Life insurance is a risk-management vehicle designed primarily to protect the financial stability of the insured’s household in the event of the insured’s death. A life insurance policy represents the contract between the insurer and the insured. It is simple in essence but has complex manifestations. Given that the contract between the insured and insurer involves both the policy document and application form, it is important to also understand the inner workings of life insurance. To have a basic understanding of life insurance, one must understand:
1) The role of life insurance in financial planning
2) The principles governing a life insurance policy
3) The underwriting process
4) The types of plans available
1) The role of life insurance in financial planning
Life cover is classified as a protection product designed for both the individual and the household. A life insurance policy may cover a lot more than final expenses. Some life insurance plans even provide other protection products such as health insurance, critical illness cover and disability income. Apart from family protection, life insurance also creates an estate immediately. Estate creation and maintenance are key aspects of financial planning that life insurance contributes to. The concept of life insurance helps to ensure that people do not need huge emergency funds in order to self-insure. Savings and dividends from cash-value life insurance can also be used to satisfy other financial needs and retirement, despite what some “experts” say.
2) The principles governing a life insurance policy
For a life to be to be insured, it must first be considered an insurable risk. The underwriter must be satisfied that death of the insured is reasonably unexpected, definite and capricious. Insurable interest is another key principle. This governs the relationship between the policy owner and the insured. Insurable interest dictates that it must be in the policy owner’s interest that the insured continue living at the time of policy issue.
Unlike general insurance, insurable interest in the life insurance context must only exist at the time of issue of a life policy. A person has an insurable interest in his own life, the life of a dependent under the “legal age”, a spouse and other legal entities where dependence on that entity can be proven.
3) The underwriting process
Underwriting is simply the assessment of risk. A life insurance underwriter would use various factors to determine the risk of accepting an insurance offer from a client. Many cynics feel that the underwriting process is a way for insurers to find an excuse for premiums to be higher or deny insuring higher risks. However, this cynicism is unwarranted. The life underwriter considers factors like age, sex, health history, occupation, financial information (for financial underwriting) and personal habits to assess the risk involved in insuring a life.
The apparent information glut is necessary to ensure that the premium set for a person is proportional to the risk of insuring that person. Life underwriters cannot reverse their decision once the principle of utmost good faith is adhered to. They have standard guidelines and standards to refer to. Since underwriters have one chance to get it right, they must do a comprehensive enough assessment. This is why a life insurance applications and policy documents are so thorough.
4) Types of life insurance policies available
There are a variety of life insurance plans available. The most basic distinction is between term and permanent insurance. Term life plans include renewable term, increasing/ decreasing term, convertible term and refundable term. The periods of coverage may vary between and among the categories of term insurance. Permanent insurance includes Whole Life and Universal Life plans. These are cash value plans that may offer additional supplementary benefits compared to Whole Life. Subcategories exist in both Whole Life and Universal Life plans as well. There are dividend-paying Whole Life and fixed or variable Universal Life policies. Endowment plans and juvenile insurance are additional life plans tailored to specific needs. Clearly, all life insurance plans are not equal.
A basic understanding of all the areas considered in this article would assist in making decisions about life insurance. You can determine when you need it, how much you need and which plan you need once you are aware of all the aforementioned factors. Understanding the life underwriting process could even help you save on life insurance. You would be aware that taking smaller amounts of coverage over time instead of a huge sum assured at once may be a better option if you feel that you may be considered high-risk. Understanding life insurance policies would help you derive maximum value from your acquisition.