Life Insurance 101
What is Life Insurance?
- Life insurance is a contract between a policyholder and an insurance company.
- The policyholder agrees to make premium payments to the insurance company in exchange for the payment of a death benefit, if death occurs within the parameters of the contract.</ li>
- This death benefit payment is paid to the chosen beneficiaries of the policyholder, typically children or spouses.
What are Premiums?
- Life insurance transfers risk from the policyholder to the insurance company.
- In return, the life insurance company charges a premium on the basis of the risk posed by the policyholder.
- Premiums vary based on the risk of the policyholder and the size of the death benefit
- The greater the death benefit, the greater the premium and vise versa.
- Each policyholder has a unique risk profile, which is why premiums vary from one individual to another based on age, health, and habits.
- Young and healthy people pay lower premiums because they are a lower risk whereas older people with illnesses pay higher premiums because they are a higher risk.
What types of Life Insurance are there?
- Term Life Insurance
- Whole Life Insurance.
Term Life Insurance
- As the name implies, term life insurance is an insurance contract that lasts for a specific duration of time (term).
- The insurance company pledges to pay a death benefit to the policyholder’s beneficiaries if the policyholder dies within the specified term.
- Term life is cheaper than whole life insurance because there is less risk for the insurance company.
- If the policyholder doesn’t die within the specified term, then the life insurance company doesn’t pay out the death benefit.
Whole Life Insurance
- As the name implies, whole life insurance is an insurance contract that last for the remainder of the policyholder’s life.
- It virtually guarantees the payment of a death benefit unless the death occurs through conditions that are expressly excluded in the contract.
- Because the death benefit is guaranteed, whole premiums are higher than term life premiums.
- Whole life insurance also can accrue a cash value at a fixed, agreed upon rate in addition to the death benefit.
- For instance, certain whole life policies will grow 5% a year, so at death a whole life policy will pay the death benefit plus the cash value that has accrued at this rate.
- Within life insurance contracts, there are certain conditions of death that exclude the insurance company from paying out a death benefit.
- Examples of such conditions are natural disasters, suicide, or death that occurs as a result a crime.
- If the policyholder dies in an excluded fashion, the insurance company will not pay the death benefit.
- Policyholders have the option to add additional agreements called riders within a life insurance policy in exchange for additional premium.
- For instance, a policyholder may decide to add a rider to their term policy that will pay them back a percentage of their premiums if they don’t die within the specified term in exchange higher premiums.
- There are many different types of riders available to policyholders.