Life insurance is a crucial tool in securing the financial well-being of your loved ones in the event of your untimely demise. It provides a safety net to those left behind, ensuring they can cover essential expenses, pay off debts, and maintain their quality of life. However, simply having life insurance is not enough.
Underinsurance is a common problem many Americans overlook or don’t realize they have. It happens when your life insurance policy doesn’t provide adequate coverage for your needs. The financial consequences of inadequate life coverage can be severe, leaving your loved ones with significant burdens and reduced quality of life.
In this article, we’ll discuss underinsurance, why sufficient coverage is crucial for your family’s financial security, and tips on avoiding underinsurance and ensuring your loved ones are protected.
Understanding Underinsurance
Underinsurance is when a policyholder has a life insurance policy that does not offer sufficient coverage to meet their family’s financial needs after death. It occurs when the policy’s coverage amount is less than the required amount to cover debts, ongoing expenses, and the future financial needs of the person’s loved ones.
Factors Contributing to Underinsurance
Here are some common reasons you might be underinsured:
Lack of understanding or knowledge about life insurance: Many Americans don’t fully understand how life insurance plans work or how much coverage they need. This can lead to choosing the wrong type of policy, such as term coverage, when a permanent life insurance policy is more appropriate, leaving your loved ones vulnerable after your passing.
Choosing lower premiums over adequate insurance coverage: 49% of American adults who need life insurance coverage but are currently without cited the cost of premium payments as one of the defining reasons they’re uninsured. This cost savings lead those who do apply to opt for lower coverage amounts to reduce their life insurance premiums.
While this may seem like a smart decision in the short term, it may lead to underinsurance and significant financial risks for your loved ones in the long run.
Misunderstanding the policy coverage: It’s essential to understand the coverage offered by your life insurance policy. Some policies have restrictions and limitations that can affect the life insurance payout to your beneficiaries. If you’re unclear on the policy’s coverage, you may be underinsured without realizing it.
Underestimating the financial impact of your death on your loved ones: When choosing a life policy, it’s crucial to consider your family’s financial needs, such as paying off debts, covering ongoing expenses, and providing for your loved ones’ future. Failing to account for these needs can lead to underinsurance.
Inadequate assessment of risks: Comprehensive coverage starts with an in-depth understanding of your personal risks. For example, suppose you have a high-risk occupation or a pre-existing medical condition. In that case, you may need more coverage than someone with lower risks in the form of an accidental disability rider.
Life insurance companies will also consider these risks in their assessment, so consider them as you approach the application process.
Overreliance on employer-provided coverage: Employer-provided life policies rarely provide sufficient coverage for your needs. They’re not customized with you and your specific situation in mind. Relying solely on this coverage can leave you underinsured.
Employer-based coverage is typically non-portable. Departing from your current job for any reason could result in forfeiture of your coverage. While conversion of your group policy to an individual policy is an option, it may come at a substantial cost.
Lack of professional advice: Life insurance can be complicated, and seeking professional advice is essential when choosing a policy. A financial advisor or insurance agent will assist you in navigating the options and ensure that you have adequate coverage.
Procrastination: Some uninsured Americans put off getting coverage, while those with a current policy fail to update their life policies as their circumstances change, like after the birth of a child, or the purchasing of a house, leaving them vulnerable to underinsurance.
Misinformation and Misconceptions: Misinformation abounds about life insurance, and some individuals make decisions based on false or misleading information. One of the first misconceptions you’ll encounter is the average cost of coverage.
A LIMRA study in 2022 showed that over half of Americans surveyed overestimated the cost of coverage by as much as threefold. It’s the number one misconception they uncovered, followed by:
2. Employer-based coverage is enough;
3. It’s too difficult to buy life insurance;
4. I don’t need coverage until I’m older.
If the pandemic taught us anything, it’s that major disasters can strike at any time. Learn how you’ll benefit from life insurance by consulting credible sources or an agent.
The Risks of Underinsurance
The consequences of underinsurance are severe and long-lasting.
Financial risks for loved ones: If a family’s breadwinner has not taken sufficient life insurance coverage, the death benefit amount may not be enough to cover the burial expenses, living expenses, mortgage payments, and other outstanding debts. This can financially burden the family, especially if the deceased was the primary or sole earner.
With the mounting list of unavoidable expenses, your loved ones may have to sell assets or take out loans to cover these costs, putting them under immense stress and financial strain.
Reduced quality of life for loved ones: If your life insurance policy does not provide sufficient coverage, your loved ones may have to compromise on their quality of life to make ends meet. This can impact their ability to achieve their goals, such as education and retirement, and limit their opportunities.
Increased stress and emotional burden: In addition to the financial burden, underinsurance increases the stress and emotional burden on your loved ones. They’ll have to deal with the additional pressure of managing finances and making difficult decisions while coping with their loss, which is emotionally draining.
