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How does life insurance work?

You’ve heard of life insurance and have probably been told that you should get it at some point in your life. However, how does life insurance actually work? What are the ins and outs and what do you need to know? Read this guide to find out.

Understanding exactly how life insurance works in different circumstances is a great way of figuring out whether it’s or you. Whilst you may understand the basics of life insurance, it’s important to know what will happen if something unexpected happens, or if certain factors affect a payout if you die. 

What is life insurance?

A life insurance policy is a type of cover that will pay your beneficiaries a lump-sum if you pass away during the policy term. You will pay monthly premiums throughout the cover and, in exchange, your loved ones will receive a ‘death benefit’ if you were to die during your life insurance policy. 

There are different types of life insurance depending on what you are looking for. The lump-sum paid out to your family could be to help pay bills, a mortgage, for your funeral or for other general living costs. 

How does life insurance work?

Purchasing life insurance is a fairly straightforward process if you know exactly what it is you need from a policy. This is why it’s important to consider the following steps in order to understand what the right life insurance policy is for you. 

Step 1: Decide what type of life insurance suits you 

There are a few different types of life insurance policies, depending on both your age and what type of insurance you are looking for. One of the most common types of life insurance is term insurance

Term life insurance guarantees your family an agreed lump-sum of money if you die within a particular time period. 

For example, you might set your period at 20 years with an agreed sum of £100,000. 

This type of life insurance is often used by those who want their family to be able to cover the mortgage if they pass away. Most mortgages only last up to 25 years, which is why term insurance is a good option. 

Limiting the term of life insurance also means that premiums are likely to be lower than other policies. 

There is also the option of increasing-term or decreasing-term insurance. The difference between these two is as follows:

  • Increasing-term insurance - The lump-sum your family receives will increase each year of your insurance policy (you can choose by how much)

  • Decreasing-term insurance - The lump-sum your family receives will decrease each year of your insurance policy (you can choose by how much)

As you can see, there are many different types of insurance policy, so it’s worth deciding which suits your financial situation better.

Step 2: Decide how much life insurance you need 

The cost of your policy will largely depend on how much you want your loved ones to receive when you pass away. To make sure that your life insurance is affordable, only pick a final lump-sum payout that will cover what your family will really need. 

In order to come up with a rough figure, try adding up the following costs:

If you are the main breadwinner in your family, you’ll need to think about the main monthly costs that you pay for, and leave a lump-sum that will allow your family to comfortably afford these without your income.

Step 3: Decide how long you want the policy to last

Many people decide to take out life insurance after they get married, have a child or buy a house. This often means that they’ll take a policy out for 25 years or so to cover the length of their existing mortgage. Most term life insurance policies last 10, 20 or 30 years. However, many companies offer additional 5- or 10-year renewals. It’s really down to personal circumstances as to how long you would like your life insurance to be. It’s worth looking at what’s currently going on in your life and what the future looks like to help decide the length of your policy. 

Step 4: Compare life insurance policies

Once you know roughly what you want from a life insurance policy, you can start looking for the best deal. Your age, health, lump-sum amount and length of the policy will all affect the cost of your monthly premiums. 

However, different insurers might offer better deals than others. Make sure you pick well-known insurers with positive customer reviews. One of the key things to look out for is how easy claiming your life insurance payout is after you pass away. Customer reviews are likely to shine a light on this.

Different insurers might offer you different incentives to pick their life insurance policy. Make sure you pick the one that suits your needs and budget best. 

Step 5: Honesty is the best policy 

Life insurance won’t work out well for you if you’re dishonest or leave out important information on your application form. If, after you die, the insurers discover underlying health conditions or lifestyle habits that you didn’t disclose, then your loved ones might not receive the payout. This means that you would have been paying monthly premiums for years for nothing. 

That’s why it’s so important to be honest about both physical and mental health conditions, any dangerous hobbies you have, and certain lifestyle habits such as smoking. Whilst it may make your monthly premiums more expensive, it’ll be worth it in the long run.

