Understanding the basics of various financial principles, concepts, and products is paramount to succeeding with your personal finances. With that in mind, today I wanted to focus on helping people understand how does life insurance work.
Life insurance comes in all different shapes and sizes, but regardless of what type of policy you’re looking to get, the process you go about applying and following through on your commitment work the same.
The following will be a guide to helping you understand how life insurance will work and it involves a few different stages.
1. Is life insurance necessary?
The first thing you must grasp is whether or not you need life insurance. While I’m not going to go into great depths here, you may need some sort of policy if you’re married, have children, or have a large amount of debt that’s been co-signed for.
Iframe support required to view this content.
2. How much do you need?
While “rules of thumb” are commonly used when calculating the amount of life insurance you should have, it’s best to talk to a professional and really delve into your personal situation to come up with that figure. If you’d like to do it on your own, then a good place to start is 10 times your annual income. So, if you make $50,000/year, then getting a $500,000 policy would be a good place to start.
In addition to that, you may want to consider how much debt you have and add that to the amount. You should also take into account future desires you may want to be taken care of in the event you’re not around: inheritance to kids or grand kids, paying for your children’s college, helping secure your remaining spouses retirement, etc.
3. What type of policy should you get?
There are two main types of life insurance (temporary and permanent) but this post isn’t about how each of them work. However, of those main types there is (1) term life insurance, (2) whole life insurance, (3) universal life insurance, and (4) variable, and you should take it upon yourself to learn more about how each work.
The final 3 of the 4 mentioned are permanent policies. A permanent policy is sometimes suitable, but it depends on your financial situation and what you’re trying to accomplish. However, if you’re looking for the cheapest life insurance out there then a good place to start is with term insurance.
4. Where should you get your policy?
While there are a trillion life insurance agents out there and tons of different brokers, the thing to determine first is whether or not you should get an individual policy or a group policy.
Many employers offer life insurance policies to their employees. Some may give you a small policy (maybe 1 or 2x’s your salary) as a part of your employment package, whereas others may also give you the opportunity to purchase additional coverage through a group policy. So, should you take advantage of that additional group insurance or should you meet with an insurance agent and get a policy on your own?
Group Policies versus Individual Policies
In the majority of cases that I’ve worked on, it’s most likely that you’re going to get a cheaper rate (assuming you’re healthy) if you get an individual policy that’s manually underwritten. The way life insurance will work is that when you get a group policy, the insurance company looks at the entire workforce and assumes some things such as: average age, general health, and the job functions performed at your employer (as a whole).
With that in mind, if your coworkers are older than you or they’re unhealthy as a whole, then the group life insurance rates will reflect that. Saying that, group life insurance is great for older people or others that may be unable to get a policy on their own.
Regardless of what you choose, I’d encourage you to check out both avenues: find out how much it’s going to cost through your work, then meet with an insurance broker to see what they can offer you.
The final thing to be aware of with group policies is that some of them are not portable. Meaning that when you leave your employer, you’ve lost your insurance policy. Now, all employers’ plans do not work that way and some of them will allow you keep the insurance in place in the event you get terminated or find a job elsewhere.
Take Note: just because an agent quoted you a particular price on an individual policy DOES NOT mean that’s what you’ll get approved for. The quote that they show you is typically an educated guess; your actual premium will not be known until you’ve gone through the underwriting process.
After you’ve determined everything above, then the second part in understanding how does life insurance work involves the application process. If you’ve determined to opt for a group policy, then you likely won’t have to worry about these next two steps as your group rates has already been determined and your personal health won’t affect that outcome.
1. The application and health screening
If you’ve decided to go with an individual policy, then you should have taken the time to shop life insurance rates on your own (or consult with a broker who can assist you with that). After finding the most affordable rate, then you must apply for the coverage.
The application will go into quite a bit of information (it’s often more detailed with the permanent policies), but it won’t take you too long to fill it all out. After the application has been mailed off (or submitted online), then blood and urine samples will be ordered by the life insurance company.
When that occurs (typically a day or two after you submit your application), you’ll be contacted by the company performing the tests and they’ll schedule a time to meet with you. You’ll generally be able to choose where you want the test to occur – such as having it done in your home or in many cases the person will even go to your work to make it most convenient for you.
2. Manual underwriting
Once the blood/urine tests are complete, all of the data will be sent back to the life insurance company. At that point, there will be a team (or person) assigned to your case and they will go through the underwriting process. This involves scouring your application, possibly contacting your doctor for any information they have on file, confirming what you wrote on your application (family history, etc.), and examining your blood-work and urine results.
After you’ve submitted the application, given your blood and urine samples, and the insurance company has gone through the underwriting process, they will come back to you with an offer (sometimes – if you’re in poor health particularly – you’ll get completely denied).
1. Accepting or declining the offer
The offer (or premium – i.e. how much you’ll pay each month/year) is based on your age, gender, and health. Again, this is not applicable if you opt for the group route as your monthly premium has already been determined based on your group. The price will be reflective of the rating that you’ve received. With that, there are 4 main ratings: Preferred Plus, Preferred, Standard Plus, and Standard. If you’re unhealthy, then there are something called Table Ratings (Table 1-8) and it’s possible that you may fall in one of those categories as well.
Hopefully your insurance agent did a good job during the quoting process, because the hope here is that you get approved for what the agent originally quoted you (if not better than what they showed you). If you got approved for the rating you were originally quoted, then great!
If not and you were approved for a much lower rating than you expected (therefore resulting in a higher premium), then you can choose to decline the policy and cancel it.
2. Pay your premiums
Whether you get a group or individual policy, the way life insurance work after you’ve gotten approved is that you must pay your premiums each month (or year…or whatever you decided on when you signed up). Now, if you accidentally miss a payment there is generally a window (maybe 10-30 days) to submit the late payment, but beyond that there’s a chance your policy could be cancelled by the insurance company. This may not be the case for a permanent policy as there may be enough cash value to pay for the premiums.
3. Hopefully you won’t need to use it
If you happened to purchase a 20-year term policy, then I think everybody wants to outlive that time period and have the policy lapse. However, that’s not always the case as there is always a chance you could die prematurely (which is the reason you bought the life insurance), then the process your beneficiary (or beneficiaries) must take is rather simple:
1. Find your life insurance contract or documents (note, you probably should put this in a safe place and inform your beneficiaries of where you keep it).
2. Obtain a death certificate.
3. Contact your insurance carrier and follow their procedures (likely as simple as faxing over the death certificate).
4. Receive the tax-free life insurance death benefit and do as they wish with it.
Understanding how does life insurance work is a fairly easy process (despite the great depth I’ve gone into to explain it). You simply must start by determining your need (how much and what type of policy best suites you), then determine the avenue (group or individual policy), then apply and follow through with paying your premiums.
Readers: what type of life insurance policy do you have? Did you go through your employer or did you opt for an individual policy?
The articles are written by personal finance enthusiasts (not certified professionals) based on their personal experience. What works for them may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
In accordance with FTC guidelines, we disclose that we have a financial relationship with companies mentioned in this website. This may include receiving access to free products and services for product and service reviews and giveaways.
Any references to third party products, rates, or websites are subject to change without notice. We do our best to maintain current information, but due to the rapidly changing environment, some information may have changed since it was published. Please do the appropriate research before participating in any third party offers.