Insurance 101: What is insurance and how much do I really need?

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Few people will go through life without buying insurance of one kind or another. But there are so many different varieties, and so many things to consider, you need a guide to the essentials:

What is insurance, really, and how does it work?

Insurance, be it home, health, life or any other kind, is a formal contract between an individual (that’s you) and an insurance company – in Canada, the big familiar names are Manulife, Canada Life, iA, Sun Life and Desjardins. You’ll make a set scheduled payment called a “premium” in return for their promise to compensate you if and when you’re the unlucky person facing an unforeseen, expensive calamity, like a house fire, a car accident or the death of a family breadwinner. And it’s a way to pool risk – your premiums will usually add up to less than the payout after a disaster. “Simply put,” says Dave Payette, chief operating officer of insurance brokerage ThinkInsure, “the premiums collected from the many will pay for the losses of the few.”

What are the various kinds of insurance?

The best-known kinds of insurance are life, health, auto and property (home or renter’s) insurance. Within each of those are a number of options or subcategories. Here are just a few:

Life insurance

Life insurance can be term insurance or whole life (with an end date or no end date); variable life insurance has an investment component – it has a cash value account that varies depending on how the investments perform.

Health insurance

Health insurance can cover anything from personal health costs, dental care, long-term care (to help pay for in-home care or nursing homes); and even lesser-known things such as critical illness insurance – a lump-sum payment in case you are diagnosed with a serious disease. In Canada, of course, most health costs are covered by government-run provincial plans – our beloved universal health care. But additional plans, often offered by employers to certain minimum levels, provide extended coverage for things such as dental care and short- and long-term disability if you can’t work because you are sick or disabled. (For that matter, many workplace insurance plans also include group life insurance.) People without a workplace plan can purchase extended health insurance on their own.

Auto insurance

Auto insurance includes liability insurance (damage or injury you cause to someone else), collision insurance (exactly as it sounds), comprehensive insurance (theft or damage to your car if, say, a tree falls on it);

Property insurance

Property insurance is divided into home, condo, tenant (renter’s), landlord – even seasonal. There is also personal liability insurance (very useful should someone slip on your home’s icy steps).

And there are many, many more. Matt Hands, director of insurance at ratehub.ca, estimates there are upward of a thousand kinds of insurance on offer. “If you have a Picasso, you’d get art insurance, and if you had a big diamond ring, you could get diamond insurance,” Mr. Hands says. “Insurance providers are constantly developing new products to meet the needs and demands of consumers. If you ask a broker, even for very specific things that the rest of us might never even think of, there’s probably a product for you.”

And what about umbrella insurance?

Umbrella insurance is, if you can believe it, a kind of insurance on your insurance. “Say you’re in a car accident and you’re being sued for $3-million – but your policy only goes up to $2-million,” Mr. Hands says. There, an umbrella policy could kick in to cover the rest. Umbrella insurance is a just-in-case little extra if your insurance isn’t enough.

Are some kinds of insurance more important than others?

Is life insurance more important that pet insurance? Of course, though if you’re independently wealthy with no dependants and a million-dollar champion racing pigeon, then maybe not. (Yes, pet insurance to cover the vet bills of your cat or dog or gerbil is a thing, and increasingly common.)

“Insurance is always based on a person’s specific needs and circumstances,” says Bob Manson, personal insurance president at Gallagher Canada Ltd. The kind and amount of insurance you choose depends on what’s important to you and what fits with your life and lifestyle. For a person living with a chronic health condition, health insurance likely far outweighs anything else. For someone with small children, life insurance is probably the priority.

Must I have insurance?

Only car insurance is legally required by the government. “If you have a car, car insurance is mandatory,” says Erica Alini, personal finance reporter at The Globe and Mail. (Caught driving without it? That’s a minimum $5,000 fine in Ontario, and it can go up to $50,000.) The other insurance categories are a bit murkier. “Home insurance isn’t mandatory,” she says, “but a mortgage lender won’t give you a mortgage without it.”

Ditto for tenant (or renter’s) insurance, which isn’t required by law, but a landlord is perfectly within their rights to add a clause to the lease that requires you get some. Health insurance isn’t usually mandatory in Canada, thanks to universal health care, but additional health insurance is mandatory in some situations, such as for international students.

So no, most of the time you don’t have to have insurance. But you know that you probably should. Which raises the next question …

How much insurance do I really need?

As much as a hard-and-fast rule would be great here, the complicated truth is it all depends. Factors to consider include your age, location, health, marital status, dependants, living situation, standard of living, even personal preference and comfort level.

The good news is, the insurance companies wherever possible have made it easy for you. “Home and auto insurance are kind of obvious because they’re measurable,” says Ms. Alini. “For auto, for example, the insurance company will ask what you drive, how often you drive, how well you drive – if you’ve been in any accidents – and then use all that to tell you exactly the amount you need.” Problem solved.

Not so much when it comes to life insurance, which Ms. Alini says people usually struggle with. To pick a sufficient amount for your family but not so much that your spouse murders you (kidding!), try some gloomy catastrophizing. “I suggest thinking about the financial consequences of your death as your starting point and then work backwards,” says Ms. Alini. “How much does your family need for a funeral? To pay off the mortgage and stay in the house?” The right amount is whatever is enough to keep your family stable and comfortable, at a premium rate you can afford.

How does my need change for insurance depending on age/circumstance?

