Life Insurance: What It Is, How It Works, and How To Buy a Policy
What Is Life Insurance?
Life insurance is a contract between a life insurance company and a policy owner. A life insurance policy guarantees the insurer pays a sum of money to one or more named beneficiaries when the insured person dies in exchange for premiums paid by the policyholder during their lifetime. Life insurance is a legally binding contract that pays a death benefit to the policy owner when the insured person dies. For a life insurance policy to remain in force, the policyholder must pay a single premium upfront or pay regular premiums over time. When the insured person dies, the policy’s named beneficiaries will receive the policy’s face value, or death benefit.
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Term life insurance policies expire after a certain number of years. Permanent life insurance policies remain active until the insured dies, stops paying premiums, or surrenders the policy. A life insurance policy is only as good as the financial strength of the company that issues it. State guaranty funds may pay claims if the issuer can’t.
Types of Life Insurance Many different types of life insurance are available to meet all sorts of needs and preferences. Depending on the short- or long-term needs of the person to be insured, the major choice of whether to select temporary or permanent life insurance is important to consider. 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. Decreasing term life insurance is renewable term life insurance with coverage decreasing 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 and are usually the least expensive term insurance in the beginning.
Many term life insurance policies allow you to renew the contract on an annual basis once the term is up. This is one way to extend your life insurance coverage but since the renewal rate is based on your current age, premiums can rise precipitously 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; look for a convertible term policy if this is important to you. Permanent Life Insurance Permanent life insurance stays in force for the insured’s entire life unless the policyholder stops paying the premiums or surrenders the policy. It’s more expensive than term. CONTENTS INSURANCE LIFE INSURANCE Life Insurance: What It Is, How It Works, and How To Buy a Policy By AMY FONTINELLE Updated April 29, 2023 Reviewed by ANTHONY BATTLE Life Insurance Investopedia / Theresa Chiechi
What Is Life Insurance? Life insurance is a contract between a life insurance company and a policy owner. A life insurance policy guarantees the insurer pays a sum of money to one or more named beneficiaries when the insured person dies in exchange for premiums paid by the policyholder during their lifetime. KEY TAKEAWAYS Life insurance is a legally binding contract that pays a death benefit to the policy owner when the insured person dies. For a life insurance policy to remain in force, the policyholder must pay a single premium upfront or pay regular premiums over time. 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 dies, stops paying premiums, or surrenders the policy. A life insurance policy is only as good as the financial strength of the company that issues it. State guaranty funds may pay claims if the issuer can’t. Watch Now: What Is Life Insurance? Types of Life Insurance Many different types of life insurance are available to meet all sorts of needs and preferences. Depending on the short- or long-term needs of the person to be insured, the major choice of whether to select temporary or permanent life insurance is important to consider. 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. Decreasing term life insurance is renewable term life insurance with coverage decreasing 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 and are usually the least expensive term insurance in the beginning. Many term life insurance policies allow you to renew the contract on an annual basis once the term is up. This is one way to extend your life insurance coverage but since the renewal rate is based on your current age, premiums can rise precipitously 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; look for a convertible term policy if this is important to you. Permanent Life Insurance Permanent life insurance stays in force for the insured’s entire life unless the policyholder stops paying the premiums or surrenders the policy. It’s more expensive than term. Whole life insurance is a type of permanent life insurance. It accumulates a cash value in order to last the lifetime of the insured person. Cash-value life insurance also allows the policyholder to use the cash value for many purposes, such as a source of loans or cash or to pay policy premiums. Universal life (UL) insurance is a type of permanent life insurance with a cash value component that earns interest. Universal life features flexible premiums. Unlike term and whole life, the premiums can be adjusted over time and designed with a level death benefit or an increasing death benefit. Indexed universal life (IUL) is a type of universal life insurance that lets the policyholder earn a fixed or equity-indexed rate of return on the cash value component. Variable universal life (VUL) insurance allows the policyholder to invest the policy’s cash value in an available separate account. It also has flexible premiums and can be designed with a level death benefit or an increasing death benefit.