How does life insurance work?

There are many things that you need to consider when thinking about Life Insurance. But one thing you need to remember if you haven’t yet taken out a Life Insurance policy, is that it might be the best protection you can buy for your family. 

Even though many people already have Life Insurance, not a great many people understand exactly how it works, what the differences are between all the different types of Life Insurance policies and plans, and which might be the best plan to go for.

When a policy owner passes away, it is down to the family of the deceased to get in touch with the insurance company. They will need to make a claim on your behalf in order to get the money. The amount of time it takes for a claim to be investigated and paid out varies but it usually takes somewhere between a couple of weeks to a couple of months for the funds to be released.

In this article, we look in detail at how Life Insurance works.

What is Life Insurance?

Life insurance is a contract between the insurance provider and the insurance policyholder in which the former provides the latter with a fixed amount of money upon the death of that person, in exchange for the payment of premiums to purchase the policy. Depending on the type of plan you have, those premiums may be paid monthly for the life of the policy, or in single lump sums.

In some cases, illness cover can also be included in the plan to provide protection in the event of a diagnosis of a terminal disease, and Life Insurance can sometimes also include cover for funeral costs. 

Categories of Life Insurances

Life insurance is divided into two main categories, known as a Term Life Insurance and Permanent Life Insurance.

Term Life Insurance

Term Life Insurance lasts for a fixed period of time, often 10, 20 or 30 years, depending on the age and health of the person taking out the policy and what you wish the policy to cover. Under Term Insurance, the insurance policyholder receives a pay out which goes to their loved ones if they pass away during the term of the contract.  

It has no value at all if you die outside of the time period of the policy. Meaning were you to die even the day after the policy expires, your loved ones would receive no pay out at all from the insurer, even if you paid every single premium. 

Term Life Insurance is ideal if you just want to ensure that your loved ones are able to pay for things like all or part of the mortgage, school or university fees, personal loans and debts, or funeral costs and you know that the period of your life when these things will need to be paid for, is limited. Term Life Insurance has the lowest premiums, which stay fixed throughout the duration of the policy.

Permanent Life Insurance

Permanent Insurance tends to cost more but it has additional benefits, the main one being that the policy does not expire at all. The main feature of this is that your loved ones will receive a pay out whenever you pass away, as it covers you for the whole of your life, irrespective of how old you are when you die. 

Other features of this type of insurance include a death benefit and a cash savings option. It also has the option of a portion of the premium being invested so that the policy builds up a cash value. 

Permanent Life Insurance comes in different varieties including Whole Life, Universal Life, Index-Universal Life, Variable Life and Variable-Universal Life. 

The initial premiums for Permanent Life Insurance are higher than for Term Insurance.

Other Types of Life Insurance

In addition to Term and Permanent Life Insurance, there are other types of Life Insurance policies available.

These include –

Critical Illness Insurance

Unplanned situations in life can sometimes leave you in a difficult place financially. If you were to suffer an unexpected illness or suffer a medical emergency, having an insurance policy in place that you know will provide financial cover when you are unable to work can give you considerable peace of mind.

Critical Illness Insurance (sometimes also known as Trauma Insurance) pays out a tax-free lump sum of money in the event that the policyholder suffers from a specific illness or injury.

The illnesses and injuries that are covered by a policy vary according to the specific plan you take out, but usually include heart attacks, strokes and non-terminal cancer, as well as physical disabilities caused by accidents or injuries. 

Income Protection Insurance

This type of insurance is designed to provide financial cover should illness, accident or injury stop you from working for a specific time.

There are usually waiting periods involved so that proper checking by the insurance provider can take place before you become eligible for a pay out and the amount you are paid will depend on the level of cover your plan provides. Typically though, this figure is around 75% of your income.  

Who Does Your Policy Benefit?

Once you have decided what type of policy you wish to take out, you need to make a decision on who the beneficiaries of your policy would be in the event of your death.

As the insurance pay out is designed to help with paying things such as your funeral costs, paying off any mortgages you may have on the family home, or to help take care of children and enable them to go to university or continue living a standard of life that they are used to presently. The recipients of a life insurance policy are almost always spouses or partners and children, but it can be whomever you choose.

When Should You Get Life Insurance?

Everyone’s personal circumstances are unique. Whether you should take out Life Insurance, and if so, what type of Life Insurance, will depend greatly on these circumstances.

