What Is Life Insurance: Definition, Benefits and How it Works

Check out this video to understand what is Life Insurance and how does it work?

How Does Life Insurance Work?

An individual may choose from the different life insurance plans available based on his needs. along with other policy details like:

• Sum assured
• Poli… term
• Premium paying term
• Premium paying frequency

In some cases, the premium is determined based on the policy details selected and the risk of covering the individual. The other key factors that affect the premium include the following:

• The sum assured selected
• The policy tenure
• The premium paying tenure and frequency
• Age of the life insured
• Lifestyle habits (smoking, drinking, etc.)
• Past or existing medical conditions
• Family history
• Gender, etc.

However, in some cases, the policy specifies a minimum premium and the policyholder can choose to pay an amount as per their life goals. The policy benefits are, then, determined based on the premium paid. A common example is ULIP wherein you can pay a premium amount of your choice (subject to the specified minimum and maximum limits). Based on the premium paid and the sum assured multiple chosen (if and where applicable), the sum assured is determined.

Each life insurance, it is essential to have knowledge about the different types of plans available in the market. Below is a list of the different types of plans in the market.

Term Life Insurance:

A term life insurance plan is a simple life insurance plan that offers optimum coverage at affordable cost. If the life insured dies during the policy tenure, the entire amount of the sum assured is paid to the nominee, and the policy is terminated. However, If the insured person survives the entire duration of the plan, nothing is payable as a maturity benefit at the end of the policy tenure.

There is no maturity benefit under the term plans except in the case of term insurance plans with ROP (return of premium) option, wherein the premium paid is refunded, if the insured person survives the policy tenure.

Whole Life Insurance:

As the name implies, whole life insurance covers you for your whole life, i.e., for 99 or 100 years of age. The insurer pays the death benefit if the life insured dies during the policy tenure. Some plans also have a maturity benefit which is paid if the insured survives the policy tenure.

3. Endowment Plan:

Endowment plans are savings-oriented life insurance plans that help you create a guaranteed corpus for your financial goals. These plans pay either a guaranteed^* death benefit on premature death or a maturity benefit if the insured survives the tenure. Some endowment plans also offer bonus, if declared, that enhance the plan benefits.

Thus, in endowment plans, if the life insured happens to die within the plan's duration, the entire sum assured, along with accrued bonuses, if applicable, would be paid to the nominee, and the policy would be terminated. However, if the life insured survives the policy tenure, maturity benefit, along with loyalty additions and accrued bonuses, if applicable, would be paid to the policyholder, and the policy would then be terminated.

Unit Linked Insurance Plan or ULIP:

ULIPs are a mix of both investment and life insurance plans. A policyholder has the benefit of investing in funds that are linked to the market, along with getting life insurance cover.

Thus, in a ULIP, the policyholder pays a premium for life insurance cover for a specific duration, i.e. policy tenure, and has the advantage of choosing the market-linked funds he would like to invest according to his risk appetite and financial goals. ULIPs are known for their flexibility and market-linked investment opportunity across various asset classes such as equity, debt, balanced, etc. Moreover, you can switch between funds, make partial withdrawals, pay top-up premiums, etc. and manage your investments accordingly, subject to terms and conditions of the policy.

Money-Back Policy²:

M… policies are a kind of life insurance that offers money-back benefits at regular and pre-determined intervals. Thus, in a money-back plan, you get life insurance cover and regular payouts as a survival benefit and a maturity benefit.

However, if the life insured happens to die within the plan's duration, the entire death benefit, i.e. the sum assured, would be paid to the nominee irrespective of the money-back payouts already made. So, money-back plans are savings-oriented life insurance plans that also provide interim liquidity.

Retirement Plan:

Retirement plans help create a corpus for retirement. There are two main types of plans - deferred annuity and immediate annuity plans.

Deferred annuity plans help you create a corpus by saving over the policy period. Under these plans, the insurance policy promises to pay the annuitant a regular or lump sum payout at a future date. You can create a retirement corpus which is then used for annuity payouts based on the choice of the annuity.

