How Does Life Insurance Work?


Life insurance is a contract between you and an insurer that promises to provide money, known as the death benefit, to those you name upon your death. This money may help replace income or cover expenses such as funeral costs or significant medical bills.

Many people purchase life insurance to provide for their families’ financial security after death and repay debt or leave behind an inheritance.

The contract

Life insurance policies are legal contracts between insurers and their insured. They guarantee that upon the insured’s death, premiums paid throughout its term will pay out in a lump sum to one or more beneficiaries in exchange for that benefit; some policies even offer maturity benefits or the return of premiums at its conclusion.

The length of a policy depends on its insured’s age and health at application time. Some companies provide accelerated underwriting that enables applicants to bypass a medical exam, quickly receiving approval. At the same time, others use more traditional underwriting processes, which could take several months.

As soon as a policy term expires, an insured can renew it with a higher face value and premium payment if their health has worsened since initial underwriting. Some insurers allow policyholders to expand coverage in exchange for higher payments.

Most life insurance policies qualify as qualifying policies under the tax code, meaning their proceeds are tax-exempt until withdrawn by the policyholder. If an insured is diagnosed with a terminal illness and requires medical expenses to be covered during treatment, partial withdrawal of their death benefit is available as an option to help cover medical costs.

The insured

The insured is any individual or legal entity covered by life insurance policies, such as businesses or trusts. They pay premiums periodically or as one lump sum to keep their policy active; should an insured die, their beneficiaries (named in their policy) will receive a death benefit that can help cover expenses or provide money management help after their demise.

There are various kinds of life insurance policies, each offering its own set of advantages and drawbacks. Some require medical exams before offering coverage, while others don’t; furthermore, specific policies offer cash value components that can be borrowed against or withdrawn as necessary, while others do not.

No matter the policy type you select, most life insurance policies cover natural and accidental deaths. There may be exceptions – such as if you commit suicide, engage in fraudulent or criminal activity in the past, make material misrepresentations on your application forms, etc. – thus, it’s crucial that when filling out your application, you provide all information honestly.

The policy owner

When purchasing life insurance policies, beneficiaries are essential. Beneficiaries include people and legal entities like family trusts who will receive your death benefit upon passing. Depending on the policy chosen, death benefit percentages can be divided among several beneficiaries as per the percentage of death benefit payout; additionally, you may select contingent beneficiaries who would receive this sum should primary beneficiaries die before you.

Life assured, known as policyholders, have decision-making and claim rights; however, they don’t possess ownership rights unless they own the policy themselves. Spouses, children, parents, and business partners who aren’t the policy owner may still be named beneficiaries. Still, their right-to-death benefits will only become effective upon the policy owner’s death.

As part of your policy selection, you’ll also need to determine how long it should last and your preferred payment schedule for premiums. Premium payments can either be made regularly, for a specified number of years or just once, depending on what your policy allows. Most permanent life insurance policies also build up a cash value you may borrow against in certain instances if necessary (though borrowing against it would reduce its death benefit).

The beneficiary

Beneficiaries are those individuals or legal entities (like trusts) designated to receive the death benefit of life insurance policies upon their death. Most often, this will be their spouse or children; they should also designate guardians if there are minors. Beneficiaries typically receive their payments in one lump sum payment. Still, some policies can also provide for an annuity or retained asset account, which provides regular installment payments and interest accumulated over time.

How much life insurance you need depends on your financial circumstances and family needs. A standard method is to multiply your annual income by 10. This doesn’t consider expenses such as loans or debts that should also be considered when making this calculation.

Insurers base premiums on various factors, including age, health, lifestyle, and occupation of their applicants. Furthermore, insurers consider factors like smoking or any history of chronic illnesses when setting premiums. Most life insurance companies require an initial medical exam which may include testing blood pressure and cholesterol levels as part of a complete medical check-up exam. If someone dies from natural causes alone, then death benefits will usually be distributed among designated beneficiaries; however, if they commit suicide or violate specific clauses within their policy (for instance, committing fraud or materially misrepresenting information), insurers will not pay out death benefits as per contract clause.