How does Life Insurance Works
There are three parties involved in a life insurance transaction: the insured, the insurer, and the policy owner, however the owner and the insured are normally the same person i.e. if Rob Smythe buys a policy on his own life, he is both the owner and the insured. On the other hand if Sarah Smythe, his wife, buys a policy on Rob's life, he is the insured but she is the owner of the policy .
Another person that is involved is the beneficiary. The beneficiary is the person/persons who will receive the policy proceeds upon the death of the insured. The beneficiary is not a party in the policy, but is designated by the owner of the policy, who may change the beneficiary unless the policy has an irrevocable beneficiary designation. Irrevocable beneficiaryis when a beneficiary must agree to changes in beneficiary, policy assignment, or borrowing of cash value.
Like all insurance policies, a life insurance policy is a legal contract specifying the terms and conditions of the risk assumed. Special provisions can apply, such as including a suicide clause wherein the policy will become null if the insured commits suicide within a specified time. Any misrepresentation by the owner/insured on the application is also a grounds for nullification.
The face amount of the policy is usually the amount paid when the policy matures, although some policies can provide for greater or lesser amounts. The policy matures when the insured dies or when they reach a specified age. The common reason to buy a life insurance policy is to protect the financial interests of the owner, in the event of the insurer's death. The insurance proceeds would pay for death costs or could be invested to provide income replacing the deceased's wages.
The insurer (i.e., the insurance company) prices the policies with the intent to recover claims to be paid and administrative costs, and also to make a profit.
Claims to be paid are determined by actuaries using mortality tables. Actuaries are professionals who use actuarial science which is based in mathematics (primarily probability and statistics). Mortality tables are statistically based tables showing average life expectancies. Usually, the three considerations in a mortality table are age, gender, and tobacco use.
Insurance companies receive premiums from policy owners and invests them, they use the time value of money and compound return principles to create a pool of money from which claims can be paid. Therefore, rates charged for life insurance are sensitive to the insurer's age due to the insurer having less premium dollars to invest and less time to invest them for an older person.
Since adverse selection can have a negative impact upon the financial results of the insurer, the insurer will investigate each insured (unless the policy is below a company-established de minimis amount) beginning with the application, which becomes part of the policy.
This investigation and the resulting evaluation of the risk is called underwriting. Health and life style questions are asked, answered, and recorded. Certain responses will be given further investigation. Life insurance companies support The Medical Information Bureau, this is a clearinghouse of medical information on all persons who ever apply for life insurance. As part of the application, the insurer receives permission to obtain information from the insurer's physicians.
Life insurance companies are not required by law to underwrite coverage on anyone. They alone determine insurability, and some people, for their own health or lifestyle reasons, are uninsurable. The policy can be declined or rated. Rating refers to when premiums are increased to provide for additional risks relative to that particular insured discovered in the underwriting process.
Upon the death of the insured, the insured will require acceptable proof of death before paying the claim. The normal the minimum amount of proof is a death certificate and the insurer's claim form completed, signed. If the insurer's death was deemed suspicious and the policy amount warrants it, the insurer may investigate the claim further until it is assured the policy should be paid.
Proceeds from the policy can be paid in a lump sum or paid over time as regular payments for either for the life of a specified person or a specified time period.
About the different types of Life Insurance
Life insurance may be divided into two basic classes -term and permanent.
Term
Term life insurance coverage provides insurance for a specified term of years for a specific premium. The policy does not accumulate cash value. Term is generally considered "pure" insurance, where the premium buys protection only in the event of death.
There are three key factors to be considered in term insurance, they are: the face amount, the premium to be paid, and length of the coverage.
Numerous insurance companies sell term insurance and there are different combinations of these three parameters. The face amount can remain constant or can decline. The term can be for one or more years. The premium can remain level or increase over time. A common type of term is refered to as annual renewable term. It is a one year policy but the insurance company guarantees it will issue a policy of equal or lesser amount without regard to the insurability of the insured and with a premium set for the insurer's age at that time. Another type of term insurance is mortgage insurance, this is usually a level premium, declining face value policy. The face amount is intended to be equal the amount of the mortgage on the policy owner's residence so the mortgage can be paid if the insured dies.
Guaranteed renewability is an important policy feature for any prospective owner/insured to consider because it will allow the insured to acquire life insurance even if they become uninsurable.
For more information on permanent term insurance companies click here
Permanent
Permanent life insurance is life insurance that will remain in force until the policy matures, this is unless the owner fails to pay the premiums. The policy cannot be cancelled by the insurer for any reason except fraud in the application, and this must occur within a period of time defined by law (commonly two years). Permanent insurance builds cash value and provides a type of savings account that the policy owner can access if needed either by borrowing against the policy or surrendering the policy and receiving the surrender value.
The three basic types of permanent insurance are universal life, whole life and endowment
For more information on permanent life insurance companies click here
Whole
Whole life insurance provides for a level premium, a set face amount, and a cash value table included in the policy guaranteed by the company. The main advantages of whole life are guaranteed cash values, guaranteed death benefits, fixed and known annual premiums, and mortality and expense charges will not reduce the cash value in the policy. The main disadvantages of whole life are premium inflexibility, cash value accessibility is limited, death benefit inflexibility, and the internal rate of return in the policy might not be competitive in with other savings alternatives.
For more information on whole life insurance companies click here
Universal
Universal life insurance is a fairly new insurance product with the intention of providing permanent insurance coverage with greater flexibility in premium payment and has the potential for a higher internal rate of return. A universal life policy will include a cash account. Premiums increase the cash account. Interest is paid within the policy on the account at a rate specified by the company. This rate has a guaranteed minimum but usually is higher than that minimum. Mortality charges and administrative costs are charged against the cash account. The surrender value of the policy is the amount remaining in the cash account less applicable surrender charges, if any.
The universal life policy addresses the disadvantages of whole life. Premiums are flexible. The internal rate of return is usually higher due to it moving with the financial markets. Mortality costs and administrative charges are known. And cash value can be considered more easily attainable because the owner can discontinue premiums if the cash value allows it. Universal life also has a more flexible death benefit because the owner can select one of two death benefit options that are availlable. Option 1 pays the face amount at death and Option 2 pays the face amount plus the cash value.
However, universal life does have its own disadvantages which mainly are caused from this flexibility. The policy lacks the guarantee that the policy will be in force unless sufficient premiums have been paid and cash values are not guaranteed.
A type of universal life is called variable universal life. The rate of return on the cash account is related to stock or bond market fluctuations.
Limited-pay
Another type of permanent insurance is Limited-pay life insurance, this is where all the premiums are paid over a specified period after which no additional premiums are due to keep the policy in force. The most common type of limited pay is twenty-year limited pay. Another type is paid-up when the insured is sixty-five.
Endowments
Endowments are policies which mature or endow before the normal endowment age. Endowments are more expensive in regard to the annual premiums than either universal life or whole life because the premium paying period in shortened and the endowment date is earlier. Annuities are a financial product issued by life insurance companies but are not life insurance policies. They are discussed in annuities.
For more information on endowment companies click here
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