Fact CheckedIf you’re googling how life insurance works, you’re likely looking to purchase a policy and want Cole’s Notes on how it all works. Sometimes, agents forget that not everyone lives and breathes this industry.
Whatever your questions, I will try to give you the answers you seek.
So, let’s examine life insurance basics right now!
How Does Term Life Insurance Work
How does life insurance work? Well, that’s a simple question with a complicated answer. But to avoid confusion, I am starting with the most affordable and straightforward form of coverage: term life insurance.
For most people, term life insurance works a charm. It provides temporary protection to cover income should a worst-case scenario unfold. Think about it: “term” is the root of “terminate.” By its nature, this protection is designed to expire. If you have kids or debt and your paycheck is needed to keep the show on the road, term insurance protects you over the 10, 20, or 30 years your dependents are most vulnerable.
While most people live until the end of their policy, some don’t. Sadly, I have friends and family that have died without life insurance. This sort of situation is tough for families to handle.
The loss of a primary breadwinner often results in the loss of a family home and inconceivable lifestyle changes.
The 2020 pandemic pushed that reality home for most of us. If you’re like me, your business either stopped or stalled, and that was just a tiny taste of what happens when your income ceases to return.
“Term life insurance can help you bridge that gap for decades at a relatively low cost. If you die while the policy is in force, you’ll leave behind a lump sum of cash for whomever you choose. Since term life insurance doesn’t last forever and has no investment component, it’s typically much cheaper than whole life insurance.”
Term Life Insurance: Traditional Coverage
Term life insurance is available in various packages, and I’ll begin by discussing the traditional version. The great news is, it’s affordable, which means most families I work with can purchase sufficient coverage.
When clients contact me, we initially review their financial situation to calculate the amount of coverage required to maintain their family’s current standard of living. This figure often surprises people.
How Much Money Do You Need: Face Value
The industry standard for income replacement is 7 – 10 times your gross salary in protection (this is known as the face value). When you crunch the numbers, you realize that $100,000 of coverage may seem substantial, but this amount can be quickly depleted after a person’s death.
Once we determine the policy’s face value, typically in increments of $100,000, $250,000, $500,000, and $1 million, we assess how long the coverage is needed.
Ivari “(Formerly Transamerica Canada), has a compelling online insurance calculator that can give you insight into how much coverage you really might need.”
How Long Do You Require Coverage: Term
The length of time you need coverage is called the term. Typically, clients select 10, 20, or 30-year periods. Choosing your term is very important. Unfortunately, I have witnessed clients choosing a shorter term, such as 20 years, because they think their needs won’t change over time. However, sometimes the need for life insurance surpasses your initial estimate. What then?
If you are younger and in great shape, it’s not too much of a worry. You pay LESS than you did 20 years ago because the risk to insure you is now lower. Why? People living longer, advances in healthcare, and more competition have made life insurance more affordable than ever!
The real issue arises if you are sick or older; life insurance may become much more expensive or even unobtainable. If in doubt, select a longer term. Remember, you can cancel your coverage if you no longer need the protection.
The Medical Review is Your Next Step
The next step is the medical questionnaire your agent reviews with you.
Whether you do this over the phone or in person, this question-and-answer session with your independent agent is critical. It helps the life insurance company determine your accurate rating class and price. Your rating is the risk a life insurance company assigns your particular medical situation, and it determines your premiums (how much you will pay monthly, yearly, or in a lump sum).
To give you an idea, approximately 80% of all life insurance applicants in Canada will receive standard rates or better. A standard rate is reasonable; that’s what I have. To be eligible for Preferred or Elite rates, you must be healthy and have no family history of serious disease before age 65.
Typical ratings are standard, preferred, and preferred plus. The better your rating, the cheaper your premiums.
Take me for example. I’m healthy; I go to the gym regularly, jog outside when the weather’s good, and do not take medications for any health issues. Wouldn’t you consider me a good candidate for a preferred health rating? Not so fast. Because there’s a history of cancer in my family (my mother and sister), I can never achieve better than a “standard” health rating when I apply for life insurance. This would be true even if I were an elite athlete on a strict vegetarian diet.
Remember, if an agent quotes your preferred life insurance rates, there’s no guarantee you’ll get them. It’s entirely up to the underwriters, so don’t let anyone tell you otherwise. Not to mention, preferred or elite rates are offered on minimum coverage amounts depending on the carrier. For example, the standard rate may be best if you apply for $250,000 for the 20-year term.
One more thing I would like to mention – it’s SUPER important for you to be as truthful as possible about your medical issues. Hiding or misrepresenting anything is a fraud, which means when you die, your beneficiaries (person/people you select to benefit from your policy) won’t get a dime.
