Life Insurance Basics
Life insurance fundamentals
Life insurance transfers the financial risk of premature death. A valid contract needs insurable interest at the time of application; the beneficiary does not need insurable interest. Underwriting classifies risk using age, sex where used, health history, tobacco use, occupation, avocations, family history, and amount of coverage. Mortality is the rate of death; morbidity refers to illness or injury. Premiums reflect mortality, interest earnings, expenses, and lapse assumptions. The needs approach asks how much capital survivors need; the human-life-value approach estimates the insured’s economic value.
The application is part of the contract. Answers are generally representations, not warranties, and must be material to matter. Concealment or material misrepresentation can allow rescission during the contestable period. A conditional receipt provides coverage if the applicant is insurable under the insurer’s rules; a binding receipt may provide immediate coverage. The medical information bureau and consumer reporting raise privacy and disclosure issues.
Death benefits are generally income-tax-free to beneficiaries. Cash-value growth is tax-deferred; loans may be taxable if the policy lapses. Individual premiums are generally not deductible.
Traps: beneficiary age does not set the premium; insurable interest is tested at inception, not at death; ‘tax-free death benefit’ does not mean tax-free policy loans forever.
Rule of thumb: ask ‘who loses money if this person dies?’ That person has insurable interest. Example: a business partner can insure a partner; a stranger cannot insure a celebrity.