What Is Life Insurance and How Does it Work?

Not enough Americans who need life insurance have it. Why is that? While most people would tell you that they’re familiar with the concept of life insurance, I don’t think that many fully understand how it works or why it’s so important. If they did, more than 40% of the population would have enough life insurance coverage.

So, what is life insurance? What are the various types of life insurance you can buy? Do you need life insurance? And if so, what kind should you get? 

I’ll provide answers to these questions and more in this article. Find out how purchasing life insurance can help protect you and your family from the financial burden of an unexpected or sudden loss.

Table of Contents
  1. What Is Life Insurance?
  2. How Does Life Insurance Work?
  3. What Are The Different Types of Life Insurance?
    1. Term Life Insurance
    2. Permanent Life Insurance
    3. No Medical Exam Life Insurance
  4. Which Type of Life Insurance Should You Choose?
  5. How Do I Know If I Need Life Insurance?
    1. Do My Children Need Life Insurance?
  6. How Much Does Life Insurance Cost?
  7. What Are the Best Life Insurance Companies?
    1. Fabric by Gerber Life
    2. Haven Life
    3. Bestow
  8. Final Thoughts

What Is Life Insurance?

Life insurance protects an insured person’s beneficiaries by providing them with a lump sum of money upon the death of the insured (policyholder). There are two main types of life insurance: term and permanent life coverage.

How Does Life Insurance Work?

When you set up a life insurance policy, you must designate a beneficiary. This is the person or person(s) who will receive the death benefit if you pass away while the policy is in effect. If you choose not to assign a specific beneficiary, the funds will be paid out to your estate.

Most life insurance companies enable you to assign primary and contingent (secondary) beneficiaries. For example, if you are married with children, you may decide to name your spouse as your primary beneficiary and list your children as contingent beneficiaries in case your spouse were to die before the benefit can be paid.

If you have multiple beneficiaries, you can split up the benefit between them.

Your life insurance policy will have a face value amount, which will equal the amount of insurance paid out in the case of death.

While the policy is in effect, you will pay monthly or annual premiums to the insurance company in exchange for your life insurance benefit.

What Are The Different Types of Life Insurance?

As mentioned, there are two main types of life insurance: Term and Permanent. Let’s take a closer look at each one. I’ll also explain how No Medical Exam Life Insurance policies work.

Term Life Insurance

Term life insurance is valid for a specified period, typically 10, 15, or 20 years. You pay a monthly (or annual) premium for the duration of the policy, and the policy pays out if you pass away during the term.

If you are still alive when the policy expires, the term ends; however, most insurance companies will allow you to renew for an additional term, albeit at a higher cost.

Term life insurance is the best option for most people because it’s simple and affordable. (It’s much less expensive than permanent life insurance, partly because it’s only valid for a specified period).

The following subcategories exist within term life insurance:

  • Decreasing term policies offer a decreasing benefit amount as the policy ages. 
  • Level-term insurance policies keep the same premium and payout benefit for the policy’s life. 
  • Convertible term policies can be converted from term to whole-life policies within the contract’s life. 
  • Renewable term life insurance policies renew each year. They may increase in price as the years go on. 

Permanent Life Insurance

Unlike term life insurance, permanent life insurance policies are valid for the policyholder’s entire life, which is one of the reasons why permanent life insurance is more expensive than term insurance – the insurance company knows that the policy will have to be paid out at some point.

Some permanent life insurance policies include a cash value, which is a savings component of the policy. The policyholder can borrow or withdraw funds from the cash value portion over time.

There are three types of permanent life insurance: whole life, universal life, and variable whole life.

No Medical Exam Life Insurance

No medical exam life insurance policies are term policies that don’t require you to get a full medical exam. Most other insurance policies require complete physical and bloodwork, often via a nurse that comes to your home or office. 

There are three main types of no medical exam life insurance policies: Simplified issue, guaranteed issue, and group coverage.

Simplified-issue policies don’t require a medical exam, but you will be required to answer a list of medical questions. 

Guaranteed-issue policies don’t require you to answer any medical questions. These policies are geared toward older people or people who can’t obtain coverage elsewhere. Guaranteed-issue is often more expensive than simplified issue policies. 

Although there are other types of life insurance policies, the ones talked about above cover the most common life insurance policies you’ll find. 

Which Type of Life Insurance Should You Choose?

When deciding which type of life insurance you should choose, start by determining if you want term life insurance or permanent life insurance.

Term life insurance is the best option for most people. This is because the premiums are cheaper, allowing you to cover your family’s needs until you no longer need the insurance.

In other words, the term policy can cover you until you’re financially secure enough that you don’t need it. If that day doesn’t come as soon as you had hoped, you can renew your term life insurance policy when it expires.

Do your research on the difference between permanent life insurance and term life insurance, and talk to a few different people with knowledge about life insurance to decide which type of life insurance is right for you.

