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What is life insurance?

What is life insurance ? a term policy or insured sum? If all this sounds alien to you , here's something for you. Get answers to your questions, at least some.

Apnainsurance.com Research Bureau

11 Dec 2007

A life insurance policy is a contract typically between an individual (called the insured) and the insurance company (called the insurer), where the insurance company promises to pay a sum of money to the insured's nominee, in the event of the insured's death.

Most life insurance policies have a specified term, such as 10, 15, or 20 years. For the nominee to be eligible to collect the insured sum, the insured's death has to occur during the term of the policy.

If the insured survives the term of the policy, depending on the type of policy purchased, she/he may or may not receive a sum of money at the end of the policy term.

How does insurance work?

On entering a life insurance contract with an insurer, the insured agrees to pay a predetermined sum of money (as a one-time payment, monthly, quarterly, half-yearly, or yearly) for the agreed-upon insurance sum. This predetermined sum that the insured agrees to pay as per the agreed-upon schedule is known as the premium of the life insurance policy.

The life insurance premium is determined on the probability of death of people in a particular category. This probability is based on the age, gender, health and lifestyle of the people in that category.

For example, the average lifespan of a group of 30-year-old men, who are non-smokers, with no health problems such as diabetes or blood pressure, no weight problems, and whose families have lived normal life periods, can be predicted with reasonable accuracy.

This classification of people into categories such as smokers, overweight, persons with existing or hereditary health problems, etc, allow actuaries to determine the probability of the number of people that could die in each category for a particular age group.

Let us take a hypothetical example - a grouping that consists of males in the 30-35 age bracket with a family history of heart ailment, obesity, and hypertension. Obviously the individuals in this group have a higher probability of death than the group mentioned earlier. Therefore, the insurance company will need a larger amount of money at hand to cover for paying death claims when they occur. This assessment will therefore translate into a higher insurance premium charged to any person belonging to the group. This process is known as risk classification or underwriting. By charging identical premium for people in the same risk group, insurers are able to provide the policy-holders with a fair deal.

A life insurance company gathers premiums from a large number of people. The larger and more diverse the group of policyholders, the lower the risk for a company to pay death claims. The premium payments collected by the insurers are used for three purposes - to settle claims, to make investments, and to pay expenses.

When a policy-holder files a claim, the insurance company pays the amount from the cash available with it or by liquidating some of its investments.

In some instances, an insurance company is deluged with death claims - such as in the aftermath of the tsunami disaster in late 2005. In such cases, the company might find it difficult to settle claims from just the amount collected as premium.

To prevent the risk of paying such overwhelming claims that could cripple the company, the insurance company purchases a reinsurance contract with a reinsurer. The reinsurance contract enables the insurance company to reimburse a part of the claims it needs to pay out, from the reinsurer. Thus, insurance companies meet claims of their policy-holders from the available cash, liquid investments, and payouts from their reinsurance contracts.

See also:

FAQs on Life Insurance Basics

Life Insurance FAQs on Premiums

Life Insurance FAQs on Claims

Life Insurance FAQs on Insurance Company and Insurance Agent

How long should I be insured?

How much insurance do I need?

Do I need life insurance?



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