For example, if you are single without any dependents, then there is unlikely to be any need for you to purchase a policy right now.  Those who have children or other dependents however, have a much greater need for Life Insurance as you need to consider how those dependents would be looked after financially should anything happen to you. 

Similarly, if you have a partner and you share a home and expenses, it makes sense to purchase a Life Insurance policy as they would struggle significantly if you were to die or become incapacitated. 

How Much Cover Do You Need?

This is a very important question to ask yourself and should be carefully considered before you apply for a policy.

Think about how many dependents you have, and for how many years they will remain dependent on you.  Also consider the lifestyle your family has, how much mortgage you have left to pay and your other outgoings. What is your average spending per month and what could you cut back on if you needed to? What, on the other hand, could you definitely not cut back on? What expenses can you see coming up in the future, such as school or university fees, weddings or your partner stopping work?

Cost of Life Insurance

The cost of the insurance policy you have will depend on various factors, but the most important thing for an insurance provider is the risk you pose them. The amount you will be asked to pay in premiums will be determined by the likelihood of you dying or becoming critically injured either at some point during the term if you are purchasing Term Insurance, or early on in the life of the policy if you are buying Permanent Life Insurance.

To make a guess at this likelihood, your insurance provider will look at things like your age, your health and your lifestyle, including whether you are a smoker, how much you drink, whether you travel a lot, and whether you take part in any dangerous hobbies or occupations. Your health history will be taken because the insurance provider will want to know whether you have any genetic issues or existing conditions that make you more likely to become seriously ill. Your gender and professional history also matter.

Once all of these factors are evaluated, then the total price is determined, and a payment structure is constructed for you, to fit with the level of cover you require.

Buying a Life Insurance Policy

The best ways to look for the best deals on insurance are to either get in touch with an independent broker or to do some comparisons of different providers online. 

There are various tools and websites available that let you compare policies so that you can come up with a decision as which contract suits your requirements and your budget. Make sure you enter the correct details to get an accurate quote though.

Using a broker can be a good idea however if you are not sure which type of policy you should be going for in your particular set of circumstances or you are not sure how to answer the questions that determine how much and what type of cover you need. In these cases, it’s best to talk through your particular concerns with a broker who can guide you through the options and help you find the right type of policy for you. 

Only when you are satisfied with everything and you are sure you have given a full and accurate disclosure of all the relevant information should you submit your application. It will then be reviewed by the insurance provider and you will receive an acceptance within a few days if all the documentation is correct.

How Life Insurance Works When You Pass Away

When a policy owner passes away, it is down to the family of the deceased to get in touch with the insurance company. They will need to make a claim on your behalf in order to get the money. The amount of time it takes for a claim to be investigated and paid out varies but it usually takes somewhere between a couple of weeks to a couple of months for the funds to be released. 

Below are the stages the claim will go through:

  1. Notification: The heirs of the insurance holder contact that insurance company with the details of what has happened; such as the accident details, injury or death details, and you will need to provide them with all the required information such as the policy number, phone number, address, cause of death or injury and the accurate dates.
  1. Forms: The insurance company then provides the named beneficiaries of the policy with the forms to complete to make their claim. These need to be signed.
  1. Documentation: Once the claimant has filled in the forms, they have to find the required documents that have been asked for which can include the death certificate, financial records, medical reports and prescriptions or accident reports.
  1. Assessment: The insurance company will then take all the forms and evaluate the circumstances related to the accident or death. This can be a long process if the circumstances are complex or not clear, but usually does not take more than a couple of weeks.
  1. Decision: Once the assessment process is completed then the insurance provider will let the claimant know if their claim has been accepted or rejected. They may need further data to verify the request or need more time to make a decision.
  1. Payment claim: After a successful decision by the provider they will make the payment via a cheque or online money transfer.

After the Pay-out

Once you have received the payment from the insurance provider, then the policy will effectively end because the contract would have been fulfilled. But there are a few things that still need attention, and some of them are discussed below.

An Income Protection Policy is a type of policy which will keep on paying until such a time as the policyholder returns to work. Once you have started working again, then you would need to begin making premium payments again to the insurance provider in order for the policy to remain in place. In a situation when a person returns to work but is not able to work at the same level as before then they can also make a disability claim. Insurance providers usually remove the condition of the waiting period in such a situation and this is known as recurrent disability benefit.

If you still have questions about the type and level of cover you require then speak to an independent insurance broker who will be able to determine the best provision for your circumstances and budget.

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