Life Insurance Basics: The Cornerstone of Sound Financial Planning
Life insurance is a product designed to provide a death benefit to a named beneficiary upon the death of the insured. Coverage is based on the timely payment of premiums, the amount of which can be determined by a number of factors including the insured’s age, gender, health, family medical history, and lifestyle.
According to the Insurance Information Institute (I.I.I.) (https://www.iii.org/article/life-insurance-basics), many financial experts consider life insurance the cornerstone of sound financial planning — it covers the risk of someone dying prematurely or unexpectedly. A life insurance payout can replace income for dependents, pay final expenses, create an inheritance for heirs, pay taxes, or create a source of savings, among many options.
Types of Life Insurance
Life insurance comes in all shapes and sizes and can be tailored to fit changing needs. To start with, however, there are two major types of life insurance: term and permanent (or whole) life.
Term life insurance is temporary, meaning it pays only if death occurs during the term of the policy, which is usually from one to 30 years. The payout is a level death benefit in which the benefit amount stays the same throughout the duration of the policy, with no equity buildup each year as the premium cost increases.
Starting out, term policy premiums are low and the most affordable life insurance options. However, as the insured grows older and statistically becomes more likely to die, premiums can increase as the risk grows for the insurance company to cover them. The premium cost can be averaged to provide level 5-, 10-, 15-year premiums, but as time passes premiums will need to increase. Thus, term insurance is suited for a limited period of coverage, whereas other types of life insurance such as whole life are designed for an entire lifetime.
Permanent or whole life insurance is designed to cover the insured for a lifetime, paying a death benefit whenever the policyholder dies.
At the start of a whole life policy, premium costs are higher than they are with a term life policy. However, the premium remains level throughout the life of the insured, resulting in cost savings for them down the line the longer they live.
Whole life insurance accumulates interest to create a cash value, or equity, in the policy. The cash value offsets the increase in premiums with age, allowing the insurance company to maintain a level premium throughout the life of the insured. By contrast, term coverage increases in cost and may become unaffordable over time.
Dive in the Pool
Insurance companies pool your risk, combining it with other people sharing the same risk. Premiums paid to the insurance company are put into the pool and the cost of a loss is paid from that pool.
Premiums are based on the collective losses expected from the pool determined by underwriters and actuaries. The larger the pool, the more accurately the insurance company can manage cost and predict claims.