how life insurance works
a life insurance policy has two main components a death benefit and a premium term life insurance has both two components while permanent or whole life insurance policies also have a cash value component the death benefit or face value is the amount of money the insurance company guarantees to the beneficiaries identified in the policy when the insured dies the insured might be a parent and the beneficiaries might be their children for example the insured will choose the desired face amount based on the beneficiaries estimated future needs the insurance company will determine whether the purchases has an insurable interes in the insured s life the insurer will also decide whether the proposed insured qualifies for the coverage based on the company s underwriting requirements related to age health and any hazardous activities in which the proposed insured participates 6premiums are the money the policyholder pays for insurance the insurer must pay the death benefit when the insured dies if the policyholder pays the premiums as required premiums are determined in part by how likely it is that the insurer will have to pay the policy s death benefit based on the insured s life expectancy factors that influence life expectancy include the insured s age gender medical history occupational hazards and high risk hobbies 6 part of the premium also goes toward the insurance company s operating expenses premiums are higher on policies with larger death benefits for individuals who are at higher risk and on permanent policies that accumulate cash value the cash value of permanent life insurance serves two purposes it is a savings account that the policyholder can use during the life of the insured and the cash accumulates on a tax deferred basis some policies have restrictions on withdrawals depending on how the money is to be used for example the policyholder might take out a loan against the policy s cash value and would pay interest on the loan principal the policyholder can also use the cash value to pay premiums or purchase additional insurance cash value is a living benefit that remains with the insurance company when the insured dies any outstanding loans against the cash value will reduce the policy s death benefit the policy owner and the insured are usually the same person but sometimes they may be different for example a business might buy key person insurance on a crucial employee such as a ceo or an insured might sell their own policy to a third party for cash in a life settlement life insurance riders and policy changesmany insurance companies offer policyholders the option to customize their policies to accommodate their needs riders are the most common way policyholders may modify or change their plans there are many riders but availability depends on the provider the policyholder will typically pay an additional premium for each rider or a fee to exercise the rider though some policies include certain riders in their base premium most permanent life insurance accumulates cash value that the policyholder can borrow against technically you are borrowing money from the insurance company and using your cash value as collateral unlike with other types of loans the policyholder s credit score is not a factor repayment terms can be flexible and the loan interest goes back into the policyholder s cash value account however if you don t pay them back policy loans can reduce your death benefit policies with a cash value or investment component can provide a source of retirement income this opportunity can come with high fees and a lower death benefit so it may only be a good option for individuals who have maxed out other tax advantaged savings and investment accounts the pension maximization strategy described earlier is another way life insurance can fund retirement it s prudent to reevaluate your life insurance needs annually or after significant life events such as divorce marriage the birth or adoption of a child or major purchases such as a house you may need to update the policy s beneficiaries increase your coverage or even reduce your coverage qualifying for life insuranceinsurers evaluate each life insurance applicant on a case by case basis with hundreds of insurers to choose from almost anyone can find an affordable policy that at least partially meets their needs in 2022 there were 912 life insurance and annuity companies in the united states according to the insurance information institute 7on top of that many life insurance companies sell multiple types and sizes of policies and some specialize in meeting specific needs such as policies for people with chronic health conditions there are also brokers who specialize in life insurance and know what different companies offer applicants can work with a broker free of charge to find the insurance they need this means that almost anyone can get some type of life insurance policy if they look hard enough and are willing to pay a high enough price or accept a perhaps less than ideal death benefit insurance is not just for the healthy and wealthy and because the insurance industry is much broader than many consumers realize getting life insurance may be possible and affordable even if previous applications have been denied or quotes have been unaffordable according to industry research firm limra 52 of americans had life insurance in 2023 8in general the younger and healthier you are the easier it will be to qualify for life insurance while the older and less healthy you are the harder it will be certain lifestyle choices such as using tobacco or engaging in risky hobbies such as skydiving also make it harder to qualify or lead to higher rates who needs life insurance you need life insurance if you need to provide security for a spouse children or other family members in the event of your death life insurance death benefits can help beneficiaries pay off a mortgage cover college tuition or help fund retirement permanent life insurance also features a cash value component that builds over time 