How Life Insurance Policies Work

Learn How Life Insurance Policies Work


How does a life insurance policy work?

A life insurance policy is one way to protect survivors or dependents from undue financial hardship if you die. 

A life insurance policy is a contract between the insurance company and the owner of the life insurance policy, which is the person who buys the life insurance.

The owner agrees to pay a premium to the insurance company, and in return, the insurer agrees to pay a death benefit on the life insurance policy upon the death of the insured person. The death benefit is paid (usually free from federal income tax) to the beneficiary, which is chosen by the owner of the life insurance policy.

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The life insurance policy document describes the rights, obligations and limitations of the insured person and the insurer (insurance company). One obligation for the insured person is to pay the premiums on time.

The amount of the insurance policy is called the coverage, or amount of life insurance protection provided by the policy. The amount of life insurance can be anything from $5,000 up to $5,000,000 or more. It depends on the amount the insured person wants, what his family needs, and how much he can afford to pay in premiums. The larger the amount of life insurance, the more the premiums will be.

When the insured person dies, the beneficiary files a claim for payment of the death benefit. This notifies the insurance company that a life insurance policy will be paid out. The beneficiary provides a copy of the death certificate as proof. Within 2 to 3 weeks the beneficiary receives a lump sum payment from the insurance company.

There are two basic types of life insurance: Term and Permanent. They each have some common features and some unique features.

Term life insurance offers temporary life insurance for a set number of years, usually from 1 to 30 years. Most term life plans offer coverage for a "term" of 10, 15, 20 or 30 years.

With term life, you pay a premium each month or annually for a specified amount of life insurance coverage. If you die during the duration of your coverage, your beneficiary receives the death benefit paid out from the insurer. If you are alive when your term expires, the life insurance coverage ends. 

Term life may offer you the option of renewing you’re your life insurance coverage when the term of your term policy ends. You may be able to renew your coverage for another 5 or 10-year term, with a higher premium based on your age at the tine you renew the policy.

Permanent life insurance provides guaranteed lifetime protection and builds up cash value inside the policy from which you may take a loan if needed.

  

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