How does life insurance work after death?

Once you pass away, it’s the responsibility of your beneficiary to get in touch with the insurer and make a claim for the money. The insurer won’t find out you’ve passed away unless a claim is made.

This is why it’s so important that you write a will that clearly states who you want your life insurance payout to go to. It’s vital that you also include the contact details for your insurer and your policy number on your will. This will allow your loved ones to quickly and easily make a claim. 

All your beneficiaries will need to do is contact your insurer with your death certificate, and the claim will be processed. Most standard life insurance policies are paid within 30 to 60 days of the claim.

In some circumstances, it can take longer for your family to receive the payout if your death involves suicide, or if there is an ongoing police investigation. 

The main reasons a life insurance policy won’t pay out include the following:

  • The insurer suspects fraud 

  • You haven’t been paying the monthly premiums, so the insurance is no longer valid

  • You weren’t truthful on your application 

The vast majority of life insurance policies will pay out without delay, but always double-check reviews to make sure customers haven’t had issues making claims with the insurer. 

How does life insurance work if you don’t die?

If you have a term life insurance policy that lasts, say, 25 years, it’s very much possible that you might outlive your policy. Whilst this isn’t necessarily a bad thing as life insurance isn’t something anyone really wants to use, what happens to all of the money you were paying? What happens if you’re still living after the end date of your policy? 

The first thing that’s worth considering is whether you still require life insurance once your policy has come to an end. When you first took out the policy, your life circumstances may well have been very different. For example, you might have just taken out a mortgage, had very young children or lacked financial security.

However, those factors may no longer apply and you might feel secure enough that you no longer require life insurance. So, if you don’t die and don’t want to extend the policy, then the insurance will simply end and the premiums you paid will be kept by the insurance company. Life insurance isn’t a savings plan so the premiums you pay will only ever be used if you pass away during the policy. However, the investment is worth the peace of mind for many. 

On the other hand, if you still feel that your family will require a payout once you pass away, it might be worth extending your life insurance policy. You can discuss the possibility of renewing with your insurer. Bear in mind that your premiums may increase. 

How does life insurance work if your beneficiaries die?

If the unthinkable happens and your beneficiary passes away before you, then your insurance will be paid out to secondary beneficiaries. This is why it’s important to write down multiple beneficiaries other than your primary one. 

In the extremely unlikely event that all of your beneficiaries were to pass away before you, then the life insurance policy will likely be paid out into your estate. Or, you could pick a charitable organisation that you would like your payout to go to. 

If you no longer have anyone or anything you would like the money to go to, you could stop paying your monthly premiums and cancel the policy. 

How does life insurance work if you die doing an extreme sport?

If you regularly participate in extreme sports, you will have to let your insurer know when you first apply for life insurance. Insurers will consider you a higher risk of payout if you participate in an extreme sport and so will either reject your application or will charge high premiums. Make sure you shop around to find an insurer that will offer life insurance even if you do extreme sports.

If you die whilst doing an extreme sport, you are likely to still receive a payout, especially if you let your insurer know that it’s an activity to do regularly when you applied. 

If you participate in a sport as extreme as skydiving, some insurance policies might include in the terms and conditions that they won’t payout if you die while jumping. This is because skydiving is considered very extreme. 

Overall, it’s best to be upfront and honest about your lifestyle choices, this will  minimise the risk of the insurance company rejecting your family's claim if you were to pass away due to extreme sports.

Life insurance and COVID-19

During the coronavirus pandemic, many people have considered the need for life insurance due to the uncertain times we find ourselves in. 

Thankfully, you can still get life insurance during the current pandemic. It’s important to note that some insurance companies are adjusting their policies so make sure you always read the details. 

If you are travelling to or live in a high-risk area, this could also affect the cost of your premiums or the likelihood of being approved. 

This shouldn’t discourage you from getting life insurance during these times, it’s always worth the peace of mind for yourself and your family. 


19th August 2020