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How Life Insurance Works

Oct. 3, 2017
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Understanding how life insurance works is a solid first step in making the right buying decision.

How life insurance policies work

Life insurance is a contract between you and a life insurance company. You agree to pay for the policy on a regular basis, and the insurer agrees to pay a sum of money to your beneficiaries if you die. Within those parameters are several types of life insurance. Choosing the right type for your goals and budget merits some research.

» MORE: The differences between whole life and term life insurance

You’ll typically have a few options for paying premiums, such as paying every month, twice a year or annually.

Life insurance companies make money by investing the premiums, hoping to make more than they’ll have to pay in claims. They also profit from customers who stop paying for their life insurance, causing the policies to lapse and leaving the insurer with the money that has already been paid.

You’ll designate beneficiaries who will receive the life insurance payout, called a death benefit. This can go toward funeral expenses, mortgage payments or anything else. It’s important to tell your beneficiaries that your life insurance exists. They don’t need the policy in hand to make a claim later, but they do need to know which company holds the policy.

Once beneficiaries submit a life insurance claim, they’ll generally receive the check within a week or two.

» MORE: How to make a life insurance claim

The buying process

You can start the buying process through a comparison site like NerdWallet or by going to an insurance agent or life insurance company. Many people also buy life insurance through their workplace.

» COMPARE: Term life insurance quotes

Agents make commissions based on the type of policy and coverage amount you choose, something to keep in mind when considering their advice. In some cases, this means an agent gets paid more if he or she sells you a certain company’s policy, or one type of policy over another.

Life insurance pricing

Rates are based on many factors that relate to your life expectancy, such as:

  • Age
  • Gender
  • Nicotine use
  • Medical history
  • Family health history, such as heart disease or cancer among immediate family members
  • Dangerous hobbies, such as scuba diving
  • Planned travel to risky parts of the world
  • Other risk factors, such as your driving record

» MORE: Average life insurance rates

Insurers typically verify the information in your application using some or all of these methods:

  • Requesting your medical records from your doctors
  • Getting data from past individual life and health insurance applications from MIB Group.
  • Having you undergo a life insurance medical exam, including blood and urine samples and possibly an electrocardiogram
  • Viewing your past and current medications via a prescription-drug history database
  • Checking your driving record, generally for drunk driving convictions
  • Reviewing your personal credit history
  • Reviewing your business credit reports and running a criminal background check, in some cases

» MORE: How life insurance companies learn your best-kept secrets

Companies typically take several weeks to review an application and issue a policy. If you’re looking to buy term life insurance quickly and are in good health, consider online instant-approval term life insurance.

After the purchase

If you develop a medical condition or start smoking after you buy the policy, you don’t have to tell the insurance company. Once you have coverage, new health problems or habits can’t change your rate.