On the other hand, immediate annuity plans usually start paying immediately after you buy the policy. You pay a lump sum to buy the immediate annuity plan, and the plan starts making guaranteed* payments based on your choice of an annuity from the available options.

Child Insurance Plan³:

Child insurance plans could be traditional endowment plans, money-back plans, or unit-linked insurance plans. Basically, these are plans designed for the benefit of a child’s financial future. The parent is usually the life insured while the child is the beneficiary under these plans.

Some child insurance plans come with the premium waiver benefit, wherein if the parent dies during the policy duration, the insurer would waive off the future premiums, and the plan would continue to pay the benefits as per the original schedule of the plan. Child insurance plans may, thus, help in securing a child’s financial future whether the parent is around or not.

What are the Benefits of Life Insurance?

Life insurance is a tool that may pave the way for a secure, peaceful and rewarding life for you and your family. Here are a few ways how life insurance benefits policyholders:

• It may help your loved ones meet the life goals you have set for them even in your absence
• Child insurance plans can help secure your child’s financial future in your absence
• The investment component of plans like ULIPs may help grow your wealth, to fulfill your dreams like buying a home, investing in real estate, going for a world tour, etc.
• If you buy life insurance with add-ons like Income Tax Act, 1961.

Factors that Affect Life Insurance Premium

The life insurance premium is the  amount you pay to keep your life cover active but this amount is not the same for everyone. It changes based on many factors . Knowing what affects the premium can help you understand your policy better. Let’s look at some of the main factors that affect life insurance premiums in a simple way.

Age

Your age plays a big role in deciding the premium. If you are younger, the premium can be lower. This is because younger people are seen as healthier and may live longer. So, if someone buys a policy early in life, the cost of the premium stays more affordable.

Gender

I One of the factor is gender which is verified by insurance companies because of health studies. These studies show that women usually live longer than men. So, women may be charged a lower premium than men for the same life insurance policy.

Health conditions

Your health condition matters. If you are healthy now and have had no major illnesses before, the premium may typically be low but if you have a disease or have had one in the past, your premium can be higher. This is because the chances of health problems increase the risk for the insurer.

Family health history

If certain diseases run in your family, it can affect your premium too. For example, if your parents had diabetes or heart problems, your insurer may think you could get the same and may ask for a higher premium. Family health background is checked carefully during the application process.

Lifestyle habits

Habits like smoking or drinking alcohol can increase your premium. These habits can affect your health and lead to serious illnesses over time. Because of this extra risk, people who smoke or drink may need to pay more for their life insurance cover.

Type of coverage

The kind of life cover you choose makes a difference. A simple plan, like term insurance, may have a lower premium but if you add extra benefits called riders (like critical illness or accident cover), the premium can go up marginally. Longer policy terms may also have higher premiums than short-term plans.

Amount of coverage

If you prefer a higher sum assured (the amount your family gets when you’re not around), the premium will also be higher. The more money you want to leave behind, the more the insurance company will charge to cover that amount.

Occupation

The job you work can influence the cost of your premium. Risky occupations such as construction work and mining, along with chemical handling operations, typically result in increased premium amounts. Employment environments that present danger include additional health risks for employees. The insurance cost stands lower for safe office work environments.

How to Select a Life Insurance Policy?

Check out this video to understand how to choose a suitable life insurance plans?

Now that you know what is life insurance, how it works, and its different types, you need to know how to choose a policy that will suit your needs. Here are some tips -

Determine your life insurance goals:

Identify your financial goals and then choose suitable plans that would help in fulfilling such goals. For instance, if financial protection is the main goal, you may invest in a term insurance plan. Alternatively, if you want to create a corpus for your child, a child insurance plan may be suitable, and if you want to plan for retirement, you may opt for a pension plan.

Tip: Thus, mapping your life goals to the plan may help you determine the plan's overall objective and select the type of plan you need.

Analyze the optimal insurance cover:

An optimal sum assured can help fill the financial gap that the breadwinner’s premature demise might cause. That is why estimating the right coverage under the life insurance policy is important.