How Do I Know If I Need Life Insurance?

While not everyone needs life insurance, most do. In fact, it’s estimated that 3 out of 5 Americans (60%) don’t have enough life insurance coverage.

At the very least, life insurance can be used to pay for final expenses, including funeral costs, burial, etc.

However, if you have a spouse and children who are dependent on your income, you need to make sure you have enough life insurance in place to pay off any debts you have, including your mortgage, and to provide for coverage of living expenses until your youngest child is 21. 

See our guide to help you determine how much life insurance you need for more information and tips.

Do My Children Need Life Insurance?

Note: You’ll find articles online suggesting that you should buy life insurance for your children. But is it really necessary?

In my opinion, the only life insurance you’d need for underage children is a small policy to cover final expenses in the case of their death. That said, if you have a healthy savings account, you may want to forego purchasing a life insurance policy for your children.

How about a spouse/partner who stays at home or doesn’t earn a substantial income? Do they need life insurance?

If you’re not self-insured, the answer is a resounding “yes”!

Stay-at-home parents perform many tasks: Cleaning, cooking, caring for the children, and driving them around to different classes and events. How would these tasks get done if they were suddenly not there anymore?

Paying for these tasks to get done in the event of an unexpected loss would be very costly. Or, the money from the life insurance policy could allow you to stay at home and take on those duties in their place.

How Much Does Life Insurance Cost?

Monthly premiums for life insurance will vary based on a number of factors, such as:

  • Term vs. Permanent Insurance
  • The length of the policy
  • The coverage amount
  • Your age
  • Your sex (females are generally cheaper to insure)
  • Your health status at the time of application

For example, I have a term life insurance policy through Bestow for $300,000. As a 55-year-old healthy woman, I pay $35.08 monthly for that policy.

Your monthly life insurance premiums will vary based on your specific age, health condition, policy amount, term length, and other factors. 

What Are the Best Life Insurance Companies?

There are many life insurance policies to choose from. You can visit an insurance agent at a brick-and-mortar office near you to learn more about life insurance policies, or you can purchase insurance from several companies online.

Here are some top online life insurance companies to consider:  

Fabric by Gerber Life

Fabric Life insurance is a Gerber life insurance company that offers life insurance for busy parents. 

The company offers 10, 15, 20, 25, and 30-year term life insurance policies. The available terms decrease as you get older. 

You can get coverage from $100,000 up to $5,000,000. Prices start at just under $8 per month. 

Fabric by Gerber Life also offers additional tools to help you organize your financial and legal information. You can also create a will for free on the Fabric website.

Get a Free Estimate from Fabric by Gerber Life

Haven Life

Haven Life is an online life insurance company that’s backed by Mass Mutual Insurance Company. 

The company offers policies ranging from $25,000 up to $3,000,000. You may or may not need to get fully medically underwritten to get a policy with Haven Life.  

Remember that fully medically underwritten policies usually come with lower monthly premiums. 

In the case that you have severe or serious medical issues, Haven Life might not be the cheapest life insurance option.

Check out Haven Life Plus, a benefits program through Haven Life that offers a free trust or will and other benefits. 

Get a Free Estimate from Haven Life

Bestow

As mentioned earlier, Bestow is the online life insurance company I use. I’ve been with Bestow for several years and am happy with the service I’ve received. 

The application process with Bestow was quick and easy, and customer service was good. Bestow offers coverage for adults aged 18-60 years old.

You can get coverage from $100,000 to $1,500,000 for terms from 10 years up to 30 years. And it’s possible to get a price quote in as fast as five minutes when you apply for life insurance with Bestow. 

Check out Bestow’s referral program when you sign up. You can get up to $25 for each friend you refer who signs up with your referral link. Learn more in our Bestow review.

Get a Free Estimate from Bestow

Final Thoughts

Learning about how life insurance works and what different policies offer is part of good financial planning and knowledge. 

Not everyone needs life insurance, but it’s an essential product for most people. With over 60% of Americans living paycheck-to-paycheck, an unexpected death would put a huge financial burden on those left behind.

Life insurance helps buffer that blow (financially, at least) by reducing or removing the financial pressure from family members experiencing unexpected death. 

If you don’t currently have life insurance coverage, take the necessary steps to protect your family members today.  

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About Laurie Blank

Laurie Blank is a blogger, freelance writer, and mother of four. She’s psyched about teaching others how to manage their money in a way that aligns with their values and has been quoted in Bankrate.

She's a licensed Realtor with Edina Realty in Minneapolis, Minnesota (also licensed in Wisconsin too) and has been freelance writing for over six years.

She shares powerful insights on her blog, Great Passive Income Ideas, that will show you how you can create passive income sources of your own.

Opinions expressed here are the author's alone, not those of any bank or financial institution. This content has not been reviewed, approved or otherwise endorsed by any of these entities.

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