Life Insurance: What It Is, How It Works, and How To Buy a Policy

 

What Is Life Insurance?

Understanding how life insurance works and how to shop for a policy can help you find the best coverage to meet your family's needs.

Life insurance is a contract between an insurance company and a policy owner in which the insurer guarantees to pay a sum of money to one or more named beneficiaries when the insured person dies in exchange for premiums the policyholder pays during their lifetime. The best life insurance companies have good financial strength, a low number of customer complaints, high customer satisfaction, several policy types available, optional riders, and easy application processes.

KEY TAKEAWAYS

  • Life insurance is a legally binding contract that promises a death benefit to the policy owner when the insured person dies.
  • The policyholder must pay a single premium upfront or pay regular premiums over time for the life insurance policy to remain in force,.
  • When the insured person dies, the policy’s named beneficiaries will receive the policy’s face value, or death benefit.
  • Term life insurance policies expire after a certain number of years. Permanent life insurance policies remain active until the insured person dies, stops paying premiums, or surrenders the policy.
  • A life insurance policy is only as good as the financial strength of the life insurance company that issues it.
Life Insurance

Investopedia / Theresa Chiechi

Types of Life Insurance

Many different types of life insurance are available to meet all sorts of consumer needs and preferences. Depending on the short- or long-term needs of the person to be insured (or their family members), the choice of whether to select temporary or permanent life insurance will be a major consideration.

Term life insurance

Term life insurance is designed to last a certain number of years, then end. You choose the term when you take out the policy. Common terms are 10, 20, or 30 years. The best term life insurance policies balance affordability with long-term financial strength.1

  • Decreasing term life insurance is renewable term life insurance with coverage that decreases over the life of the policy at a predetermined rate.
  • Convertible term life insurance allows policyholders to convert a term policy to permanent insurance.
  • Renewable term life insurance provides a quote for the year the policy is purchased. Premiums increase annually at renewal. These plans usually provide the least expensive term insurance in the first year.

Many term life insurance policies allow you to renew the contract on an annual basis once the original term ends. However, since the renewal premiums are based on your current age, the cost can rise steeply each year. A better solution for permanent coverage is to convert your term life insurance policy into a permanent policy. This is not an option on all term life policies, so look for a convertible term policy if this is important to you.

Permanent Life Insurance

Permanent life insurance is more expensive than term, but it stays in force throughout the insured’s entire life unless the policyholder stops paying the premiums or surrenders the policy. Some policies allow for automatic premium loans when a premium payment is overdue.2

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