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Last updated on Sep 02, 2020

What Is Life Insurance?

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No matter the stage of life you’re in, you’ve probably at least heard about life insurance. Maybe you’re wondering, “What is life insurance?” or “What does life insurance cover?” or “Do you need life insurance?”

Life Insurance’s definition is an agreement between you (the policyholder) and a life insurance company (the insurer) where the latter agrees to pay a predetermined sum of money to your loved ones (beneficiaries) when you pass or after other agreed-upon criteria are met. In return for this agreement, you’ll pay a monthly amount of money (a premium) to keep your policy active.

There are many different types of life insurance and a multitude of different ways that you can adjust a policy to meet your exact needs. There is also a wide variety of life insurance companies to choose the right coverage for you and your family.

Why Buy Life Insurance?

People purchase life insurance policies for a multitude of different reasons. The overarching reason, though, is almost always driven by a desire to make adequate preparations for your loved ones in case of your absence.

  • Parents who are the primary source of income may want to get life insurance. The money can be set up to help cover the costs of raising their children in their absence.
  • People who don’t want to leave the financial burdens of debt and burial expenses may want to look into life insurance policy types that help prepare for these types of expenses.
  • Maintaining the quality of life for your loved ones can be a reason to look into life insurance, especially if you’re the primary source of income.
  • Some insurance policy types create a cash value that you may be able to utilize like a savings account while you’re still alive.
  • If you want to pass on an inheritance to your dependents, a life insurance policy can help even if you don’t have any other financial or physical assets to pass on.

How Does Life Insurance Work?

Life insurance can seem confusing when you first start looking into it. There are plenty of different types of policies and a lot of industry jargon that may leave you confused. By understanding what life insurance terms actually mean, you can have a better idea of what you’re potentially investing in.  

  • Policy – This term refers to the contract you sign that details all of the conditions of your life insurance agreement.
  • Beneficiary – This is the person or persons who will receive money if the conditions for payouts are met.
  • Death Benefit – This refers to the specific benefits that are paid out if the person who owns the policy passes away.
  • Rider – A rider is an add-on that increases or alters coverage to an insurance policy.
  • Premium – This is the monthly amount of money you have to pay in return for your policy.
  • Lapse – When you fail to make your insurance premium payments, it is said that you have lapsed in coverage.
  • Grace Period – Some policies give a period of time that the policy is still active after a missed or failed payment.
  • Insured – This refers to the person who is covered by the life insurance policy.
  • Insurer – The insurer is the company that is offering benefits to the insured.

Life Insurance Policy Types

Term Life Insurance

One of the most common policy types is term life insurance. This policy offers coverage for a set number of years. If the criteria for benefits is not met by the time the policy ends, then it expires, and no benefits are paid out. Term life insurance policies are best for people who only need coverage for a fixed period of time, like maybe until another asset becomes liquid or until their kids are out of school.

Whole Life Insurance

The opposite of term life insurance is whole life insurance. With this type of policy, as long as you continue paying your premiums, you will continue to receive benefits if the policyholder passes. Additionally, whole life insurance policies have a cash value that is drawn from a portion of your monthly premiums. Whole life insurance is best for people that want their loved ones covered indefinitely and also may want to build a tangible asset in the process.

Final Expense Insurance

Usually, a much less expensive policy is final expense insurance. This type of life insurance covers all of the expenses associated with your passing. Generally, it includes things like funeral costs, cremation costs or some medical costs. This type of policy is ideal for people who don’t want to (or need to) pay for a full-fledged life insurance plan but still want to cover the cost of their final expenses.

Universal Life Insurance

Similar to whole life insurance, universal life insurance policies carry on as long as you pay your premiums. The policies also carry a cash value. However, the difference is that universal life insurance allows you to change your premium and benefits without the need to get a new policy. This type of policy is good for people who are worried they might not be able to meet their premiums in the future.

Variable Life Insurance

Variable life insurance policies carry a cash value like whole and universal life insurance. However, instead of the money sitting idle, the money is invested in mutual funds and similar investments. While this can help to increase the cash value of the policy, it also opens you up to risk (you can lose money). Ideally, this type of policy is only good for people who are in a position to take on more risk.

Learn more: Term Life Insurance vs. Whole Life Insurance,

Life Insurance Riders

A life insurance rider is a fancy term that means an add-on to your policy. When you want to customize a life insurance policy to include additional words or benefits, you get a rider. Riders are not required but come in many different shapes and sizes to offer you the ideal coverage you’re looking for. As riders generally increase the level of coverage you’re getting, they do also increase the cost of your premiums.

  • Accidental Death Rider – With this insurance rider, the beneficiaries are paid extra when the cause of death is accidental. These riders are good for people who want extra coverage for the unexpected.
  • Spouse Insurance Rider – Instead of getting your spouse a separate policy, you may be able to add them to your policy with a spouse insurance rider. Ideally, this would be best for dual-income households.
  • Child Insurance Rider – While sad to think about, a child insurance rider offers benefits in case your child passes. The money can be used to cover the expenses that come when someone passes.
  • Waiver of Premium Rider – With this rider, you can get your premiums completely waived if you become permanently disabled or meet a certain list of criteria outlined by the rider. While no one expects this to happen, it could be something to consider if you work a hazardous job or if your family has a hereditary history of debilitating conditions.

Shopping for the Right Life Insurance Policy

You have a lot of factors that you need to consider when you’re shopping for the right type of life insurance policy. First, you need to look at what types of coverage are available and how much coverage you need to fill the gaps that may be left if you pass. Second, you need to determine how much you’re comfortable paying to maintain coverage. Getting the perfect life insurance policy is about managing risks and costs in a way that best protects your loved ones.

How much life insurance do you need?

The best way to determine how much life insurance you need is to look at what financially will be missing if you should pass. It’s a somber topic, but by taking a realistic look, you can ensure protection for your loved ones down the road.

Additionally, you should look at the capabilities of your loved ones to fill any of these financial gaps on their own. For example, is your spouse able to work? Are your kids old enough to care for themselves?

The exact answer to how much life insurance you need is highly determined case by case.

Getting approval for coverage

Insurance companies have the right to choose who they are willing to insure. If the company feels the risk is not worth the reward, you may be denied coverage. Some of the more common reasons you may not get approval for coverage include health problems, higher levels of alcohol consumption, a bad driving record, recreational drug use, lack of income or having a hazardous occupation.

Learn more: Top Life Insurance Companies and Ratings

Other Uses for Life Insurance

Life insurance may also be able to be used for other reasons than just protecting your loved ones when you pass. With certain riders and policy types, you can set up your policy as a savings-type account, enjoy benefits while you’re still alive or deliver protection for other situations than just your passing. Be sure when considering these alternate uses that you understand all of the details, parameters of coverage and any tax implications

About the Authors

Jason Lee is a U.S.-based freelance writer with a passion for writing about dating, banking, tech, personal growth, food and personal finance. As a business owner, relationship strategist, and officer in the U.S. military, Jason enjoys sharing his unique knowledge base and skill sets with the rest of the world.