Ted Barnhart is a freelance investment and financial writer with extensive experience in investment advisory, risk arbitrage trading, and public accounting and auditing. He has worked at firms including Arthur Andersen & Co., Merrill Lynch, and Morgan Stanley. He holds a FINRA Series 65 registration.
Ted has ghostwritten for executives and firm publications on a wide spectrum of financial topics including commercial real estate, investment advisory, wealth management, trading, economics, and energy. He is a member of the Independent Writers of Chicago and the Financial Communications Society of Chicago.
Doug is a Chartered Alternative Investment Analyst who spent more than 20 years as a derivatives market maker and asset manager before “reincarnating” as a financial media professional a decade ago.
Before joining Britannica, Doug spent nearly six years managing content marketing projects for a dozen clients, including The Ticker Tape, TD Ameritrade’s market news and financial education site for retail investors. He has been a CAIA charter holder since 2006, and also held a Series 3 license during his years as a derivatives specialist.
Doug previously served as Regional Director for the Chicago region of PRMIA, the Professional Risk Managers’ International Association, and he also served as editor of Intelligent Risk, PRMIA’s quarterly member newsletter. He holds a BS from the University of Illinois at Urbana-Champaign and an MBA from Illinois Institute of Technology, Stuart School of Business.
Life insurance is a contract that provides a death benefit when the insured person dies while the policy is in force. The policyholder pays premiums for coverage and names one or more beneficiaries to receive the death benefit. Depending on the type of policy, coverage lasts for a specified term or for the insured personās lifetime.
What are the two main types of life insurance?
The two main types are term and permanent life insurance. Term life provides coverage for a specified period, commonly 10, 20, or 30 years. Permanent life insurance is designed to provide lifetime coverage as long as the policy remains in force, and it builds cash value that the policyholder can access during the insured personās lifetime.
Who needs life insurance?
Life insurance is typically most important when other people depend on your income or would face financial hardship after your death. Parents and couples often use it to replace income and provide for children, while wealthier families may use life insurance in estate planning. Businesses also insure executives and other key employees whose deaths could cause financial losses.
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Life insurance helps protect against loss or hardship.
Life insurance can help replace lost income after a death and can also play a role in estate planning.
The lives of executives and other key employees are often insured by their employers.
Permanent life insurance policies provide an element of savings and investment.
But life insurance can be intimidating to the uninitiated. The jargon aloneācash value, surrender value, beneficiary, permanent insurance, whole life, not to mention the myriad of policy and coverage typesācan make the topic confusing for anyone.
At the end of the day, however, life insurance is just insurance. It means paying to protect your loved ones from the financial consequences of your death.
So how does life insurance work? Simply put, you can āpurchaseā a policy by paying a premium (usually a monthly bill), on the life of a specific individual. If the insured person passes away during the term of the insurance policy, a benefit will be paid to the beneficiary or beneficiaries.
But unlike auto or home insurance, where the value of the insured asset is determined in advance, with life insurance the purchaser (policyholder) decides how much insurance they would like to purchase.
Based on the individualās health history and outlook, youāll be quoted a premium rate for the coverage you would likeāthat is, the amount that will be paid out to the beneficiary of the policy upon the death of the insured. Depending on your needs and the premium you can afford, you decide the amount.
Types of life insurance policies
Life insurance policies come in two basic types: term or permanent. In addition, permanent policies come in various subtypes.
Term insurance. This is the cheapest form of insurance, as it provides coverage for a specified periodā20 years is a common termāand not one day beyond. Although most term policies offer provisions for renewal, if the policy expires, the contract is over, just as your auto or homeownerās insurance would be.
Permanent insurance (sometimes loosely called whole life). These policies provide coverage for the insuredās lifetime (if the buyer makes all the required premium payments). In addition to the death benefit, a permanent policy builds a cash value over time. This cash value may be used by the policyholder during the lifetime of the insured (more on this below), but itās not received by beneficiaries if the insured person dies and a benefit is paid out.
Perhaps the better question is āwhy might someone need to insure someone elseās life?ā In order to take out a life insurance policy, you need to have whatās called an insurable interest (i.e., proof that you would experience loss or hardship should the insured person die).
Young families. Raising a family in this day and age is a fiendishly expensive endeavorāwith two parents in the household, let alone just one. Thatās why young and āworkingā families have a strong need for life insuranceāto provide for a spouse and children in the event of a premature death. Younger couples who plan to start a family in the future may choose to purchase life insurance before the arrival of kids, as insurance is typically cheaper and easier to get when youāre younger and healthier.
Mature and wealthy families. On the other end of the family spectrum are older couples, particularly those with a high net worth, who often use life insurance policies as part of their estate plans. In general, life insurance policies held in certain trusts are able to sidestep (or at least reduce) estate tax liability.
Companies. Big corporations, small partnerships, and all sizes in between frequently share one thing in common: Employees who, if they were met with a sudden demise, would cause serious financial disruption inside and outside the company. Companies often buy insurance on executives and other key personnel, with the company designated as the beneficiary.
Key life insurance terms
Shopping for insurance? Use this A-to-Z guide to help you sift through the jargon.
Beneficiary. The person (or people) chosen to receive the death benefit payment. A beneficiary can also be a trust or a corporation. The beneficiary is not necessarily the policyholder.
Cash value. The amount of cash that has accumulated and is earning interest or invested in the policy. Some of the amount may be withdrawn, or the policyholder may borrow against it. Cash value is not the same as surrender value.
Death benefit (aka ācoverageā). The amount of money that will be paid to the beneficiary upon the death of the insured.
Insured. The person whose life is being insured. The insured is not necessarily the policyholder.
Policyholder. The person or entity who purchases and owns the policy.
Premium. The cost of the insurance policy. Premiums are usually paid on a monthly basis, but other payment schedules, such as annual payments, may be available.
Surrender value. The amount of money that will be returned to the policyholder if the policy is āsurrenderedā or canceled. The surrender value may be lower than the cash value due to fees and any outstanding loans the policyholder may have taken out against the policy (yes, you can do that).
Term. The length of the life insurance policy. A policy can be purchased for any term, but typical term policies are 10, 20, and 30 years. For permanent policies, the term is typically the entire life of the insured (assuming the policyholder stays current on all premiums).
The bottom line
Life insurance is typically a key component of a familyās investment and financial plan. Policies come in many shapes and sizes, so itās important to understand the differences and trade-offs of various policy types and features. Itās also critical to determine the amount of life insurance neededāand the costsāto help determine which policy to purchase.
Think you know life insurance? Take the quiz.
This quiz isnāt easy, but life insurance is one of the biggest, most consequential financial decisions youāll ever make. Understand the details before signing on the dotted line.
EncyclopƦdia Britannica, Inc.
This article was most recently revised and updated byĀ Ted BarnhartThis article was most recently revised and updated byĀ Doug Ashburn
