How does life insurance work?

When you die, certain financial obligations become the responsibility of your loved ones, such as your spouse or child. With a life insurance policy, you can have peace of mind knowing that even after you’re gone, your family will be financially secure because they have the money to cover various expenses. 

But if you want to save money on life insurance and ensure you get the most of what life insurance has to offer, it is important to know how life insurance works. We’ll explain life insurance coverage and break down the meaning of life insurance terms to help you get started.

What is life insurance?

Life insurance is an agreement or contract between a policyholder and a life insurance company. The policyholder agrees to pay a premium in exchange for short-term or long-term coverage. Upon the insured’s death, the life insurance company pays out a certain amount to the designated beneficiary. The money can be used for various purposes, including funeral expenses, college tuition, medical bills, child care services, and other expenses that may have previously been covered by the insured’s income.

Term and permanent life are the two main types of life insurance. If you are interested in short-term coverage that lasts a certain number of years, consider term life. But if you’re looking for long-term coverage that lasts your entire life, consider permanent life.

We’ll explain each type of life insurance coverage in more detail. 

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What are life insurance types?

Here are the main types of life insurance. 

Term Life Insurance

Term life insurance is a short-term, affordable life insurance option. It provides coverage for a term of one, five, 10, 15, 20, 25, or 30 years, and the policyholder can enjoy a stable, predictable premium for the duration of the policy. 

How does term life insurance work? If you pass within your term, your beneficiary receives a tax-free payout in the amount you chose. However, if you outlive your policy term, when it expires, you can renew at a higher rate, but there may also be the option to convert the policy to permanent life depending on the insurance company. 

Permanent Life Insurance

Permanent life insurance provides long-term coverage that lasts the insured’s entire life. Similar to term life insurance, the policyholder chooses a death benefit amount, but with permanent life, there is a cash value component. A portion of the premium is put into a savings account and over time the value builds as a result of the interest rate or investments. This allows the policyholder to borrow against the policy, withdraw the money, or surrender the policy and receive the cash as a payout. Typically, any cash value available when you pass will not be added to the death benefit, but certain policies add the cash value to the death benefit. 

There are several varieties of permanent life insurance, including the following:

• Whole life insurance: A permanent life insurance policy that offers a cash value component that increases at a guaranteed rate of return and has the potential to earn dividends, which can be used to lower the premium or added to the cash value. 
• Universal life insurance: A permanent life insurance policy that builds cash value and offers a flexible premium and an adjustable death benefit. 
• Burial insurance: A small whole life insurance policy that covers the cost of a funeral and other final expenses, such as medical bills.
• Survivorship life insurance: Also known as second-to-die life insurance, this type of whole life insurance policy insures two individuals and doesn’t pay out the death benefit until both individuals pass. 

Now that you know what your life insurance policy options are, let’s take a look at what life insurance covers. 

What does life insurance cover?

How does insurance work after an insured dies? If the insured dies as a result of an accident, disease, illness, or homicide, the beneficiary receives a payout. Although all causes of death are typically covered by life insurance, there are a few exceptions. 

Suicide is covered, but only if it occurs after a certain period, which is usually at least two years after the policy was purchased, but this depends on the insurance company. And even though murder is covered by life insurance, this does not include situations where the insured was killed by the beneficiary. 

The life insurance company can always deny the life insurance claim if fraud was committed. For example, the information provided on the life insurance application was false or it is found that the policyholder was manipulated or coerced into making changes to their policy, such as changing the beneficiary. 

How to Choose the Right Life Insurance Policy Type

Below are a few different scenarios to consider when choosing which life insurance policy type is right for you.  

Term life insurance is best if: 

• You want short-term coverage that lasts one to 30 years.
• You have financial obligations you have during that specified time period.
• You want coverage with a high limit and a low, fixed premium.
• You have a mortgage, credit cards, college tuition, and other financial obligations to cover within the next 30 years. 

Permanent life insurance is best if:

• You want a flexible premium. 
• You want an adjustable death benefit.
• You want to build cash value. 
• You want the option to borrow against your policy to cover the cost of various expenses. 

If you want to choose the best life insurance policy for you, consider your needs and budget. 

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How much does life insurance cost?

Term life insurance is less expensive than permanent life, but the cost of life insurance can still be impacted by several factors. 

Here are four major factors that impact the cost of life insurance. 

• Age
• Sex
• Health
• Lifestyle

Remember, if you can’t afford permanent life insurance, you can always go with term life insurance and convert at a later date.  

How to Choose a Life Insurance Coverage Amount

To estimate your life insurance coverage amount, you can use a variety of methods. However, the below method can give you a good idea of how much cover you’ll need. 

Financial obligations – existing assets = life insurance coverage amount

This method considers your expenses, as well as your savings and other assets available to cover these expenses. 

How to Get Life Insurance Quotes

Term and whole life insurance quotes are free and available through various life insurance companies. Depending on the company, you can request a quote online or through a life insurance agent. 

To receive a quote, you’ll provide personal details about your health and lifestyle, and if you move forward with an application, further details will be requested and you may have to complete a medical exam. Depending on the type of underwriting, the application process can days to months to complete. 

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How does life insurance work?

Here are some useful life insurance definitions you should know. 

• Premium: Payments made to the life insurance company for the policy. 
• Beneficiary: The individual, organization, or entity who receives the death benefit when the insured dies. 
• Death benefit: The amount of money paid to the beneficiary after the insured dies. 
• Rider: An optional coverage that can be added to your policy. 

Life insurance can be intimidating, but if you have the basic terminology down, the process of buying life insurance won’t be so overwhelming. 

How to Choose a Beneficiary

What about life insurance beneficiaries? Choosing the beneficiary may not be an easy decision. For some, there is a clear choice, but this isn’t always the case. Since you can name an individual or multiple people, charity organizations, a trust, or your estate as your beneficiary, you have a lot to consider. 

If you name multiple beneficiaries, each can receive a percentage of the death benefit. Or you can choose a contingent beneficiary who only receives the payout if the primary beneficiary dies. When naming a trust, you can decide how the life insurance payout is spent. 

Since life events can impact your choice of beneficiary, if you want to make any changes, it is best to contact your insurance company and update the policy right away. For example, if you are married and have a child, you may want to add your child as a beneficiary. 

How do you make a life insurance claim?

To make a claim, the beneficiary needs to contact the life insurance company and submit documentation. 

Here’s a quick overview of the claims process. 

1. The beneficiary obtains a certified copy of the death certificate. 
2. A claim is filed and a copy of the death certificate is submitted to the life insurance company. 
3. Once all claim requirements have been met, the claim is paid out to the beneficiary, which usually takes up to 30 days. 

To ensure your beneficiary receives the payout, it is best to inform them of their designation as your beneficiary and the name of your life insurance company. 

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