Saturday, August 09, 2008

What is life insurance?

First of all, lets discuss what "insurance" means. Insurance is the transfer of risk of financial loss from an individual to a company which, for consideration, assumes that risk for a stated period of time against a stated peril(s) up to a stated amount. In other words, insurance is where the policyowner trade for a small loss (the premiums) for the insurance company's promise to pay for a large, unknown loss. All the policyowners lose a little, but no one has to take the risk of losing everything. All insurance policies are contracts, which means nothing more than an agreement between two or more individuals or parties.

If you ask yourself, what is your greatest asset? Without much thought, you would say that it is your bank, your car, or your house. If you answer anything besides "yourself," your answer is wrong. Your earning ability is your greatest asset. Your ability to go to work and bring home a paycheck is your greatest asset. But you can't go on with life without being exposed to risk. In insurance, risk is defined as "uncertainty of financial loss." You have to live with the risk that you (or your spouse or partner) could lose the ability to bring home a paycheck. This is where life insurance comes into play.

What is life insurance? Life insurance is a contract under which the insurance company agrees to pay a stated amount to a beneficiary upon death of the insured. If something were to happen to you tomorrow, how would your family live? Would their life style change for the worse, be the same, or be better? In most cases, your family would be worser off because the flow of income from you has stopped. Your spouse may need to sell the home, use your kid's college funds to pay off bills, and so on. Without adequate protection, your family will not be able to maintain the same life style that they are currently in.

Life insurance can't protect you from dying, but it can protect your income. Financial experts say you should have coverage of 8-12 times of your annual gross income. If you earn $40,000/year, then you would need coverage of around $400,000. The question is: Do you have life insurance and if you do, do you have adequate coverage on yourself?

If you are single, you are probably wondering why you need life insurance. For most singles, they really don't need life insurance. There's no one really dependent on his/her income. He/she has no financial obligations that will be passed on to other family members (unless the debt is a joint account such as a mortgage or credit cards). But there are some reasons why a person who is single may need life insurance. He or she may want to leave money to their loved ones such as parents, brothers or sisters. He or she don't want to pay higher premiums in the future. He or she don't want to be un-insurable because of the possibility of declining health. In any case, a person being single has to determine whether he or she needs life insurance.

There are two main types of life insurance you should know about. One type of life insurance builds savings, which is called "cash value life insurance." The other type is known as pure insurance because its just insurance without any savings. This is called "term insurance." It is important to know that all life insurance policies are term insurance because all policies expires at a certain age (usually at age 100).

See also:
Cash value life insurance
Term insurance
Comparing cash value life insurance and term insurance in numbers.