Loading the player...

What is 'Life Insurance'

Life insurance is a protection against financial loss that would result from the premature death of an insured. The named beneficiary receives the proceeds and is thereby safeguarded from the financial impact of the death of the insured. The death benefit is paid by a life insurer in consideration for premium payments made by the insured.

BREAKING DOWN 'Life Insurance'

The goal of life insurance is to provide a measure of financial security for your family after you die. So, before purchasing a life insurance policy, consider your financial situation and the standard of living you want to maintain for your dependents or survivors. For example, who will be responsible for your funeral costs and final medical bills? Would your family have to relocate? Will there be adequate funds for future or ongoing expenses such as daycare, mortgage payments and college? It is prudent to re-evaluate your life insurance policies annually or when you experience a major life event like marriage, divorce, the birth or adoption of a child, or purchase of a major item such as a house or business.

How Life Insurance Works

Life insurance is a contract between an individual with an insurable interest and a life insurance company to transfer the financial risk of a premature death to the insurer in exchange for a specified amount of premium. The three main components of the life insurance contract are a death benefit, a premium payment and, in the case of permanent life insurance, a cash value account.

Death Benefit: The death benefit is the amount of money the insured’s beneficiaries will receive from the insurer upon the death of the insured. Although the death benefit amount is determined by the insured, the insurer must determine whether there is an insurable interest and whether the insured can qualify for the coverage based on its underwriting requirements.

Premium Payment: Using actuarially based statistics, the insurer determines the amount of premium it needs to cover mortality costs. Factors such as the insured’s age, personal and family medical history, and lifestyle are the main risk determinants. As long as the insured pays the premium as agreed, the insurer remains obligated to pay the death benefit. For term policies, the premium amount includes the cost of insurance. For permanent policies, the premium amount includes the cost of insurance plus an amount that is deposited to a cash value account.

Cash Value: Permanent life insurance includes a cash value component which serves two purposes. It is a savings account that allows the insured to accumulate capital that can become a living benefit. The capital accumulates on a tax-deferred basis and can be used for any purpose while the insured is alive. It is also used by the insurer to mitigate its risk. As the cash value accumulates, the amount the insurer is at risk for the entire death benefit decreases, which is how it is able to charge a fixed, level premium.

RELATED TERMS
  1. Universal Life Insurance

    A type of flexible permanent life insurance offering the low-cost ...
  2. Guaranteed Issue Life Insurance ...

    A type of financial-protection policy that provides cash to a ...
  3. Key Person Insurance

    A life insurance policy that a company purchases on a key executive's ...
  4. Annual Renewable Term (ART) Insurance

    A form of term life insurance that offers a guarantee of future ...
  5. Term Life Insurance

    A policy with a set duration limit on the coverage period instead ...
  6. Insurance Industry ETF

    A sector-following fund that invests primarily in insurance companies, ...
Related Articles
  1. Financial Advisor

    Permanent Life Policies: Whole Vs. Universal

    If you're looking for life-long security, choosing between these two is the key.
  2. Financial Advisor

    Getting Life Insurance in Your 20s Pays Off

    Find out how Americans in their 20s can benefit from a well-thought-out life insurance policy, especially if they are able to build cash value for retirement.
  3. Financial Advisor

    Why the Wealthy Should Buy Lots of Life Insurance

    Wealthy clients have an enviable problem — managing, preserving and growing wealth. Properly structured life insurance can help with these goals.
  4. Financial Advisor

    Buying a Life Insurance Policy? Read This First

    Knowing who needs life insurance, how it works and the different types of insurance can help consumers make informed decisions about this product.
  5. Insurance

    4 Things That Keep You From Getting Life Insurance

    We look at four common reasons people give for not applying for life insurance, and see if they're legitimate.
Hot Definitions
  1. Forward Contract

    A customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract ...
  2. Leveraged Buyout - LBO

    The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. ...
  3. Current Assets

    A balance sheet account that represents the value of all assets that can reasonably expected to be converted into cash within ...
  4. Tax Liability

    The total amount of tax that an entity is legally obligated to pay to an authority as the result of the occurrence of a taxable ...
  5. Preferred Stock

    A class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares ...
  6. Net Profit Margin

    Net Margin is the ratio of net profits to revenues for a company or business segment - typically expressed as a percentage ...
Trading Center