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What Is life insurance?
Life insurance is a contract between an individual and a life insurance company whereby a lump sum of cash, known as the death benefit, is paid to a named individual (or individuals), known as the beneficiary in the event that the insured dies.
How does life insurance work?
Life coverage works using a very simple concept. In return for the payment of a premium, a set amount of proceeds will be paid out to a named beneficiary (or beneficiaries) if the insured dies while the insurance contract is in force.
The funds that are paid from a life insurance policy are received by the beneficiary free of income tax. That way, loved ones, and survivors are able to make use of the full amount that is provided by the policy.
Today, there are some life policies that also provide “living benefits.” These living benefits can be added as a rider on an insurance policy like an accelerated death benefit rider.
Living benefit riders offer access to some or all of the death benefit proceeds if the insured becomes diagnosed with a chronic illness, a critical illness, or a terminal illness, and must reside in a skilled nursing home facility
Types of policies
There are several types of life insurance coverage to choose from in today’s market. Knowing more about the different types of life coverage available, as well as what each offers, can help you to narrow down the type that is right for you.
Term life insurance
A term life insurance policy consists of death benefit protection only, without any type of cash value or savings component. Because of that, term insurance is usually cost-effective in terms of securing a large benefit for a little premium. With term insurance, coverage is purchased for a set amount of time, or “term,” such as 10-years, 20-years, or even 30-years.
Whole life insurance
A whole life insurance policy, as its name implies, is designed to cover an insured with lifetime coverage as long as the premiums are paid. It’s the most well-known of the permanent life policies. This type of policy offers death benefit protection for your entire life, as well as a cash value component that grows on a tax-deferred basis. Whole life insurance will help protect you your entire life and is even used to help pay estate taxes, and the cash value will continue to compound.
Universal life insurance
A universal life insurance policy is a form of permanent insurance protection. Offering both death benefit coverage and it will build cash value, universal life policies can be flexible by allowing the policyholder to alter the timing and/or the amount of the premium (within certain guidelines) to better fit changing needs over time. Universal life insurance is a permanent life insurance policy.
Also, see term vs whole life insurance article
Cost of life insurance
Just like with most other products and services, there are a number of factors that go into your life insurance cost and how the best life insurance quotes are determined. In this case, the key components that determine the premiums include:
- Tobacco Use
- Product Type
- Health History
- Financial History
- Criminal History
- Medication History
- Insurance Company
- Family’s Medical History
- Length of coverage
- Height & Weight Charts
- How Much Life Insurance Coverage
Example of monthly life insurance premium payments
*Female, Preferred Best, Non-Tobacco Rates Shown. 10 Year Term Effective 02/18/2020.
All life policies have some type of underwriting guidelines that must be met in order to qualify for coverage.
Underwriting is used by insurance companies to assessing the risk of the applicant, as well as to better ensure that the life insurance quote that is charged for the coverage is in proportion to the risk that the insurance carrier is taking on.
There are two types of underwriting on life insurance policies. Full underwriting and simplified underwriting.
A policy that is fully underwritten will require the applicant to take a medical exam in order to better determine his or her health condition. This exam includes providing a blood and urine sample for testing. The applicant does not have to pay for this exam.
In addition, the applicant will also have to fill out an application for coverage, which requires answering health and medical questions, as well as provide information about any medications that they are taking.
Approval is then based upon the answers to these questions, the exam results, and various other information, such as an RX report (that provides more detail on prescription medications), a report from the Medical Information Bureau (MIB), and a motor vehicle report.
Depending on the life insurance company and underwriting requirements, it can often take between 4 and 6 weeks to evaluate an applicant for a fully underwritten life policy.
Simplified Issue Underwriting
A policy with simplified underwriting (no medical exam) will still require the applicant to answer medical questions. However, no medical exam will be required.
The underwriting decision is determined by the answers to the questions on the application, as well as by the information that is on the RX report, MIB report, and motor vehicle report.
Most insurance carriers now offer some form of simplified underwriting. In most cases, an individual can purchase up to $500,000 in coverage, and there are a few carriers that offer coverage of up to $1 million using simplified underwriting.
Unlike a fully underwritten policy which can take 4-6 weeks to issue, those using simplified underwriting may only take 15 minutes to 36 hours for the underwriting process to be completed.
This shorter time frame is due in large part to the fact that there are no medical exam results to wait for. It could be, though, that simplified issue life insurance quotes are higher than those of fully underwritten policies.
