When inflation spikes, we often focus on making sure our investment portfolio can keep pace with the increasing costs of living. However, one aspect of financial planning that doesn’t get enough attention during inflationary periods is insurance. For many folks, it’s a good idea to double check that your insurance coverage remains adequate in the face of higher inflation.
Dwelling coverage
A great place to start is with your homeowners insurance. More specifically, the dwelling coverage amount incorporated into the policy. In a nutshell, the dwelling coverage represents the maximum amount your insurance company will pay to help rebuild your house. If your house costs $500,000 to rebuild, but you only have $450,000 of dwelling coverage, that’s not good.
And when the cost of construction services and materials starts rising very fast, your dwelling coverage can fall behind. Start by doing a deep dive to estimate what it would cost to rebuild your home. If your dwelling coverage doesn’t come close, then it may be time to increase it.
Fortunately, many insurance companies will automatically increase dwelling coverage amounts when renewing the policy each year. But it’s not a given, so be sure to ask your insurance agent to double check.
Remember that the velocity of current inflation rates can introduce significant risk in a short period of time. For example, $500,000 of rebuild costs today turns into $540,000 in one year with 8% inflation. If you fail to increase the dwelling coverage, you could be out of pocket for that extra $40,000.
Life and disability
The effectiveness of life insurance will also be degraded by inflation. Most life insurance death benefit amounts are not indexed to inflation. In effect, you lose a portion of your insurance protection each year to inflation. In times of low inflation, the degradation of coverage is offset by a lower need for insurance over time (i.e. fewer years of salary or earnings). However, this is not the case when inflation ramps up.
Many long-term disability insurance policies allow for inflation adjustments, but sometimes not enough to keep up with current inflation rates. Again, running the numbers is the key to understanding whether you need to purchase additional coverage.
Hopefully, if you’re retired or near-retired, you don’t have a need for life or disability insurance. For those of us still in the midst of our earning years, accelerated savings and investing can help. The faster you reach a level of assets that can fund your future spending, the faster you can cancel any unneeded insurance policies.
Social Security, pensions, and annuities
Most people don’t realize it, but Social Security, pensions, and fixed annuities are really a form of longevity insurance. Delaying Social Security can offer one of the most powerful protections against financial ruin later in life.
Most private pensions and annuities offer little or no protection against inflation. But Social Security and some state/federal pensions offer great inflation protection. Be sure to explore what protections you have in place.
Stay flexible
The most important thing to remember in the current environment is to stay flexible. No, I’m not recommending that you jettison your financial plan at the first sign of danger. But it’s important to take a look at your financial situation at least once per year and assess if you are still on track. Often, you can make small changes to address any developments in the markets, tax laws, or whatever else pops up.
