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Sunday, October 23, 2016

How Life Insurance Works (Part 1)

If you've thought about life insurance but just don't know where to start, this article by Dave Roos from might help you with the basics. Life insurance can be an important part of succession planning. We don't sell life insurance, but at Gardner & Billing CPAs, we can certainly help you understand the tax implications and how it fits into the bigger picture of estate and financial planning!

How Life Insurance Works
Life insurance should really be called "death insurance." Like other types of insurance, life insurance is protection against the unknown. When you buy life insurance, you're paying for the peace of mind that your family will be taken care of in the event of your sudden demise. Life insurance is the life jacket in the fishing boat. You hope to never have to use it, but it's nice to know it's there.

Some people call life insurance gambling. They think that you're throwing away a bunch of money on the off chance that you'll die young. But when life insurance is handled correctly, it isn't gambling at all. It's simply part of a larger economic plan whose goal is the financial security of your family.

So what is the best type of life insurance to buy and how much coverage do you need? If you don't have any kids, do you even need life insurance?

What is Life Insurance?
People buy life insurance to provide money for their families if they die young. When you buy a life insurance policy, you pay a monthly, quarterly or annual premium for the term of the policy. The term can be as short as one year or as long as a lifetime. If you die within the term of your policy, your beneficiary will receive a fixed amount of money.

The earliest records of life insurance come from ancient Rome, where burial clubs pooled money among the poor to pay for members' funerals. Beginning in the Middle Ages, life insurance was dominated by fraternal and religious organizations, labor guilds, and mutual life insurance companies. Similar to credit unions, mutual life insurance companies are owned by the members, who share in any profits. In the late 17th century, astronomer Edmond Halley came up with the first actuarial tables for calculating the risk of insuring an individual based on mortality statistics. The higher the risk, the higher the premium

Risk calculation is still a big part of the life insurance business. When you apply for a life insurance policy, you'll be asked to fill out a full medical history (including your family medical history). You'll also be asked questions about your lifestyle and hobbies, your credit history, your driving record and your travel habits. All of this information is used by insurance actuaries to figure out how much they should charge you for a life insurance policy, or if they should deny you a policy altogether.

The most important factors that affect the price of life insurance premiums are age, sex and pre-existing medical conditions. Older people will generally pay more for a life insurance policy, as will men. Heart conditions, high blood pressure, mental illness, or a strong family history of heart disease or cancer will raise your insurance premiums. Insurance companies also offer higher rates to people who participate in "dangerous" hobbies like skydiving or scuba diving. Smokers can expect to pay rates that are twice as high as non-smokers.

To collect on a life insurance policy, a surviving family member must fill out an official claim. Usually, he or she will also have to provide a certified death certificate that states the date, location and cause of death. In some cases, he or she will also be asked for original copies of the insurance policy. Once approved, the claim is settled with one lump sum payment to the person indicated in the policy as the beneficiary.

Unfortunately, life insurance claims can also be denied. Many life insurance policies don't cover suicide. If an insurance company suspects that a claim is fraudulent, it will investigate it fully. If it finds that the claimant lied about the cause of death, or that the policyholder neglected to mention pre-existing medical conditions or dangerous hobbies, it could deny payment.

But does everyone need life insurance? And what are the best times to buy a policy? Check out our next installment of this article to learn more.