As you progress through your life and your circumstances change, so will your insurance needs, Mr. Payette says. “For example, earlier in your life you have a mortgage and young children, so you’ll need enough to pay off your debts and provide their future support. As you get older, maybe your debt is gone and your children are grown, so you just don’t need that level of coverage any more.”

Having children and buying property are the obvious ones, but there are other situations when it’s time to revisit your insurance policy. Just a few are marriage, divorce, another kid, a new car, job loss, a big promotion, retirement, a home renovation, or just because the time has come. “It’s recommended you review your policy once a year,” Ms. Alini says.

What is the difference between whole and term insurance?

While whole (or universal) insurance is indefinite, term insurance has an end date. Ms. Alini explains: “Maybe the term is 10 or 20 years, but basically the idea is that you although you need lots of insurance now – maybe you have a spouse and young kids – by the time you’re 65 or 70 and retiring, you’ll be in a better financial situation with more savings and less liabilities, so you don’t need so much insurance any more.” In fact, if you’re of a certain age with lots of savings, no debts and no dependants, you might not need insurance at all.

But as for the rest of us, why would a person choose a policy that ends before you do? “Because it’s significantly cheaper,” Mr. Hands says. And if term insurance is what you can afford, it’s still far better than no insurance at all.

What is the difference between an insurance broker and an insurance agent?

An insurance broker represents the client (you) and can shop at any insurance company. An insurance agent works for or is contracted to a particular company and wants to sell the client (you, again) their specific packages or services. So while a broker can help you compare multiple companies to each other, an agent will have much more knowledge within their company about what package(s) to choose.

Are there any red flags to look for when I’m buying insurance?

As always, when shopping for insurance, beware of fraudsters. The Insurance Bureau of Canada warns of a common scam where criminals pose as insurance agents or brokers and offer discount rates. They’ll often use a slightly altered name of a well-known legitimate insurance company and hope you won’t notice. A legitimate insurance broker or agent will never request a signing fee or a payment directly to them through electronic or wire transfer. “Always check that the insurance broker, agent or direct writer you are working with is properly licensed,” the bureau warns, and remember the adage: If it’s too good to be true, it probably is.

But insurance companies and professionals, like every other for-profit business in operation, are trying to make money and do so by selling – or upselling – policies that you may not actually need. Some kinds of insurance are controversial, with little consensus about whether they’re necessary or merely prey on people’s fears. Take, for example, children’s life insurance. It’s statistically very unlikely that you’ll ever use it, let alone need it, and that money is probably much better stashed elsewhere, like a registered education savings plan. If you feel that you’re being pressed to buy insurance you don’t need, consider getting a second (or third) opinion and definitely reconsider whether you should change companies or brokers.

What if I stop getting whole life insurance, then want to start up again?

Not a problem, says Mr. Payette, except maybe to your pocketbook. “You would need to re-apply for coverage and your premiums would be subject to your current situation,” he says. Since you’re definitely older – and maybe rounder and with higher blood pressure – you’ll have to be reassessed and will almost certainly pay more than your past self. Far better to get life insurance early and keep it, if you can. “Get it when you’re young and healthy and it will cost you next to nothing,” Ms. Alini says. “At maybe $20 a month, it’s a total no-brainer.”

If I’ve never had insurance, where do I start?

If you’re comfortable on the web, shopping for insurance has never been easier thanks to an ever-expanding roster of digital tools. “There’s been a lot of progress in the insurance industry in streamlining the buying process as well as making information about all aspects of insurance and products readily available,” Mr. Manson says. Digital tools have made the process, particularly for life insurance, much easier and less invasive than it once was. “You used to do a physical and send it bloodwork and such, but now it’s usually just a few clicks,” says Ms. Alini, who suggests policyme.com and Ratesdotca as great places to start. Mr. Hands, naturally, recommends ratehub.ca.

When do I need to see an insurance broker or consultant?

There’s no definitive situation where it’s time to call up a professional. “It’s all about how confident you are in understanding your needs and knowing that you’re buying the right product for you,” Mr. Manson says. Self-serve options work well for many people but experts are happy to help. Advisers or agents represent single insurance companies, while independent brokers such as ThinkInsure complete a needs assessment and provide options from multiple insurance companies, he says. Call them if you’re overwhelmed, and remember that being overwhelmed is completely normal. “Nobody expects you to be an insurance expert,” Mr. Hands says. “We’re here to break it down, help you choose and set you up.”

Are there times when I can’t get insurance if I want it?

“Insurance, at its best, works when the event that you’re trying to protect against is rare and expensive,” says Ms. Alini. “If it’s not rare, then you would plan for it, and if it’s not expensive, you’d just pay for it yourself.”

And therein lies an unfortunate Catch-22. Take, for example, a flooded basement – increasingly seen in both urban and rural settings. “As flooding becomes a more common occurrence, insurance providers struggle to cover it all. It’s no longer ‘rare,’ and since the risk factors are very identifiable – proximity to rivers and lakes, overwhelmed sewer systems – flooding insurance gets harder to get. Those who need it the most are finding they’re not eligible,” Ms. Alini says.

Sadly, the same conundrum happens with health and life insurance: The more you need it, the more it costs and the harder it is to get. “If the risk outweighs the premium they can charge, an insurance company will deny to offer a policy,” Mr. Manson says. The trick to insurance, therefore, is to buy when your risk is low, or before you think you need it (admittedly, easier said than done).

Key takeaways

Insurance works this way: Everyone pays a little bit into an emergency fund that promises to pay for the unlucky few who face an actual emergency