In previous articles, I wrote about life insurance for children. In planning those articles, I assumed that everybody knew what life insurance was, what life insurance was for, what kinds of life insurance existed, who needs life insurance and when, how it was priced, how to buy it, and related issues. Boy, was I wrong.
Judging from the number of people who contacted me with questions, I guess the articles about life insurance for kids were interesting (or poorly written). But the questions asked were more basic than just about life insurance for children, so we need to circle back to some real fundamentals. We’ll do that in a series of life insurance articles; there is just too much ground to cover to do it in one or a couple.
I’ve named this article “Overview of Life Insurance” because it is going to be a high level look at life insurance. Subsequent articles will drill down into specifics, including:
• uses of life insurance
• who should and can buy life insurance
• ways to buy life insurance
• how to apply for life insurance
• types of life insurance companies
• types of life insurance policies and pricing
• extra features that might be available with a basic life insurance policy and how each works
• in general, how much life insurance to buy (but remember, I’m not a financial planner!)
• how to read and understand a life insurance policy
• how to collect life insurance proceeds
Some of these topics overlap each other so we may cover related topics in a single article. Therefore, read all of them so that you a full understanding of life insurance.
What is a Life Insurance Policy?
Like all other insurance policies, it is a contract. A contract is an agreement between 2 or more parties to do, or to refrain from doing, one or more acts. For a contract to be enforceable, there must be an exchange of “consideration.” It is easiest to think of consideration as “you do this for me and I’ll do that for you.” There are other requirements of an enforceable contract such as that the subject of it must be legal.
In the context of insurance, a person of legal age, or another legal entity pays money (the premium) to an insurance company. The premium is the consideration from the insured. In return, the insurance company promises to pay an amount of money to one or more people or entities named in the insurance policy (the “beneficiaries”) if certain events occur. The promise to pay is the consideration from the insurance company. Sometimes, the insurance company promises to pay for something for the insured, such as the cost of repairing a car; it depends upon the kind of insurance policy involved. Those mutual promises make an insurance policy an enforceable contract. The policy can require other acts by the insured that if not done, may be defenses to payment, but that is an entirely separate discussion and is fact-driven.
A life insurance policy might be considered to be a death insurance policy. That’s because the life insurance company promises to pay the face amount of the policy when the insured dies if the policy is in force at that time of death. Normally, it will be in effect if premiums have been paid. The cause of death must be for a reason not excluded by the life insurance policy. For example, suicide is usually an excluded cause of death for a period of time after the life insurance policy policy is issued.
Who are the Parties to a Life Insurance Policy?
The parties to a life insurance policy are:
- The insured: the person named in the insurance policy as the insured. The insured may or may not be the same person who bought it. The insured is the person who’s death triggers the payment of the life insurance proceeds.
- The insurer: the insurance company that issues the life insurance policy. To lawfully issue a life insurance policy in a state, the insurance company must be “authorized”, or “licensed” to conduct life insurance business in that state. A “certificate of authority” or “license” is granted to a life insurance company to operate in a state if it meets the legal requirements to run an insurance company in that state. A great concern of insurance regulators is the finances and the claim-paying ability of the insurance company.
- The beneficiary: the individual or entity designated in the life insurance policy to receive the proceeds of the policy upon the death of the named insured. Technically, the beneficiary is not a “party” to the life insurance policy because in most cases, the owner can change the beneficiary. Nonetheless, because the beneficiary is so intertwined with life insurance, it deserves mention.
Who Can Buy a Life Insurance Policy?
Life insurance policies are often purchased by the same person whose life is insured. However, someone else can buy a life insurance policy on the life of another. For example a spouse can buy a life insurance policy on the other spouse..
A crucial requirement is that that an individual or entity buying a life insurance policy must have an “insurable interest” in the life of the insured. The need for an insurable interest exists in all kinds of insurance policy purchases, not just life insurance. Although determining whether an insurable interest exists can be complex and is often fact-driven, it boils down to whether the purchaser stands to lose something of value. With life insurance, it can be financial support or “love and affection” were the insured to die. The reason why an individual can buy a life insurance policy on their own life is because one is always considered to have an insurable interest in his or her own life.
A business may have an insurable interest in the life of an individual because they may be considered “key persons”. Called “key person insurance”, the company receives the insurance proceeds upon the death of the person insured. A good analysis of key person insurance appeared in Entrepreneur Magazine . It explained that it can be important because the death of a key person in a small business often causes the immediate death of that company. The purpose of key person insurance is to help the company survive the loss of a person who plays a significant role in operating the business. The company can use the insurance proceeds for expenses until it can find a replacement person, or, if necessary, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner.
The individual buying the insurance policy must be of legal age. That means that he or she must be old enough to enter into a legally binding contract. There is sometimes a difference in what the legal age is for the purchase of a life insurance policy from what it is for other contracts, to drink, to drive, to vote or to do other things that requirement attainment of a certain age. If the buyer of the life insurance policy is a business, such as a corporation, it must be duly formed according to the laws of the state where it was incorporated and in active status at the time of purchase of the insurance policy.
There is a lot to understand about life insurance, so stay tuned.