies within the period of coverage (and the premiums are paid), the beneficiary receives the death benefit as stated in the policy. The coverage ends at the specified term. It can be renewed after the term, however, the premium may increase since premiums may depend on the insured’s age.
  2. Permanent – it covers the insured throughout their lifetime (unless the insured fails to pay the premiums). There are two kinds:
    • Whole life insurance – this guarantees that your premiums will not change as you get older. This type of insurance has a guaranteed minimum cash value and death benefit amount.
    • Universal life insurance – this is a product combining life insurance and investment.

Health insurance

Health insurance can help you pay for services that the provincial health care plan does not cover. Some types can supplement your income if you suffer a major illness or injury. Other types can pay for medical expenses if you become ill while on vacation.

Here are some types of health insurance:

  • Supplementary health insurance
  • Disability insurance
  • Travel medical insurance
  • Critical illness or trauma insurance
  • Long term care insurance

Read Do I need supplementary health insurance? to know more.

Property and Casualty (General) Insurance

Property insurance covers losses or damage to your home or personal possessions, to your car, or your business. Casualty insurance shields the insured from legal liability for losses caused by injury to other people or damage to property of others.

Here are some kinds of general insurance:

  • Home or Property insurance
  • Tenant or Renter’s insurance
  • Auto insurance
  • Liability insurance
  • Accident benefits/bodily injury insurance
  • Collision insurance
  • Comprehensive insurance
  • Business insurance
  • Commercial property insurance
  • Public liability insurance
  • Errors and omissions insurance

Group Insurance

“Group insurance provides a mechanism for employers to provide employee benefits as part of an employee’s total compensation package, as part of one group, outside of government-provided benefit programs” (Benefits Consultant.ca). Many workplaces in Canada offer this to provide additional benefits to employees, show that they care for their employees’ well-being, and to ensure a healthier workforce. On the practical side, costs paid into a group insurance program are considered a tax-deductible business expense.

Some commonly provided group insurance benefits in Canada are: supplementary health insurance, basic life insurance, dental insurance, long-term disability insurance, and accidental death and dismemberment insurance.

Where do your premiums go?

Insurers put premiums to pay claims costs, investments, and operational expenses. They practice diligent financial management so that claims can be paid. For instance, they invest in low-risk investments that can be easily liquidated in case they need to pay out claims. They also set money aside as a legal reserve. They are required by law to maintain this amount. The legal reserve guarantees that an insurer can pay a large number of claims within a short period of time (such as in cases of disaster, for example).

Applying for insurance

Insurers will evaluate whether they can issue a policy based on certain criteria such as:

  • Age
  • Medical history
  • Previous claims made
  • Amount of coverage you are requesting

Some types of insurance, such as life insurance, would require a medical exam. After which, the insurer would review your application and access your personal and medical history to assess your risk. After this assessment, you will know the amount of coverage you are qualified for and the premiums you need to pay.

No matter what type of insurance you are applying for, answer all questions on the application fully and honestly. If you withhold important information or if you lie on the application, it can be the basis for cancelling your policy, or worse, refusing your claim in the future.

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Definition of terms:

Policy – a legal contract between you and the insurer. It details what risks are covered, under what circumstances the insurer will make a payment to you, how much money and what type of benefit you will receive if you make a claim.

Policyholder – the insured or the person covered under the policy.

Coverage – the amount of protection you have bought. It is also the maximum amount the insurance company will pay you if you make a claim for loss or event covered by your policy.

Benefit – the amount the insurer will pay you if the insurer accepts your claim.

Premium – the amount you pay for the insurance.

Cash value – this is the amount the insurer pays to the policyholder when a life insurance policy is cancelled. It can also be an amount added to the death benefit and can be paid upon the insured’s death. This term is used with permanent life insurance policies.

Death benefit – the amount the insurer will pay the beneficiary or beneficiaries upon the insured’s death.

Claim – this is the official notice to your insurer to be paid for a loss or event covered by your insurance policy.

Beneficiary – this is the person or entity the insured names or assigns to receive the proceeds of the policy. A beneficiary can be revocable (can be changed at any time without informing the beneficiary) or irrevocable (can’t be changed without the beneficiary’s written permission).

Deductible – the amount you agree to pay before the insurer pays the rest.

Exclusions – things that are not covered by your policy. For example, some health insurance policies may exclude certain medical conditions you had before you applied for insurance or a travel insurance policy may exclude claims if you travel to a high-risk country. This is why it is important to read your policy thoroughly to check what it covers and what it doesn’t cover so that there will be no surprises when the time to claim comes.

Risk – probability or likelihood that an insured event, such as loss, injury or death, will happen while the policy is in effect.

Rider – it is a clause or term added to your insurance policy to provide protection. This has an additional cost because it covers risks not covered in the basic policy.

Term – the time period you are covered by your policy.

Sources: Module 6: Insurance, Financial Consumer Agency of Canada; Understanding insurance basics, Financial Consumer Agency of Canada; Insurance Bureau of Canada; and Insurance Basics (Insurance 101), Insurance Bureau of Canada. All accessed January 23, 2018.

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