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Life Insurance Decoded

Aug 6, 2008
Simply put, life insurance is bought to make sure your dependents are financially secure when you pass away. Premiums are paid to the life insurance company and the company takes the premium money and invests it. When the person paying the premium (the insured) passes away, the insurance company pays out that individual's beneficiary.

Although it may sound simple, purchasing the appropriate life insurance policy is not as straightforward as is seems. In the past few decades life insurance has served as a basic building tool for the constantly changing variety of financial planning.

Some of the pros of buying a life insurance policy include: providing a financial safety net for your dependents, replacing your income or salary with a non-taxed death benefit, and reducing the financial pressures placed upon your family in the event that you pass away. A life insurance policy can aid in putting your children though college, paying your mortgage, bills, funeral expenses, estate taxes, or other debt.

Generally when life insurance is purchased, it's the policy solely, not stocks, bonds, or securities. It is technically illegal for a life insurance agent to sell insurance by referring to it as an investment. Although cash value can be accumulated with some policies, the interest on the cash value is not usually very significant. Dividends and other benefits are typically not guaranteed and definitely are not predictable. Some policies, however, will permit the insured to invest their cash value into various securities.

Now that you are more familiar with the function of life insurance, it may be helpful to understand how life insurance is different from other kinds of insurance. The primary difference is that other types of insurance protect people from situations that might happen, such as auto insurance. Auto insurance protects against potential car accidents, regardless of fault, stolen cars, or break-ins. Health insurance is in case you get sick or injured. If the auto or health insurance is not used, the premiums paid by you go to cover claims by other parties who are also insured by the insurance company.

A life insurance policy is different from these types of insurance because it insures people for a guaranteed event, as opposed to hypothetical events. Although it is unpleasant to think about, death is inevitable, and life insurance is the one kind of insurance that exists because of it.

Life insurance is also different because the insured purchase the policy to protect somebody else, while auto and health insurance protect the owner of the policy. Due to tax consequences, it would be unwise to be the beneficiary of your own policy.

Life insurance companies pay out their insured parties by deducting the funds from a life insurance pool. This pool is made up of all of their policy holders, and the premiums paid go into this pool. The life insurance company guarantees payment to each member of the pool as long as their premiums are always paid.

Some people worry that something could happen to them before they get a chance to pay their premium. Life insurance companies realize this risk, and account for it in the unfortunate event that you pass away shortly after purchasing your policy. The company assumes you will live a long life, and the premiums paid will cover the company's pay out. But in the event that the premiums do not, that financial responsibility remains in the hands of the insurance company.
About the Author
Sarah Martin is a freelance marketing writer based out of San Diego, CA. She specializes in travel, leisure, home improvement, life insurance, and fine wines. For a free life insurance quote, please visit http://www.equote.com.
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