Policies with no underwriting
Because some people who need coverage may have certain health-related issues known as pre-existing conditions, it can make it difficult to qualify for coverage. In this case, a guaranteed acceptance policy could be beneficial. Anyone can secure this type of coverage – even if they have an adverse health condition. While the premium for this type of coverage is typically more than that of a fully underwritten option, guaranteed acceptance insurance can offer the protection that is needed.
Guaranteed Acceptance Guidelines
With a guaranteed acceptance insurance policy, the applicant will be approved for coverage, regardless of his or her health condition. These policies do not require going through a medical examination, nor a list of health questions to be answered on the application.
It is important to note here, though, that the amount of coverage that can be secured with this type of insurance policy is usually limited to $25,000 – $50,000 in coverage.
In addition, some guaranteed acceptance plans will only pay the beneficiary a return of the paid-in premium (plus interest) if the insured dies within the first two years of securing this coverage.
Pros and cons of life insurance
As with any other financial tool, there can be both pros and cons to purchasing life insurance. One Con “drawback” is the premium. But, when considered against all of the pros that a life insurance policy can provide, you’ll find that the cost is well worth it.
Just some of the Pros that a life insurance policy includes:
- Income Replacement – the proceeds can replace lost earnings, both for young couples and families and for retirees.
- Debt Payoff – The proceeds from a life insurance policy can pay off debt so that survivors won’t be saddled with added financial responsibility. This includes the payoff of a mortgage balance, credit cards, auto loans, and business-related debt.
- Payment of Funeral and Final Expenses – With the average cost of a funeral today being over $8,500, having funds available to immediately pay this expense can be beneficial. Oftentimes, having a life insurance policy can prevent families from having to dip into savings accounts or sell other assets.
- Living Benefits – Contrary to popular belief, someone does not have to die in order to benefit from life insurance. Some policies may also be tapped for “living benefit” needs, such as when diagnosed with a chronic or a terminal illness, and for payment of skilled nursing home expenses.
- College Funding – Permanent policies that build up cash value in a tax-deferred manner may also be used for needs such as college funding. Here, the money inside of the cash component of the policy can compound exponentially – and, should the insured pass away, the self-completing nature means that the death benefit funds will still ensure that the beneficiary will have money when it is needed.
When to buy life insurance
Although everyone’s needs are different, the best time to get covered is sooner rather than later. This is because some of the key factors in qualifying for any type of life insurance are age and health.
With that in mind, applying for a policy now can better assure you that financial protection may want to be locked in, and that loved ones will have the peace of mind in knowing that they can count on this financial safety net. Younger and healthier applicants will also typically be rewarded with more affordable life insurance quotes online.
Who should get life insurance
Life insurance can help many people. Everyone eventually will need life insurance. How much life insurance will vary from person to person. Just some of these include:
- Parents who have young children
- Spouses who are counting on each other’s income
- Business owners and key executives
- Retirees who don’t want to burden loved ones with final expenses
- Parents and grandparents who want to help fund a child’s future college costs
Things life insurance can protect against
Buying life insurance is one of the best ways to protect family members. A life insurance payout can help pay for many financial obligations someone may leave behind. Such as the end of life expenses like funeral costs, a child’s education, replacing lost income, paying off credit card debt, tax burdens, and many other items.
Reasons to purchase life insurance
Because everyone’s needs and situations are different, there is a wide range of reasons for purchasing life insurance, such as:
- Protecting your family from debts like a mortgage and student loans
- Ensuring that ongoing living expenses will be paid – even if the unexpected occurs
- Creating a way to supplement and replace retirement income
- Covering short-term debts
- Paying for a child’s or a grandchild’s future education expenses
What life insurance won’t provide*
While insurance is a flexible and dependable financial tool, there are some things that it will not provide. For example, policy exclusions are situations where the insurance company will not pay out benefits.
One of the most common exclusions found in life insurance is the suicide clause. Although there are some life insurance policies that will allow for the payment of benefits – even in the event of suicide by the insured – this is not the case with all plans.
There are other situations that could also preclude the payout of benefits. These can oftentimes include:
- Disability Insurance
- Critical Illness
- Reckless Endangerment
- Long Term Care
Having a good understanding of what life insurance will and won’t provide can be extremely helpful in narrowing down the type and the amount of coverage that is right for you.
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