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An Introduction to Life Insurance

Life Insurance

Life insurance is a contract between an insurer and a policy holder in which the insurer promises to pay a beneficiary a designated amount of money when the insured person dies or, sometimes, becomes terminally ill.  

To receive the benefits, the policyholder must pay the insurer set amounts of money at regular times.  Life insurance companies make money by charging a bit more money during payments than they eventually must pay out over the long-haul.  

Life insurance can still be useful for policy holders, however, because it provides the peace of mind that no financial difficulties will arise as the result of the death of the insured person.  Life insurance policies often have specific exclusions that disallow the transfer of benefits for certain deaths, including suicide, fraud and war.

While the policyholder and the insured person are often the same, this is not necessarily the case.  If you take out a life insurance policy for yourself, you are both the policyholder and the insured person.  If your spouse takes out a life insurance policy on your life, however, he or she is the policy holder, while you are the insured person.  

The policy owner is always responsible for life insurance payments.  You cannot buy a life insurance policy on just anyone's death, however.  There is a policy called "insurable interest" which stipulates the policy holder must have some relation to the insured person.  

This usually includes close family members and business partners.  At the very least, a policyholder must show he or she would stand to lose money in the event of the death of the insured person.

When signing a life insurance contract, the insured person must specify a beneficiary who is to receive the benefits upon the insured person's death.  The beneficiary is not actually legally part of the policy and the insured person can change the beneficiary at any time.  

The only way this is not the case is if the contract has an irrevocable beneficiary clause, in which case the beneficiary has to agree upon a change in beneficiary.  

A life insurance contract's face amount is the amount to be paid when the insured person dies or reaches a specified age, although this face amount is usually slightly different from the actual benefits paid at death.

The two primary types of life insurance are term life insurance and permanent life insurance.  Term life insurance is known as a "pure" type of life insurance because it buys protection versus death and only death.  Term life insurance provides insurance for a designated number of years, and there are only three factors that go into it: face amount, premium and length of coverage.  Insurance companies will sell policies with different combinations of these factors, such as a face amount that either remains the same or declines.  

The most common type of term life insurance is a Level Term policy.  A Level Term policy has a constant premium for any time longer than a year, usually coming in five-year increments.  These policies are great for long-term planning and often contain an option to renew at the end of the contract.  

Some even have a guaranteed renewal whereby the policy holder can renew the deal for the same or less premiums, regardless of the state of the insured person.  Many companies do not offer guaranteed renewals because they give them no opportunity to limit their risk.  

With guaranteed renewals, life insurance companies are often offering insurance to risky individuals at premiums which are too low for the company to make money. 

Permanent life insurance remains intact until the policy pays out.  The only exception is if the policy holder fails to pay a premium or the insurer can prove fraud.  There are four types of permanent life insurance: whole life coverage, universal life coverage, limited pay and endowment.  

Whole life coverage provides guaranteed death benefits and asks for fixed annual premiums.  The major disadvantage of whole life insurance is that the rate of return is thought to be low when compared to other savings options.  

Universal life coverage is similar to whole life coverage, but it offers greater flexibility with the payment of premiums and the cash value of the policy can grow.  Universal life coverage was invented to address the disadvantages of whole life insurance.  

Limited pay life insurance calls for premium payments over a specified period of time, as opposed to over the life of the contract.  An endowment policy is a life insurance policy in which the cash value inside the policy matches the face amount of the policy at a specified age.  

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