Tip: To do so, assess your financial goals, liabilities and needs. Then find out how much sum assured would be sufficient to fulfil your goals. You can use life insurance calculators that help in determining the premium payable for the required coverage amount.

Choose a suitable tenure:

Based on the timeline of your financial goals, choose a suitable tenure of the plan so that you can get coverage while creating a corpus for your goals.

Enhance your coverage:

You can choose to enhance your life insurance cover with the add-ons or the riders pertaining to the type of insurance policy that you opt for. Riders can be opted for, on payment of nominal additional premium.

Tip: Riders may be worth the incremental cost you need to pay if the benefit of the same enhances your overall coverage.

Opt for a plan early on:

Since the life insurance premium does not increase with age under an active plan, it may be preferred to opt for a life insurance plan early on in life, as the premium remains fixed throughout the tenure.

Choose a plan according to your needs:

There are multiple types of life insurance plans which cater to various needs. So, you need to weigh the pros and cons of each plan carefully before opting for the plan that best suits your needs.

Tip: You may opt for multiple life insurance plans to meet different financial goals, i.e. child insurance plan for your child’s financial future, an annuity plan for your retired life, etc.

Assess your insurance needs regularly:

It is a good practice to assess your insurance requirements from time to time as the insurance need may change due to a change in your life stage, need, requirements, etc.

Tip: You can always opt for an additional life insurance plan at a later point in time to enhance your coverage.

Read the fine print:

Each life insurance plan has certain terms and conditions which need to be carefully read and understood before opting for the same.

Tip: Read the policy document carefully when you receive the same so that you are completely aware of all terms and conditions and not taken by surprise at the time of claim!

Keeping these points in mind, you will be able to select a suitable plan that meets your life insurance requirements.

Documents Required to Buy Life Insurance

You have to submit some common documents when buying life insurance plans. Some of the common documents include the following –

• Proposal form, filled and signed
• Identity proof
• Income proof
• Medical check-up reports (if required)
• Any other documents needed by the insurer

What is Life Insurance Premium?

While the life insurance company undertakes to insure you against the risk of premature demise or pay a benefit on maturity, you have to pay a premium for the policy that you buy.

The premium includes the cost of mortality risk (risk of premature demise) and a saving element if the insurance policy offers a maturity benefit.

Life insurance plans allow three premium payment modes which are as follows -

• Li… premium - wherein you pay the premium for a limited tenure while the policy runs longer
• Age
• • Income and expenses
  • Existing financial assets
  • Existing liabilities
  • Financial goals
  • The number of dependents, etc.

There are different methods to calculate the right life insurance cover for your needs. For instance, one simple way to determine life insurance cover is a multiple of your annual income. Under this mode, say a minimum of 10 times times your annual income makes for an adequate sum assured.

There are other modes of calculating your coverage needs as well. Alternatively, online calculators help you find a suitable sum assured based on the details you enter. You can use the calculator to assess how much life insurance you would need.

Check out this video to understand Do's and Don'ts while buying life insurance policy

Key Takeaways

• A life insurance policy covers the risk of death during the policy term and can provide financial security to your family in your absence.
• There are various types of life insurance plans, including term plans, endowment plans, ULIPs, whole life plans, money-back plans, and annuity plans.
• Some of the benefits of life insurance plans include financial security, tax savings, creating a corpus for your goals, etc.
• The life insurance premium depends on various factors like your age, coverage chosen, medical history, lifestyle habits, etc.
• Choose a suitable life insurance plan depending on your financial goals, coverage needs, riders required, and other factors.

Conclusion

Given its benefits and the coverage that it provides, life insurance may prove to be a valuable addition to your portfolio. So, understand the life insurance meaning and consider buying a suitable policy for financial protection as well as goal fulfilment. You can also save taxes with life insurance plans as the premium paid and the payouts received may have tax-saving benefits under the applicable provisions of Income Tax Act, 1961⁵. Also, build your insurance portfolio to be financially protected against the challenges that life throws at you.