25% of American families feel the financial strain of losing a primary breadwinner within a month. Added to the 19% who experience the effects in six months, 44% of U.S. households are adversely affected. Only 14% of those surveyed were in a secure financial position not to experience a difficult time. [Source]
Steps to Avoid Underinsurance When Buying Coverage for the First Time
If you’re looking into buying coverage, here’s how you can secure adequate life insurance coverage:
Increase awareness and education on life insurance policies and their benefits: Start by educating yourself on the different types and benefits. This will help you make an informed decision and choose the right policy for your lifestyle needs.
Assessing financial responsibilities and future goals: Assess your current financial situation, including your debts, ongoing expenses, and future financial goals. This will give you a better understanding of the coverage level you need to protect your loved ones adequately.
Seeking professional advice: Work with a financial advisor or insurance agent to determine the right policy for your needs. They can provide valuable advice and help you make an informed decision.
Comparing and choosing the right policy: Shop around and compare different policies to find the one that best suits your needs. Consider factors such as coverage amount, premiums, and exclusions when deciding.
Reviewing and updating insurance regularly: Review your life policy regularly to ensure it meets your needs. Life changes such as marriage, the birth of a child, or a new job can affect your coverage needs. Update your policy accordingly.
Only 17% of Americans with limited knowledge about life insurance opted for coverage, while a majority of 62% with coverage consider themselves knowledgeable. [Source]
How to Determine If You're Underinsured as a Current Policyholder
Checklist for Assessing Your Life Insurance Needs
To determine if you’re underinsured, use the following checklist:
- Evaluate your financial situation: Take a close look at your finances, including your annual income and what percentage you spend on your current bills, expenses, savings, and debt. If you’re in a dual-income household, have your partner do the same and evaluate your collective expenditure.
- Consider your future financial obligations: Think about your future financial obligations, such as mortgage payments, child care, college education, and other household expenses that your family may incur.
- Assess your assets: Assess your current assets, including your home, car, investments, and other valuable possessions.
- Evaluate your potential risks: Evaluate your potential risks, such as health conditions, accidents, or other unforeseen circumstances that could impact your financial stability.
Calculating Your Life Insurance Needs
Once you’ve assessed your financial situation and potential risks, you can calculate your life insurance needs. The recommended life insurance coverage is at least ten times your annual income.
Calculating with the most current data from the Bureau of Labor Statistics, the median weekly earnings of full-time wage and salary workers for the first quarter of 2023 was $1,100. Estimated, it’s a $57,200 yearly salary. Multiply that by ten, and you get a life insurance policy of $572,000.
For a personalized calculation of your needs, consider the following factors:
- Income Replacement: Estimate how much money your family would need to maintain their current lifestyle and avoid a financial crisis if you were no longer around. Multiply this figure by the number of years you want to provide financial support.
- Debt and Expenses: Calculate your outstanding debts, such as mortgages, car loans, and credit card debts. Add this figure to your estimated expenses, such as college tuition or other significant payments.
- Assets: Subtract your assets, such as savings, investments, emergency funds, and retirement accounts, from your estimated financial obligations.
- Potential Risks: Factor in any potential risks, such as healthcare costs and end-of-life expenses, and leave room for unexpected expenses that could impact your family’s financial situation.
Life insurance is not a one-size-fits-all solution, and your coverage needs may change over time. Consult with an insurance professional and update your policy to grow with your obligations.
What to Do If You're Underinsured
If, after your assessment, you recognize you’re underinsured, take immediate action to secure adequate life insurance coverage. Here are some next steps:
Increase Your Coverage: The most straightforward solution to being underinsured is to increase your life insurance coverage. Speak to your agent or financial advisor to determine the coverage you need and the best policy for your situation.
Shop Around for Better Rates: If you’re underinsured because of the cost of insurance coverage, shop around for an affordable option. Different providers offer varying rates and coverage options, so compare quotes to ensure you get the best deal.
Review Your Policy: Regularly review your life insurance policy to ensure it covers your needs. As your life circumstances change, your coverage needs may change as well. Reviewing your policy annually or after significant life events, such as a marriage, a new baby, or a change in employment, will help ensure you have the right level of coverage.
Consider Supplemental Coverage: If you have group life insurance through your employer, consider purchasing additional protection to supplement your policy. Supplemental policies provide extra coverage and increase your death benefits at a lower cost than buying a new policy.
The average payout for a group life insurance death benefit is about $20,000 or a year’s salary. While the average expense for a funeral in 2023 is over $11,000. Let’s take that $20,000 and subtract the $11,000, and your family’s left with $9000.
Depending on your household size and if you’re the breadwinner, your family will start feeling the effects within a month. Or less if they also subtract outstanding medical bills if you require emergency care before your passing.
Conclusion
The importance of having adequate life coverage cannot be overstated. Life insurance protects your loved ones financially, ensuring their needs are met after your passing.
The dangers of underinsurance are significant and can have severe consequences for your loved ones. From financial risks to reduced quality of life, the impacts of underinsurance can be devastating.
By increasing your awareness and education, assessing your financial needs, seeking professional advice, comparing and choosing the right policy, and reviewing and updating your insurance regularly, you can avoid underinsurance and protect your loved ones.
Don’t let underinsurance put your loved ones at risk. Take the necessary steps to strengthen your coverage today. Your family’s financial future is worth it.
