Life insurance 101 - Explaining what you need to know |
How does life insurance work?

Life insurance explained

Need a quick rundown on how life insurance actually works?

Life insurance in the US provides a benefit payment to nominated beneficiaries following the death of the policyholder.

This benefit ensures the people that depend on the insured financially have enough money to cover any outstanding debts or pay for future expenses that can no longer be covered by the policyholder. This benefit payment ensures that the policyholders loved ones are not placed under any kind of financial strain following their death.

What types of life insurance can I get?

There are essentially three main types of life insurance to choose from and they can be purchased separately or bundled together under one policy.

  • Life Insurance. Provides a lump sum benefit following policy owner’s death or diagnosis of terminal illness.
  • Critical illness insurance. Provides a lump sum payment if the insured person suffers a serious illness or injury that is specified in their policy.
  • Disability. Provides a lump sum benefit payment if the insured becomes permanently disabled or is unable to work.

There are other types of insurance offering reduced levels of coverage including accident insurance, accidental death and dismemberment insurance and funeral insurance.


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    How much does life insurance cost?

    This will vary greatly between people and is determined by the level of risk that they present to the insurer. This risk will be reflected in the premium that is paid and is based on a number of factors including:

    • Age
    • Whether they smoke and how much alcohol they consume
    • Any health conditions
    • Occupation
    • Gender
    • How much you’re insured for

    How do I work out how much life insurance to take out?

    Create a list or spreadsheet of all your financial obligations — debts, mortgages, funeral costs, family expenses — that you take care of for your dependents and try to find an amount that would provide adequate coverage for your loves ones. A good rule of thumb is that you should be insured for 10 times your annual income.

    What is the difference between variable and fixed premiums?

    Life insurance premiums can be structured as either:

    • Variable: Premiums increase over the life of the policy with the insured’s age.
    • Fixed: Premiums remain the same over the life of the policy.

    How does life insurance work if you pass away?

    In the event of the policy owner’s death, the insurance provider will pay the benefit to their nominated beneficiaries. Insurance companies should have claim documentation on their website.

    Below is a description of the stages of the life insurance claims process;

    • Insurer is notified of the claim: The policyholder or their beneficiary contacts the insurance company with the policy information and number to report the cause of death or nature of medical illness if claiming critical illness insurance.
    • Claim forms sent to policy owner: The insurance company will provide necessary claim forms to be completed.
    • Claim form and necessary documentation returned: Return the claim form and necessary supporting documentation. This may include death certificate, medical reports and financial documents.
    • Claim assessed: The insurance provider will assess the claim and all supporting documentation — this process can be anywhere from 10 days to 2 months.
    • Claim assessment decision: Claimant will be advised whether the claim has been accepted, declined or if further information is required.
    • Payment of claim: Insurer makes claim payment by check. Ongoing payments are made by check or direct deposit to the policyholders account.

    How does life insurance work after a payout?

    Following the payment of a benefit for life insurance, the policy will cease to exist.

    What about critical illness and disability insurance that’s linked to a life insurance policy

    If there is a claim payment for critical illness or disability that’s bundled with a life insurance policy, the amount insured will be reduced by the benefit that has been paid.

    How do life insurance beneficiaries work?

    Each policy applicant will nominate the beneficiaries that they wish to receive the benefit that’s paid in the event of their death. This will usually be a spouse or children, but can really be anyone that is financially dependent on them. It’s not unusual for applicants to nominate close friends or business partners as beneficiaries.

    If the applicant doesn’t nominate a beneficiary the funds will be distributed to their estate as lined out in their will.

    What if I want to change my life insurance beneficiaries?

    In the event that you want to change the nominated beneficiaries on your policy, you can contact the life insurance company and request how to update the beneficiaries. It’s also recommended that you contact your estate planner to notify them of the change.

    So how does buying life insurance work?

    If you are unsure of the policy you’re after, you can fill out a form online to get in touch with an insurance provider to receive quotes and discuss different policy options. Listed below are the steps taken to purchase life insurance:

    1. Make an inquiry online. Enter correct details to receive an accurate preliminary quote.
    2. Contacted by an agent. An agent will contact you to discuss your possible policy options. There’s no fee charged and absolutely no obligation to sign up for a policy.
    3. Compare policies. Compare different policy options that are suitable for your situation. Compare prices, benefits and features and policy exclusions. This information can be found in the terms and conditions.
    4. Submit your application. Once you’ve found a policy to suit your needs, you can now work with your agent to submit all of the necessary application paperwork to the insurer.
    5. Application reviewed. Based on the details provided, the insurer will decide whether or not to provide you with coverage and an appropriate premium. They may request further information including medical evidence or further personal details.
    6. Policy accepted. Once the application is accepted, the insurer and insured will sign the policy contract of agreement and coverage will be put in place.

    Common questions around how life insurance works

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    Richard Laycock

    Richard is the Insurance Editor at finder, and has been wrangling insurance Product Disclosure Statements for the last 4 years. When he’s not helping Aussies make sense of the fine print, he can be found testing the quality of Aperol Spritzes in his new found home of New York. Richard studied Journalism at Macquarie University and The Missouri School of Journalism, and has a Tier 1 certification in General Advice for Life Insurance. He has also been published in CSO Australia and Dynamic Business.

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