More often than not, we forget a very simple fact of life... 'Simple is beautiful'. As kids, we always find things more fascinating, as they appear simple to us given our limited knowledge. But as we grow up and learn various things, we develop our preferences based on our education, understanding, and experiences. Not everyone likes the medical field or can become a mathematical genius. Hence, things related to unfamiliar subjects fall outside our comfort zone. Similar is the case with finances. For most people that have not studied finance, buying financial products falls outside their comfort zone; simply because they are not familiar with financial jargon used in relation to most financial products. So, they either end up staying away from financial products or make wrong choices which in turn affects their financial health. So, what should they do? They may consult a financial advisor who can guide them in purchasing financial products. However, when it comes to consulting someone for your sound financial advice, the trust and comfort level play a major role. You need to have clear communication with your advisor and for that, you need to be aware of some key terminologies associated with the financial product you are contemplating utilizing.
A Life insurance policy is one such financial product that leaves people mystified because of the various jargon associated with it. As reported by Business Wire in Mar’19, according to the AIG Life Insurance IQ Study, seven in ten Americans (70 percent) feel that life insurance will protect their ability to live a long, financially secure life. And yet roughly half of the respondents (51 percent) do not have life insurance or are unsure if they do, leaving themselves and their families vulnerable to considerable financial risks. The study was conducted by Morning Consult for AIG from December 2-5, 2019, among a national sample of 2,201 adults. More than half (54 percent) indicated they did not know whether the death benefit for term life insurance is set at a fixed amount (for example, a \$250,000 policy) and does not change. What does this indicate? This indicates that people are not familiar with the basic concepts of life insurance. Let us make it a little easier for you by simplifying a few key terminologies, which are widely used in relation to life insurance policies. But before that let us understand in a nutshell, how a life insurance policy works. You approach a life insurance company to buy a life insurance policy. The insurance company underwrites the risk of the requested term, policy coverage, your income level, etc. Once the underwriting is done, the insurance company stipulates an insurance premium. By paying the first premium, you become a policyholder. If you buy coverage for yourself then you are the primary insured., paying the premium to the insurance company to keep the policy active and in force. If you die while the policy is active, the insurer pays out the death benefit to the designated beneficiaries which are typically your loved ones. The death benefit functions as an income replacement so that your beneficiaries can continue to afford housing, food, bills, and other expenses. Now let us have a look at the key terms highlighted above.
A ‘Primary Insured’ is the person whose life is insured. In case of the death of the primary insured, the insurance company pays out the policy death benefit to the beneficiaries. However, the primary insured may or may not be the policyholder. For example, if a person buys an insurance policy for their spouse/partner, then he/she becomes the policyholder and the spouse/partner becomes the primary insured. But if a person buys life insurance coverage for their own life, then he/she becomes the policyholder as well as the primary insured. A policyholder controls the policy decisions such as paying a premium, changing the beneficiaries, changing the coverage, etc. A policyholder is responsible for paying the premiums to keep the life insurance policy alive, even if the ‘primary insured’ is someone else.
The person who receives the death benefit from a life insurance policy is called a ‘beneficiary’. You can list multiple beneficiaries on your life insurance policy. Your policy’s beneficiary should be someone you want to protect financially or someone you can trust to deploy death benefit funds appropriately. This is generally a spouse, a partner, or a trusted guardian. Listing the right people as your life insurance beneficiaries is important and should be done cautiously. The life insurance death benefit cannot be paid out to certain beneficiaries, such as a minor child or a pet. If you list a minor child as a beneficiary without mentioning the trusted guardian details then, in case of your demise, the minor child may not receive the funds when they need it the most.
Similarly, listing no one as your life insurance beneficiary can cause problems. In such cases, your policy’s death benefit is paid out to your estate. It can go through probate and be collected by any creditors you owe debts to, leaving minimal death benefit funds to take care of your family.
Reviewing and updating the policy regularly and listing valid recipients as your beneficiaries is the best way to make sure that life insurance death benefits are paid out as you had envisaged.
Premium is the recurring amount you pay periodically to the insurance company to keep the life insurance policy active over the policy duration. For term life insurance, the premium is to be paid for the policy term. After the policy term is over, the policy coverage expires and you no longer need to pay the premium. However, in the case of permanent life insurance, you need to keep paying the premium forever to keep the policy active.
The premiums are calculated based on the type of policy, coverage amount, term length, age of the person to be insured, their health condition, their occupation, and lifestyle, etc. The premiums are paid either on a monthly or annual basis. Some insurance companies may offer a discount if you decide to pay the premium on an annual basis.
Usually, insurance companies offer a 30 days grace period in case you are not in the position to pay the premium on the due date for some reason. Failing to service the premium in the stipulated grace period results in the cancellation of the policy.
In the case of term life insurance, the premium remains unchanged over the policy term.
When you apply for a life insurance policy, your insurance broker or the insurance company gives you premium estimates based on your application, which are called ‘quotes’. During the processing of your application, the quotes may get revised based on the information you share in your telephone interview with the insurance agent. After this stage, your application and health details are evaluated by the underwriting team of the insurance company to assign you an insurance classification. The underwriter works on behalf of the life insurance company to determine if you should get the premium you were originally quoted or a higher premium should be charged based on your insurance classification.
Every company has its underwriting manual. The underwriter looks for risk factors that could shorten your lifespan such as a smoking habit if your hobbies include risky sports or activities, your personal and family history of illness, your age, etc. The more prevalent risks, the higher is the premium stipulated by the underwriters.
The death benefit is the lump sum amount paid out by life insurance companies to the beneficiaries of the policy, in case of death of the primary insured during the policy term. The death benefit should be large enough to cover various situations such as funeral expenses, everyday expenses, education expenses of your children, outstanding debt obligations, etc. The death benefit amount is generally tax-free in the hands of the beneficiary. However, if you list your estate or a trust as your beneficiary or if you get a taxable policy, such as an employer-sponsored plan or cash value life insurance, the death benefit can be taxed.
To get the life insurance death benefit, the policy’s beneficiaries need to file a death claim form with the life insurance company and provide proof of death such as the death certificate of the primary insured.
So now you would agree that concepts related to a life insurance policy are not difficult to understand. Getting familiar with them will help you in choosing the right insurance policy. In the end, it is all about the priorities. If the well-being of your loved ones is your priority, you should buy a life insurance policy right away!So now you would agree that concepts related to a life insurance policy are not difficult to understand. Getting familiar with them will help you in choosing the right insurance policy. In the end, it is all about the priorities. If the well-being of your loved ones is your priority, you should buy a life insurance policy right away!