What is life insurance, and how does it work?

Ask most people what life insurance is, and they’ll tell you it’s a policy you buy that pays money to your family if you pass away. Ask them to explain key policy features, the different kinds of policies available, how they work – and they’ll probably try to change the subject.

But if you’re looking for life insurance those things are important. This article will help answer your questions – specifically:

  • What are the key features of a life insurance policy?
  • How do different kinds of life insurance policies work?
  • What are the benefits of life insurance at different stages of life?
  • FAQs about life insurance

Each life insurance policy is different, and each state’s laws regulating insurance policies are different. Before purchasing a life insurance policy, you should consult with a life insurance professional. It may also be a good idea to consult with your legal or tax advisor. The information provided below is general guidance only and should not be relied on in connection with any specific policy.

 

What is a life insurance policy, and what are its key features?

A life insurance policy is an agreement between an insurance company and a person (or legal entity). Each life insurance policy is different, and each state’s laws regulating insurance policies are different. In general, most insurance policies identify the following:

  • The insurer: Only certain companies can provide life insurance, and these companies are regulated by state insurance departments.
  • The policyholder: The person or entity (such as a family trust or a business) which owns (or “holds”) the policy. The policy can insure the holder, or it can insure another person.
  • The insured: The person whose life is insured.
  • The death benefit: The amount the insurer will pay when the insured passes away.1
  • The beneficiaries: The people or entities that will receive the death benefit. It can all go to a single person (e.g., a surviving spouse) or it can be divided by percentage among many different people and entities (e.g., three children could each get 30% and 10% could go to a charity).
  • The policy length: The time period that the insurer agrees to pay a death benefit. This can be a specific term (e.g., 10 or 20 years) or it can be permanent – a policy that lasts for the life of the insured for as long as premiums are paid.
  • The premium: The monthly or yearly payments needed to keep the policy in effect.
  • The cash value: Permanent life policies, like whole life insurance, have a cash value component that builds over time2 and can be cashed out or borrowed against.3 A term policy has no cash value.
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