Life Insurance Basics
The big picture
Life insurance is a risk-transfer device: many policyowners pay premiums into a pool, and the insurer pays a death benefit to the few whose insureds die. Three forces drive the premium: mortality (how likely death is for the insured class), interest (what the insurer earns investing premiums in advance), and expense (commissions, overhead, taxes). Mortality and expense push premiums up; interest pulls them down.
Concepts you must own
- Insurable interest - the owner must stand to suffer a financial loss if the insured dies. It is tested at policy inception, not at death. You may buy coverage on yourself and name anyone; a business may insure a key employee; partners may insure each other.
- Underwriting - the field underwriter (producer) completes the application: Part I (general/health history) and Part II (medical), plus the agent's report. The insurer may order a paramedical exam, an attending physician's statement, or an MIB check. The MIB reports coded information, not full medical records, and the Fair Credit Reporting Act requires notice to the applicant.
- Uses - personal (income replacement, mortgage, education, estate liquidity) and business (key person, buy-sell, split-dollar). The human life value approach capitalizes future earnings; the needs approach totals obligations and subtracts existing resources.
- Temporary coverage - a conditional receipt gives coverage from the date of application only if the applicant is insurable under the insurer's rules; a binding receipt covers regardless.
Traps
Questions love "insurable interest must exist at time of death" (false) and "the MIB releases your medical file" (false). Watch for ownership questions: the owner controls the policy, not the insured or beneficiary.
Worked example
Needs approach: income need $60,000 × 20 years = $1,200,000, plus debts $200,000, minus existing assets $300,000 → about $1,100,000 of coverage.