Understanding Life Insurance Policies

Merriam-Webster defines insurance as “coverage by contract whereby for an agreed payment one party agrees to indemnify or guarantee another against loss by a specified contingency or peril”. In more plain English, insurance is a method of replacing income or assets in the unlikely event that they are rendered unavailable or unusable.

For your particular situation, life insurance has a much more specific definition, namely the ability to provide you and/or your family with an amount of money that is equal to your current active income, should an unforeseen tragedy occur.

Most people have a vague understanding of the concept of life insurance; this is true because, when broken down into its most basic components, it is not a complicated product. Very simply, the idea of life insurance is that the company will collect regular monthly or annual premium payments from a person, and if that customer happens to die then his family will be paid a lump sum of money.

It sounds easy enough, right? Well, it’s not. There are so many different types of life insurance products, each one with its own pros and cons, as well as hundreds of life insurance companies, each one also with its own pros and cons. And let’s not forget that once you figure out the different kinds of life insurance products that are available, you must then figure out how much coverage you need.

When you begin your investigation of life insurance, determining your appropriate amount of coverage is the first step. There are multiple ways of gauging your life insurance need, but I will not explain each one of them in great depth here, as that is the job of your insurance agent. It’s important that you keep in mind there is no right or wrong amount of life insurance. Clients ask me all the time what the right amount of life insurance is, and I explain to them that there is no such thing. As long as you can sleep well at night knowing what kind of situation your family will be in if you simply don’t wake up, then that is the right amount of coverage for you.

The most common type of life insurance is term insurance. These policies are usually relatively inexpensive when compared to permanent policies, and are extremely simple. Term insurance is considered “pure” insurance, meaning that it does nothing more than protect an asset for a certain period of time.

Think of the word term as being short for terminate. The function of a term insurance policy is to provide a death benefit for a specified period of time. When you purchase one of these policies, you select the duration of the coverage, typically between ten and thirty years. The policy provides a death benefit for that number of years, during which your premium payments should stay level. Simply, you agree to pay the insurance company every year for the entire term, and they agree to provide coverage during that term. At the end of the term, your coverage will essentially expire.

Permanent insurance is designed to provide coverage for the policyholder forever. Of course, forever to a life insurance company is usually between 95 and 100-years-old. Again, the policy should be designed to keep premium payments level for the rest of your life, and as long as those payments are made the coverage should remain in force.

However, the manner in which life insurance companies provide a level premium for a permanent policy results in a certain amount of equity that accumulates inside the contract. This equity is referred to as cash value or policy value, and presents the policyholder with certain unique options with regard to how that equity is handled. More specific information, as well as a detailed description of the different permanent life insurance policies that exist, should be obtained from a licensed professional insurance agent.