UsefulFAQs.com - What is Life Insurance?

Life insurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a sum of money upon the occurrence of the insured's death. In return, the policyowner (or policy payor) agrees to pay a stipulated amount called a premium at regular intervals.

There are three parties in a life insurance transaction; the insurer, the insured, and the owner of the policy (policyholder), although the owner and the insured are often the same person. For example, if John Smith buys a policy on his own life, he is both the owner and the insured. But if Mary Smith, his wife, buys a policy on John's life, she is the owner and he is the insured. The owner of the policy is called the grantee (he or she will be the person who will pay for the policy).

Another important person involved is the beneficiary. The beneficiary is the person or persons who will receive the policy proceeds upon the death of the insured. The beneficiary is not a party to the policy, but is designated by the owner, who may change the beneficiary unless the policy has an irrevocable beneficiary designation. With an irrevocable beneficiary, that beneficiary must agree to changes in beneficiary, policy assignment, or borrowing of cash value.

The policy, like all insurance policies, is a legal contract specifying the terms and conditions of the risk assumed. Special provisions apply, including a suicide clause wherein the policy becomes null if the insured commits suicide within a specified time for the policy date (usually two years). Any misrepresentation by the owner or insured on the application is also grounds for nullification. Most contracts have a contestability period, also usually a two-year period; if the insured dies within this period, the insurer has a legal right to contest the claim and request additional information before deciding to pay or deny the claim.

The face amount of the policy is normally the amount paid when the policy matures, although policies can provide for greater or lesser amounts. The policy matures when the insured dies or reaches a specified age. The most common reason to buy a life insurance policy is to protect the financial interests of the owner of the policy in the event of the insured's demise. The insurance proceeds would pay for funeral and other death costs or be invested to provide income replacing the deceased's wages. Other reasons include estate planning and retirement. The owner (if not the insured) must have an insurable interest in the insured, i.e. a legitimate reason for insuring another person’s life.

Insurance vs. Assurance

The specific uses of the term "insurance" and "assurance" are sometimes confused. In general, the term insurance refers to providing cover for an event that might happen while assurance is the provision of cover for an event that is certain to happen.

When a person insures the contents of their home they do so because of events that might happen (fire, theft, flood, etc.) Insurance is a way of spending a little money to protect against the risk of having to spend a lot of money. The point is, when a person insures their home contents they do so to provide protection against something that might happen. They hope their home will never be burgled, or burn down but they want to ensure that they are financially protected if the worst happens.

When a person insures their life they do so knowing that one day they will die. Therefore a policy that covers death is assured to make a payment. The policy offers assurance on death; even if the policy has a prescribed termination date the policy is still assured to pay on death and therefore is an assurance policy. Examples include Term Assurance and Whole Life Assurance. An accidental death policy is not assured to pay on death as the life insured may not die through an accident, therefore it is an insurance policy.