Understanding How a Life Insurance Policy Works
You purchase a life insurance policy to protect your loved ones against money problems if you die.
There are different stages of life and major life events when a person may need more or less life insurance protection.
Of course, protecting your family while you are working and earning an income to provide for mortgage payments, college tuition and living expenses is a priority.
During your retirement years, life insurance may not seem as important, but may become a way to lower the tax exposure of your estate assets, funding the amount needed to pay for estate taxes after your death.
All life insurance policies have certain information that is in common, regardless of the type of life insurance policy you buy.
Understanding the basic information and sections of your life insurance policy will give you an overall understanding of how to read your policy, how to understand it and how your life insurance policy will work for you. By understanding the language and basics of your policy, you will be able to understand other types of life insurance policies in the future.
Realize what type of life insurance policy you own. There are temporary (term life insurance) or permanent (whole life insurance or universal life).
Temporary life insurance ends at the term date and is much less expensive than permanent life insurance, which provides coverage until you die regardless of your age.
Locate the basic components of your policy on the face page - this is the first page of your life insurance policy that states the insured’s name, policy type and policy number, period of coverage, and other personal and policy specific data.
The basic components of interest are: insured, beneficiaries, coverage amount, policy term, premium payment, death benefit, surrender charges.
Look for the section called “Exclusions”. This section will tell you what causes of death are not covered by the insurance policy. If the policy is an accidental death insurance policy, it will explain that the policy will not pay if the insured person dies from an illness or natural death.
Look through your life insurance policy and find the called “Definitions”. Review it carefully to understand the terms listed. This part of the policy explains the technical definitions that are used in your policy.
Find the section called “Conditions”. Read it very carefully, because this section will be important if your beneficiary or you need to file a claim on your life insurance. This section will go into detail about what the person buying the life insurance has to do to comply with the terms of using the policy.
Locate the section called “Endorsements and Riders”. This section covers issues that could come up in the future. This section explains that the life insurance company has the legal right to make certain changes to the coverage or to the conditions at some later date. It will explain what changes to your policy the insurance company will be allowed to make and how you will be notified of any changes to your coverage.
The “Endorsements” section might also give you information about other coverage available in an additional policy, or how to get additional coverage by raising your policy limits, or adding coverage to your policy for your children or spouse.
Confirm the name listed on the first page of your policy as the insured. If the policy should pay benefits when you die, then you are the person insured by the life insurance policy. Confirm that the name, date of birth and address of record are correct. If not, contact your insurance company and agent and request the revision to your policy.
Confirm the names of the beneficiaries listed in your policy. Beneficiaries receive the death benefits when the insured person dies. You may need to amend the beneficiaries or add contingent beneficiaries--if your wife is your primary beneficiary, your children might be contingent beneficiaries in case your wife is not alive to claim the benefits. If you need to change beneficiaries, you can contact the insurance company and request a change of beneficiary form.
Review the premium payments to make sure your premiums are the same as those stated when you purchased your life insurance policy. A premium payment is the money you send to the insurance company to pay for your insurance coverage guaranteeing the death benefits to be paid to your beneficiaries. Always confirm that the life insurance policy reflects the premium payments you were quoted in the application process.
Confirm that the death benefit provides the financial coverage you desire. Death benefits are the benefits paid to beneficiaries when the insured dies. It is the amount of life insurance you purchased. Some permanent life insurance policies allow for loans against the insurance policy - in the case of any outstanding loans, the death benefit is paid to beneficiaries less any outstanding loan balance.
Read through the surrender charge schedule of fees. Term insurance has no surrender charge but permanent life insurance does require you to maintain the policy for a specified number of years before cancelling, or there is a penalty called the “surrender charge”.
Changing insurance carriers or canceling the policy to take out the cash value results in a penalty called the surrender charge that is a percentage of the cash value. Surrender charges usually decline with each policy anniversary, until there is no surrender charge after several years.
Tips and Warning
Cash value is the accumulation of premium payments less the cost of insurance plus any earnings obtained in a permanent life insurance policy. Cash value grows over time inside a permanent policy. Usually, there is no cash value the first few years of being insured. Term life insurance has no cash value, it is not an investment, it is “pure protection”.
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