What is Life Insurance and How does it Work?

While watching your favourite TV show, have you ever sat through an entire commercial break? If you have, you’ve probably seen those depressing ads where people die and their families are left grieving. As jarring as it is to see something that sad, the ads always try to end things off on a high note. It’s revealed that the deceased person bought some life insurance before they passed and now their family will be financially stable. It’s a nice enough message, but it may have left you wondering a few things, for instance – What exactly is Life Insurance? How does it work? And is it really that important? What is Life Insurance and How does it Work?

Life insurance can best be viewed as a type of contract between insurers and those who purchase their policies. Generally speaking, the individual will pay premiums to the insurance company (usually a certain amount per month), and in return, the insurer is contractually obligated to provide their loved ones with a payout upon the individual’s death. 

Still a bit confused? Well, let’s look at a simplified example to better understand the process – 

  1. John agrees to pay an insurance company R2000 per month until his death. In return, the company agrees to pay his named beneficiaries (his wife and child) a lump sum of R200 000 upon his death. 
  2. Some years later, after many premium payments, John dies. (Ripped to shreds in a tragic horse riding accident).
  3. The insurance company upholds their part of the agreement and John’s wife and child receive a R200 000 payout. 
What is Life Insurance and How does it Work?
What is Life Insurance and How does it Work?

Obviously, there’s a lot more that goes into this process than just that, but hopefully, this gives you a rough idea of how everything works. In reality, the insurance company would also consider certain factors that may affect the likelihood of John’s death and could adjust the premium amount based on these elements. Additionally, John would have multiple types of life insurance to choose from, rather than just a simple, all-purpose cover. 

Which Factors Affect Life Insurance Quotes?

Every insurance company will have different criteria that they consider when handing out policies. That said, there are some common points that tend to come up regardless of who you talk to – 

Contributing Factors for Life Insurance 

Career – Certain jobs are far more dangerous than others. For this reason, a lumberjack will probably have much higher premiums to pay than your average office worker.
Hobbies – Just like jobs, certain leisure activities are more dangerous than others. As such, people who spend their free time doing things like white water rafting will normally end up paying more for their life insurance than people who collect stamps and do crossword puzzles.
Lifestyle – Things like smoking or heavy drinking are usually seen as negative influences which may result in early death. Obviously then, these habits will negatively impact your premiums.
Physical and Mental Health – Don’t think that you can quickly go get a life insurance policy after your doctor tells you that you have 6 months left to live. Complicating factors related to your physical and mental health will drive up the price that you pay for your policy.
Age – The cost of life insurance tends to increase as you get older. Teenagers, for instance, will find much cheaper rates than octogenarians. 
Family History – Various ailments tend to be hereditary to some extent. This means that people whose family members suffer from certain illnesses may need to pay more for their life insurance. 
Weight – Individuals who are either severely overweight or underweight are normally viewed as being more susceptible to certain problems such as heart disease and immune system issues. These factors can negatively impact your premiums when applying for life insurance. 

The complications don’t stop there. As mentioned, there are many types of insurance to choose from and each kind will operate differently from the rest.

What is Life Insurance and How does it Work?
What is Life Insurance and How does it Work?

What are the Different Types of Life Insurance?

Believe it or not, there are so many different kinds of life insurance available, that we’d need another hundred pages to go through all of them in-depth. That said, some are more common than others and it may help if we briefly go through a few of them – 

  • Whole Life Insurance – This is the kind of insurance we covered in our earlier example. You pay premiums every month and, so long as you keep paying them, your insurance will payout when you die, regardless of when your death occurs. Additionally, this kind of insurance also offers cash value accumulation
  • Term Life Insurance – By contrast, this type of insurance is only in effect for a certain period of time (perhaps for a few years). Normally, the premiums for this type of cover are lower than others, but, if you outlive the timer, your loved ones will not receive a payout.   
  • Universal Life Insurance – This one is similar to whole life insurance except it’s cheaper and usually has little cash value to offer.

Once again, these are just a few examples. There are many different types of life insurance available and it’s worth your while to do some research and find one that works best for you.

Does Life Insurance Give You Money?

Beyond the payment that’s made to your named beneficiaries, certain types of life insurance (such as whole life) may also offer a cash value feature. Although these types of insurance are normally more expensive than others, the cash value attached to them earns interest at a certain rate. This means that the cash value of the policy increases in value over time and may allow the individual to withdraw or borrow against it in certain scenarios.

Is it Important to have Life Insurance?

It depends on your personal situation.

Most people have friends or loved ones that they wish to provide for in some way, shape or form. Alternatively, they may simply wish to ensure that these loved ones are not saddled with funeral costs after their death. In either case, life insurance is an important form of cover that should not be avoided or put off. 

That said, a person with no close relatives or relations may not feel the need to put money away, or, perhaps, their loved ones are all exceedingly wealthy and in no need of financial aid. In these cases, constantly spending money on life insurance may not provide worthwhile gains. 

Why Should I Get Life Insurance?

As noted, life insurance is oftentimes a moral imperative rather than a financial one. Many people worry about their loved ones and want to ensure that they are financially secure once they’re gone. 

On the other hand, even in cases where the surviving relatives are financially stable, you may worry about the potentially exorbitant costs of a funeral which could fall on the shoulders of those you care most about.

What is Life Insurance and How does it Work?
What is Life Insurance and How does it Work?

Do you get your Money Back if you Cancel your Life Insurance?

For the most part, no, you do not receive money back when you cancel your life insurance. 

As noted, in the case of whole life insurance, you may be able to receive your cash value back, but everything else will be kept by the insurance company. 

In Conclusion – What is Life Insurance and How does it Work?

Life insurance is a kind of contract made between the insurer and the client. At its most basic level, it involves the client constantly paying premiums to the insurance company (usually each month) with the knowledge that the insurance company will provide a lump sum to their named beneficiaries (loved ones) after their death.

Life Insurance is generally used as a way to ensure that the most important people in your life are kept financially secure after your death or that they are able to pay for any funeral costs without having to take up the burden themselves. 

There are many types of life insurance available, all offering their own benefits. Some versions may be more costly but can last for your entire life, while others may be cheaper but could come with a kind of time limit with regards to any payouts. 

There are also many factors that are considered by insurers before they agree to any contracts. For instance, a person with health problems (eg, heart disease) or an unhealthy lifestyle (eg, alcoholism) may have to pay higher premiums than other, more medically sound individuals. Other concerns may involve high-risk hobbies (eg, rock climbing) and bodily factors (eg, old age or obesity). 

Life Insurance is generally seen as a morally important and responsible thing to invest in but it has to be noted that certain individuals may find less use for it than others. If, for example, you do not have any close relatives to leave money to, or if your relatives are all highly affluent, it may be wiser to spend your money elsewhere. 

While whole life insurance covers may allow you to withdraw your cash value when you cancel your insurance policy, most of the time you will not receive any money back when exiting an insurance contract.

Disclaimer Finance101: All of our posts are for research purposes only. Finance 101 aims to assist its readers with useful information on the laws of our country that can guide you to make financial decisions that will enable you to become more financially independent in the future. Although our posts cite the constitution in many instances, they are intended to assist readers who are looking to expand their knowledge of the law & finance-related queries. Should you require specific legal/financial advice we advise you to get in touch with a qualified financial expert.

Found this article interesting? Leave us your thoughts below

You may also like...

1 Response

  1. March 23, 2022

    […] other words, you will have to consider your own personal situation to determine whether or not funeral cover is a worthwhile investment for […]

Leave a Reply

Your email address will not be published. Required fields are marked *