A life insurance policy is a legal and binding contract that binds an insurance company to the paying of a death benefit to a beneficiary upon the death of the insured person. The cost of maintaining a functional policy is that the insured or another eligible party pays a cost (called a premium) per year.
Life insurance is based upon the law of large numbers in that the insurance company knows how many people on average are going to die in each given year. The premiums are then charged to the payer of the policy to correspond with the expected death rate, interest rates to be earned on collected premiums, and expenses factored in.
Since not everyone dies in the same year, a statistical balance is achieved so that there is always enough money left over to invest and earn interest once claims are paid. In other words a few of the insured people will die along the way, but far more of the policy holders will continue to live and pay premiums, making the whole process work very well.
Term insurance is a type of life policy that insures a person for a limited time only. The period of time, or term of coverage might be for 10, 15, 20, or 30 years, and then the policy expires. The term policy is relatively inexpensive, and most term policies expire before they are paid as death claims.
Permanent insurance is scheduled to insure an individual to at least age 100, and this form of coverage has a build-up of a cash reserve, or a cash value from within the policy. This is primarily used to offset the increasing mortality risk as an insured person ages, and by having this reserve, the premiums are kept at a level rate of payment.
The cash reserve in the permanent policy is also available to the policy owner as a loan, which will reduce the amount of the death benefit by the amount borrowed, as the cash value is deemed to legally be a portion of the death benefit.
Insurance to cover one’s life in case of premature death has been a very important financial vehicle for the economy for nearly 200 years. It serves to provide needed cash to a family or business at the exact time that it is needed. It replaces income that would have been earned by the deceased and helps to keep families and business intact at a very difficult financial moment.
Choosing the right life insurance policy can be a daunting prospect for some so it’s worth learning as much as possible before signing on the dotted line. Martin Lewis of Money Saving Expert has information on all things financial including life insurance, payment protection insurance, car and home insurance and just about any other type you can think of.