What Is Life Insurance? [Updated]

Does anyone depend on you financially? Do you have any significant debts? Do you own a business? Do you want to leave an inheritance behind when you pass away? If you answered yes to any of those questions, you might need life insurance.

Definition: What Is Life Insurance?

The purpose of all life insurance is to help provide a secure financial future for your family after you’ve passed away. Many people determine how much coverage is appropriate for them based on the needs approach. This would involve estimating how much money your family would need to help replace your lost income and make debt payments in your absence. It could include one-time expenses, like funeral costs, as well as ongoing expenses after you’re gone.

How Do Life Insurance Plans Work?

A life insurance policy is an agreement between you (the “policyholder”) and the insurance company (the “insurance provider”). It says that if a specific person passes away (the “insured”), while the monthly payments (the “premiums”) are paid-up, the insurer will make a lump sum payment (the “death benefit,” also referred to as the “coverage amount”) to the person or persons of your choosing (the “life insurance beneficiary”).

How Much Does Life Insurance Cost?

That varies based on a number of factors: the kind of life insurance you're looking for, your age, gender, health, whether you smoke, how risky your hobbies are and more. For policies that consider your health when determining the cost to insure you, even something like weight loss can affect your rates. In some cases, you'll need to undergo a health exam to receive a final rate. That said, some insurers may be able to fast-track your application without a health exam. Some kinds of insurance are guaranteed issue, which means they don't take your personal health situation into account. With guaranteed-issue policies, you don't need a health exam. Once you’ve completed the health exam (if required), life insurance underwriters will evaluate your results and determine your rating classification. Essentially, that summarizes how risky it is to insure you. From there, you'll receive your final, confirmed price.

If I Buy a Policy Today and Pass Away Tomorrow...

Then how much of the policy would be paid? For most policies, the answer is one hundred percent, as long as the event leading to your mortality is covered by your policy and the premiums are paid. In some cases, such as with a guaranteed issue life insurance policy, the policy might not pay out if you pass away within the first two or three years. It’s also worth noting that most policies have a contestability period, which is a period of time—usually the first year or two of your coverage, depending on your state—when the insurance agency can investigate and possibly deny claims. That said, as long as you didn’t misrepresent yourself at all on your original insurance application, your beneficiaries would receive the death benefit. There are a number of types of life insurance. Here are a few:

Term Life Insurance

Term life insurance provides a death benefit if you die during a certain time period, or term. If you had a 20-year term policy, you'd be covered for that 20- year span. After that, you'd either need to buy another policy or let your coverage lapse. Often, people choose term life insurance as an affordable way to help protect their loved ones during a specific, high-need time. One of the most common situations is the time frame when they’re raising kids. After 20 years, for example, your kids might be out of the house and your need for life insurance might be lower. Term life insurance is often medically underwritten, which means it may require a physical exam, though a new breed of companies like Fabric are using algorithms to allow some applicants to skip the medical exam. Term life insurance also tends to get more expensive as you age, which is a reason to apply sooner than later. Full disclosure: Fabric offers this kind of life insurance. You can apply online in just five minutes, without ever speaking to an insurance agent.

Accidental Death Insurance

Unintentional injuries are the leading cause of death for Americans 44 and younger. Accidental death insurance is built specifically for that. Accidental death insurance can be affordable. Because this type of insurance generally doesn’t require a medical exam, you can purchase it extremely quickly. While accidental death insurance can be right for some people, some causes of death may not be covered and you should refer to your policy for details.

Whole Life Insurance

Whole life insurance, also called permanent life insurance, offers coverage for your entire life as long as premiums are paid. With this type of insurance, some of the premium you pay goes toward the death benefit, and a portion of your premium goes toward building cash value that can be borrowed against or withdrawn before you pass away. Whole life insurance plans are more expensive and complex than term life insurance, because they can provide lifetime protection and cash accumulation. Certain fees and expenses will reduce the cash value, which can, in turn, affect and even reduce the amount of the benefits.

Universal Life Insurance

This is another form of permanent life insurance. You’ve got more flexibility with universal life insurance to adjust the death benefit without opening a new policy, subject to the terms of the contract. You can also lower your premium payments by paying from the cash value account. If you expect your economic situation to change dramatically, and you think permanent life insurance is your best fit, universal life may give you room to adjust as you go. You can potentially increase your death benefit down the road if you pass medical and other requirements. And if your income drops suddenly (for example, due to unemployment), paying premiums from available cash value funds can help you keep the policy active while you get back on your feet. If coverage is your main concern, though, you may be able to purchase a term life policy with the same or higher death benefit at a lower rate than universal life. If universal life plans appeal to you because you’re worried about eventually not being able to pay premiums, considering options with a lower monthly cost may make sense for you.

Who Might Want Life Insurance?

The first reason, and the main purpose of life insurance, is the death benefit. You’ve likely thought about what would happen to your family if the primary wage-earner were to unexpectedly pass away, whether that’s you or your partner. Purchasing life insurance shouldn’t just be about the lost income of the“breadwinner.” It’s also worth considering how much childcare would cost if a non-earning spouse, who has the responsibility of staying home with children, were to pass away. Another reason to get a policy is because life insurance creates an immediate estate, so to speak. Estate creation can be especially important for young families that are just getting started and don’t have much when it comes to assets.

Which Type of Policy Is Right for Me?

Experts often recommend a coverage amount that's about 10 times your annual salary. (Here's a more detailed rundown on how much life insurance coverage you need.) When you compare life insurance policies, spend some time thinking through your family's financial needs. How will they be impacted if you or your spouse were to suddenly pass away? A solid rule is to read and understand all the information that’s available to you on any type of insurance policy before buying it. If you’re unsure where to start, here are some questions to help get the ball rolling:

• How long should I have insurance coverage?

• Would it make sense to have lifetime coverage?

• Do I need the cash accumulation features of a whole life policy?

• Am I willing to take a medical exam?

Then, down the road, when you're assessing a specific policy, there are a few more questions you might ask. These include:

• Are there any limitations and/or exclusions in this plan? If so, what are they?

• What happens if I miss a payment?

• How long is the coverage term, and what's the coverage amount?

• Do I need to take a medical exam?

At the end of the day, you need the right kind of coverage for your life.

Fabric exists to help young families master their money. Our articles abide by strict editorial standards.

Information provided is general and educational in nature, is not financial advice, and all products or services discussed may not be offered by Fabric by Gerber Life  (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Consult an attorney or tax advisor regarding your specific legal or tax situation. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. The views and opinions of third-party content providers are solely those of the author and not Fabric by Gerber Life.