How Does Life Insurance Work?
Home Insurance protects your house. Car Insurance protects your car. Life assurance.
Your insurance policy will pay out should your car get damaged, so you can repair it without putting your hand in your pocket. Imagine trying to rebuild a house if you didn’t have insurance!
How healthy are your savings?
While Life Insurance doesn’t apply quite so literally, it’s even more important as it protects your loved ones if you die during the term of your policy.
Human life can’t be repaired (well not yet anyway…give it a few years!) – if you die, you stay dead, but life insurance is vital for replacing your income if you die.
Look, you know it’s important, and you’re pretty sure you need it, but you have questions. How about we start with the big one: “How does Life Insurance work?”
How Does Life Insurance Work for You?
I hate to be the one to break it to you, but you are a walking pay cheque. You work hard, get paid, provide your family with all they need.
If you die, the pay cheque dies too. How screwed would your family be without that income?
Very I would imagine…and that’s why Life Insurance exists – to protect them financially. You choose a suitable amount of cover to replace your income and you pay your premiums. When you die, the insurer pays this tax-free lump sum to your family.
The magical thing about Life Insurance is that it allows you to continue taking care of your loved ones even though you’re no longer here.
The various types of Life Insurance:
Term life insurance
Here, you’re insured for a set number of years. So if you have a policy that covers you for 30 years, as long as you keep paying your premiums, your family will receive a pay-out if you die in those 30 years.
Term 30 life insurance
When the 30 years are up, though, you no longer have coverage ( unless you extend it ). Because coverage is limited by time, and you might outlive your policy, Term Life Insurance is the cheapest form of Life Insurance.
Of course, the idea of you outliving your policy has the insurers rubbing their hands with glee as it means they get to keep the money.
Whole of life insurance
This doesn’t have an expiry date. Instead, it covers you for your entire life (as long as you continue to pay the premiums). Because of this guaranteed pay-out, the premiums are higher than Term Life Insurance.
Avoid Reviewable Whole of Life policies like the plague. Although it has a savings element built in, as you get older the scoundrel insurer will review and increase your premiums to a level you can no longer afford. You’ll end up cancelling the policy at some stage…and the insurer will pocket all those sweet sweet premiums.
If you have a Reviewable Whole of Life policy, you should consider replacing it with a Term or fixed price Whole of Life policy. If you’re lucky enough to have a cash value built up, happy days, you get to trouser it.
Should you choose Whole of Life or Term Life Insurance?
Okay, so now you know that Reviewable Whole of Life is evil BUT Guaranteed Whole of Life Insurance is pure.
There are no reviews and your premium is fixed from the start of your policy. There’s no end date to the policy and it can be paid out tax-free to cover any dreaded inheritance tax bill.
Moral of the story: Guaranteed Whole of Life and Term Insurance both have benefits. The big negative of Term Insurance is that you might outlive your policy– if that’s the case, make sure you buy a policy with a conversion option.
With a conversion option, you’ll be able to get a new quote based solely on your age. The insurer can’t ask medical questions or increase your premium based on factors like your health, weight, blood pressure, or the sort of bad shit that creeps up on us all as we get older.
Everyone’s situation is different, so I can’t recommend whether you should go with Term Life (with a conversion option) or Guaranteed Whole of Life off-hand, but either are good shouts.
How much cover should you get?
When you’re buying insurance, you’ve two options for how your family will be “paid”:
A lump sum (to replace your potential earnings until retirement).
A monthly payment (not dissimilar to what your income would be).
So let’s say you earn the national average of €45,000 a year. You might be thinking, “sure, if I’m covering myself for 30 years, then I need over a million.”
That’s not quite how it works. For one, if you have a mortgage, your Mortgage Protection will pay that off so that’s one less cost. You’ll also be out of the picture as well so your ‘running costs’ disappear.
That’s a rough guide but it’ll give you an idea as to how much cover you’d need. No two people should have the same amount of cover, so don’t just copy what your sister did or what your friend did or what Brian in Accounts did. (If you’re quoting for €250,000 over 25 years, you’re definitely doing it wrong!)
How do insurers actually make money, then?
Okay, so now you know the inner workings of Life Insurance, you might be wondering how it works for the Fat Cat in the glass building. Life Insurance is big business – and ultimately it is a business.
The insurance company needs to make a profit. How does that work if they pay claims of €500,000 or €1 million, or more?
Insurance companies keep your premium in an account, right, while they sit and pet a fluffy, white cat and giggle maniacally?
Often, the money paid in premiums is invested. Not anything particularly risky, but also not in run-of-the-mill savings accounts. That way, the insurance company can earn money on your money.
Military life insurance
Over a lifetime, the money paid in premiums and the earnings from the investments will cover the death benefit paid out (or even exceed it). Life Insurance company wins again!
Where do you get a Life Insurance quote?
So you’ve read all the above and it all makes sense. It sounds reasonable even – so where do you go now to figure out how much you might pay and what the insurers would offer?
Over to you…
How does Life Insurance work? It doesn’t really matter. What really matters is that you buy a policy that can protect your family from financial hardship should you die unexpectedly.
Make sure you have a suitable amount of cover in place. You don’t want to leave your loved ones saying “is that all there is?” as they wonder why there aren’t more zeros on the life insurance cheque.
Want some guidance on putting the correct cover in place? Complete this questionnaire and we’ll be right back to you.