Life Insurance Basics and Purpose
The core idea
Life insurance transfers the financial risk of an early death from one person to a pool of many. Because the insurer can predict, within a narrow range, how many of thousands of insureds will die in a given year (the law of large numbers), it can charge each person a small, predictable premium instead of leaving a family exposed to a catastrophic loss. Insurable interest must exist when the policy is applied for and issued - not at the time of death. A policy taken out by a stranger with no relationship to the insured is void.
The three premium factors
Every life premium is built from mortality (expected claims), interest (what the insurer earns on reserves), and expense (commissions, administration, taxes). Mortality and expenses push premiums up; interest pushes them down. A level premium works because the insured overpays in the early years, and that overpayment accumulates as a reserve - the source of cash value in permanent contracts.
What it is used for
Personal uses: income replacement, paying off a mortgage or other debt, funding education, final expenses, and estate liquidity. Business uses: key-person coverage, funding a buy-sell agreement, split-dollar plans, and executive bonus arrangements. The two classic measuring approaches are human life value (capitalized future earnings) and the needs approach (what the survivors actually require).
Traps to watch
Questions love to hint that cash value is "an investment" or that the death benefit is taxed as ordinary income - both are wrong; death proceeds are generally income-tax free to the beneficiary. Another favorite: reinsurance is insurance purchased by an insurer from another insurer, never a retail product. Also remember the insurer's obligation is to pay the face amount, and suicide and incontestability clauses are time-limited.
Rule of thumb
Use DIME as a quick needs shorthand - Debt, Income replacement, Mortgage, Education - then subtract existing assets and coverage.