Life Insurance
Life insurance is pretty easy to understand, it is not intended to really benefit the person that has the coverage because life insurance only pays out if the person covered dies. The people that benefit are the beneficiaries.
Life insurance is based on dollar amount which has been purchased and paid for, normally with annual payments but there are a number of options. The amount of the life insurance has no bearing on reality, it only has a bearing on how much you want to buy and will pay for. As with everything else, greater coverage has a greater cost.
If you buy a $100,000 term life policy then your death will result in someone being paid $100,000 assuming that all of the terms have been fulfilled. A term policy is designed to provide a fixed amount of coverage for a specific period of time or there is a termination to the coverage. Other types of policy have continuing coverage options and many will build up value over time.
The idea of life insurance is simple, provide a means to provide financial assistance to others if you die, unexpectedly. Let's consider a couple of examples. First, a parent, with spouse and children is the sole financial provider for the family. What happens to the future plans of the family if the parent dies? Without insurance, the financial plans will normally fall apart, however, insurance provides options. Insurance will pay out to the survivors after a death, often paying off the home and providing money for college education or other options. While a death will change the family, there is an opportunity for life to go on for the rest of the family.
Second, a business is made up of two partners, both providing value to the organization. If either partner dies, then the business would be in serious trouble. The way to protect the business is to provide life insurance on both partners so the business is protected from loss.
The most important concept to remember with life insurance is that the value of the insurance is not provided to the person covered by the policy but to others and there are no restrictions as to who can benefit. The beneficiary does not need to be related, a business associate or a close friend. At the time the policy was put in place, the insured and the beneficiary simply needed to have some dependency or relationship. Assume that a wife takes out a policy on her husband, they divorce but she continues to pay the premiums. When he dies, she would be the beneficiary of the policy payout. The policy needs two parts, first, an insurable interest in the insured, and, second, the payment of the premiums.
Proof of this is the recent advertisements where you can sell any insurance policies you have to a company that is simply gambling on you dying in a reasonable period of time. The company that purchases the policy does not need to have an insurable interest because that was established when the policy was implemented. This new company simply needs to make sure that the premiums are paid and then wait for the eventual demise of the insured. So, what actually happens? The buying company does a calculation to estimate the balance of the insureds life span, then they do a calculation on the present value of the of the payout at a reduced percentage and that is what they will pay for the policy, kinda creepy if you ask, but there must be money to be made and it appears there are no limits.
Okay, now that ghoulish part of the discussion is over, let's talk life insurance. There are two big groups of life insurance: term life and other options. By this, you should understand that the insurance industry is like every other group that wants to sell something, in that they will develop something different if there is a need.
Term Life Insurance is the easiest to understand because you pay a fixed premium for a fixed period of time and you have coverage of a fixed amount for that fixed period of time. If you don't pay the premium, then the policy is cancelled and you lose the coverage, however, during the life of the policy it doesn't build up any value, so there is no loss at termination, unless you just like having a policy and then you can get another one. Now these are rules, the policy premium is based on several factors like the amount of the coverage and your age at the time the policy is purchased. You need to understand how the insurance company figures out your premium, it is very simple. When you are young, the chances of you dying are slim and since the Term Life Insurance will only last so long, then the insurance company is betting that you will make the payments before you die. Now, they know that others will die during the term of the policy so they will pool all of the premiums and make the payments for the people that die and it balances out.
As you age, the chances of dying go up so the insurance company knows that the odds of getting all of the premium payments keeps dropping as you get older so they increase the amount of the premium because more payouts will be required for this older age group. There are people and all they do is put together tables to support these estimates. Now, while it seems weird, it is critical that it be done. Insurance companies must stay in business and too many payouts would drive the company into bankruptcy, and insurance companies provide a valuable service with the protection they provide at a smaller cost.
Does any of this make sense? Let's put it a different way. Flip the concept of life insurance and you have a lottery. Millions of people buy a ticket at a low price and then they draw the winning numbers. If you have the winning numbers, you get a payout and if you don't, you get nothing and wasted your money (but they trust you play again next week). In order to award large payouts, you need a lot of people putting money into the pool. If you don't have millions playing then your can't award a million dollars as the grand prize every week. Back to the concept of life insurance, if you are the winner, then you died and the payout is going to your family but not everyone that plays can win because there isn't enough money in the pool
The nice thing about Term Life Insurance is that it lasts for a fixed period of time and ends, or you can drop out at any point along the way, but you don't get any money back while not having to pay anymore. Term Life Insurance is cheaper than most life insurance because the coverage is rather limited and the benefits are limited. People get Term Life Insurance when they want coverage for a fixed period of time (waiting for the kids to be 21 years old) or waiting for the house to be paid off (at the end of a 30 year mortgage).
There other forms of life insurance but now you are getting into special features and benefits. Let's discuss just two types. The first is referred to as whole life and is a very simple concept because it lasts as long as you are alive and the premiums are paid. The big difference is that during the life of this policy, the premiums can contribute part of the premiums into a deferred cash value account that is tied to the policy. The premiums on a whole life policy are normally fixed until you get to be 100 years old, so the premiums don't change as you age, but that just means that you age at the time the policy is written will be lower the younger you are. Just like Term Life Insurance, it is all based on how much longer they expect you to live so your goal is to stick around forever and get the last laugh.
The cash value concept of Whole Life Insurance means that there is this dollar amount sitting out there waiting to provide a little help if you need it. Consider, you can take out a loan, from yourself, to get by the hard times and then pay it back restoring the full cash value for the next moment of need. However, the big deal is that this policy just keeps going one, providing coverage year in and year out.
Some companies will provide dividends that add to you cash value, but don't depend on these. The great part of whole life coverage is that if needed and you can't make your payment one time, the insurance company will use the cash value to pay the premiums and then you can repay the policy in the future.
The purpose of this discussion is not to convince you to buy life insurance but to understand how you can mitigate the potential losses that occur in your life and the lives of others. No you can't replace the loss of a loved one but life does not stop for everyone when someone close to you dies, you must go on.
The other life insurance has many of the features of whole life but can act more like a health savings account. As indicated, insurance companies will develop new programs that fill the needs of a growing customer base. The most important point to get from this discussion is to look around, ask questions and understand why you are buying what you need not what someone wants to sell to you.
This is an important consideration when looking for insurance, the agent makes his money by getting a commission for each sale so you must not buy something that someone wants to sell you because it is best for them if it is not best for you.