What is a Life Insurance Policy?
Life insurance (or commonly life assurance, especially in the Commonwealth) is a contract between an insured (insurance policy holder) and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money (the "benefits") in exchange for a premium, upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness can also trigger payment. The named beneficiary receives the proceeds and is thereby safeguarded from the financial impact of the death of the insured.
The face amount on the policy is the initial amount that the policy will pay at the death of the insured or when the policy matures, although the actual death benefit can provide for greater or lesser than the face amount. The policy matures when the insured dies or reaches a specified age (eg. 90 years old).
Upon the insured's death, the insurer requires acceptable proof of death before it pays the claim. The normal minimum proof required is a death certificate and the insurer's claim form completed, signed (and typically notarized). If the insured's death is suspicious and the policy amount is large, the insurer may investigate the circumstances surrounding the death before deciding whether it has an obligation to pay the claim.
Purpose of Life Insurance
- Estate Protection - to help cover estate taxes
- Childcare - to replace a home-maker's contribution
- Mortgage Protection - to cover your mortgage loan or payments
- Employee Benefits - typically offered as group life insurance through your employer
- Retirement - the savings, cash value build-up or investment opportunity help build a family's net worth or nest egg
- Protect Your Business - to protect a business against the loss of a key employee, known as key man life insurance
Life-based Insurance Policies
Protection policies - Designed to provide a benefit in the event of specified event, typically a lump sum payment. A common form of this design is term insurance.
Photo shows a person filling out a life insurance form.
- Term assurance - Provides life insurance coverage for a specified term of years in exchange for a specified premium. The policy does not accumulate cash value. Term is generally considered "pure" insurance, where the premium buys protection in the event of death and nothing else.
- Investment policies - Where the main objective is to facilitate the growth of capital by regular or single premiums. Common forms (in the US) are whole life, universal life and variable life policies.
- Permanent life insurance - Life insurance that remains in force (in-line) until the policy matures (pays out), unless the owner fails to pay the premium when due (the policy expires OR policies lapse). The policy cannot be canceled by the insurer for any reason except fraud in the application, and that cancellation must occur within a period of time defined by law (usually two years).
- Whole life insurance - Provides for a level premium, and a cash value table included in the policy guaranteed by the company. The primary advantages of whole life are guaranteed death benefits, guaranteed cash values, fixed and known annual premiums, and mortality and expense charges will not reduce the cash value shown in the policy.
- Universal life insurance - (UL) is a relatively new insurance product intended to provide permanent insurance coverage with greater flexibility in premium payment and the potential for greater growth of cash values. There are several types of universal life insurance policies which include "interest sensitive" (also known as "traditional fixed universal life insurance"), variable universal life (VUL), guaranteed death benefit, and equity indexed universal life insurance.
- Limited-pay - Another type of permanent insurance is Limited-pay life insurance, in which all the premiums are paid over a specified period after which no additional premiums are due to keep the policy in force. Common limited pay periods include 10-year, 20-year, and paid-up at age 65.
- Endowments - policies in which the cash value built up inside the policy, equals the death benefit (face amount) at a certain age. The age this commences is known as the endowment age. Endowments are considerably more expensive (in terms of annual premiums) than either whole life or universal life because the premium paying period is shortened and the endowment date is earlier.
- Accidental death - A limited life insurance that is designed to cover the insured when they pass away due to an accident. Accidents include anything from an injury, but do not typically cover any deaths resulting from health problems or suicide. Because they only cover accidents, these policies are much less expensive than other life insurances.
- Single premium whole life - A policy with only one premium which is payable at the time the policy is issued.
- Survivorship life - A whole life policy insuring two lives with the proceeds payable on the second (later) death.
- Joint life insurance - Either a term or permanent policy insuring two or more lives with the proceeds payable on the first death or second death.
- Modified whole life - A whole life policy that charges smaller premiums for a specified period of time after which the premiums increase for the remainder of the policy.
Insurance Policy Nullification
Special provisions may apply, such as suicide clauses wherein the policy becomes null if the insured commits suicide within a specified time (usually two years after the purchase date; some states provide a statutory one-year suicide clause).
Any misrepresentations by the insured on the application is also grounds for nullification.
Most US states specify that the contestable period cannot be longer than two years; only if the insured dies within this period will the insurer have a legal right to contest the claim on the basis of misrepresentation and request additional information before deciding to pay or deny the claim.