Life insurance is a contract between you and an insurer that pays out a sum of money upon your death to those you designate as beneficiaries. You, the policyholder, pay life insurance premiums in exchange for the coverage. Life insurance companies invest the premiums they receive from customers, hoping that returns on their investments will yield a profit before they have to pay out a life insurance claim.
There are two main types of life insurance: term and permanent. The kind of policy you choose depends on how long you want the protection to last and how much you're willing to pay.
Term life insurance covers you for a set period of time, such as 10 or 20 years.
Permanent life insurance covers you for your entire life and has a cash value savings account that you can withdraw or borrow against. For these reasons, a permanent life insurance policy is more expensive than term life insurance.
Within the above two categories, there are different types of policies to choose from. Term, whole and universal life are among the most common.
Term life insurance definition
Term life insurance is a type of life insurance that covers you for a specific number of years. Policy amounts range from the thousands to the millions. The cost of term life insurance is often lower than permanent policies as coverage is valid only for a set period of time. Depending on the policy, you may be able to renew your coverage or convert it to a permanent policy when it expires.
Whole life insurance definition
Whole life insurance is the most common type of permanent life insurance. Coverage lasts your entire life, and the policy’s cash value component issues guaranteed returns while you’re still alive. Premiums for whole life stay the same throughout the length of the policy, and the coverage amount doesn’t change.
Universal life insurance definition
Universal life insurance is a type of permanent coverage with more flexibility than whole life. You can increase your premiums to help boost the policy’s cash value or decrease premiums if the cash value can cover the difference. You can also raise or lower the coverage amount if your insurance needs change. A medical exam may be required to increase coverage.
Understanding life insurance
A life insurance policy can provide a financial safety net for your beneficiaries when you die. For example, your policy’s death benefit can help your beneficiaries pay for:
Household expenses, such as food and clothing.
Final expenses, such as funeral costs.
How are life insurance premiums calculated?
Life insurance premiums are typically based on your life expectancy, which equates to how likely it is the insurer will have to pay out a claim. The higher the chance of paying a claim, the higher the premiums. To estimate your life expectancy, insurers typically use personal information, such as your age, health and family medical history.
Some policies require no medical exam and few to no health questions. However, because the insurer can't estimate your life expectancy as accurately as with an exam, the rates for these types of policies can be high. Be sure to compare life insurance quotes from different companies before selecting a policy.
» MORE: How life insurance works