Traditional life insurance often requires a medical exam
This is one of those things that some of my clients loathe. I’m not sure why because it’s a straightforward process. I wrote an article about how most people are healthier than they think. So, the fear is, for the most part, baseless.
Also, depending on your health, age, and the coverage you apply for, you may not be required to do a blood or urine test. Some carriers, like Empire Life, issue you a policy after you’ve successfully answered the questions on their e-application. Some applicants are required only to do a phone interview with a nurse practitioner. Depending on how the health interview goes, you may or may not be required to do additional tests. The life insurance company always reserves the right to have you do blood and vitals.
Please take note of the following information:
Your independent life insurance agent will schedule a convenient time for a medical test to be conducted in your home. A nurse arrives at the agreed-upon time to collect a urine and blood sample, measure your height and weight, check your blood pressure, and ask you some health-related questions. It’s important to note that the insurance company covers the cost of the test, regardless of whether you end up purchasing the insurance. To maximize the results of your physical, there are a couple of things you can do:
1. Schedule the exam first thing in the morning
2. Don’t eat anything before the exam
3. Drink plenty of water on the day of the exam
4. Get a good night’s rest
5. Clean up your diet a couple of weeks before the exam
6. Avoid caffeine 24 hours before the nurse arrives
7. Avoid working out the night before your medical
After this, your information is sent to labs for analysis, and underwriters receive the results. An underwriter is a professional trained to assess the risk of insuring applicants.
“The exams “really provide a source of data that has a significant protective value for life insurance writers,” Boylan says. The exams can confirm the information provided on the application, or reveal health issues that applicants aren’t aware they have or might not have disclosed. The full medical underwriting process can help group applicants into health classes, which determines what their rates will be. Those who are healthier pay lower rates for coverage.”
Underwriting & Your Premiums
As I mentioned in most of my articles, not all life insurance companies are created equal. To compete, they develop niches. For example, one company may be lenient regarding type 2 diabetes, while another may be very strict.
This is where the advice of a GREAT independent life insurance agent comes in.
We know which companies work best for specific medical conditions, and this changes all the time.
If I doubt a client’s circumstances, I shop their profile to different underwriters to see how they would handle the application. This saves time, money, and a potential denial.
One of life insurance’s most important decisions is picking the right insurer. This can mean saving thousands of dollars over the term.
How Does Life Insurance Work: Simplified Issue & Guaranteed Issue Coverage
So what if you have a phobia of needles – or maybe you have more serious medical issues and fear being rejected?
Well, I have some good news for you.
You can get coverage without a medical exam. There are two different approaches.
Simplified Issue
The first is simplified-issue life insurance. While you don’t need to complete a medical exam, you must answer particular health and lifestyle questions. These questions help underwriters classify your eligibility and assess your premiums.
Simplified issue policies are marginally more expensive than traditionally underwritten policies, but this is changing and becoming increasingly affordable. We will be moving toward issuing more simplified policy issues in the future, especially after the coronavirus.
Guaranteed Issue
If you don’t qualify for Simplified, guaranteed issue may be your only option because everyone qualifies. This Tier of coverage is for people with serious health issues like life-threatening cancer or dementia. As you can imagine, this is more expensive coverage as the insurer takes on much more risk. You are added to a pool of higher-risk applicants with moderate to serious health conditions. This is a way for the insurance companies to cover their butts.
All guaranteed-issue life insurance typically comes with a two-year waiting period. If you die of natural causes within the first two policy years, the insurance company will refund your beneficiaries all the money you paid into the plan. After the policy has been in force for two years, you’re covered for the full death benefit regardless of the cause of death.
Both of these types of coverage have their place. Simplified issue is available as term or whole life insurance. It works well for those with mild to moderate health issues or clients who want coverage immediately and don’t have time to wait for underwriting.
Guaranteed insurance is a fantastic option for those with serious medical conditions that would otherwise make them uninsurable. Both simplified and guaranteed insurance are wonderful tools for final expense planning.
Read more here if you are looking for burial coverage.
How Does Life Insurance Work: Permanent Life Insurance
….and that’s not all! There are even more choices.
If you want coverage for life and cash value accumulation, check out permanent life insurance. As I mentioned above, term insurance works as a safety net to cover lost income during periods of vulnerability. Permanent life insurance provides your beneficiary with some cash, no matter what.
This is a highly complex product and costs a lot more because there is a guaranteed payout. Does this permanent insurance work for most people? Nope…but there are exceptions.
Whole Life Insurance
If you are thinking about whole life coverage, I don’t suggest it unless you:
- Have an estate you want to protect from burdensome taxes
- Are you a business owner with excess cash
- Own a property you would like to pass down to a family member
- Have exhausted all your tax shelter options
- Need to create a trust for a child or dependent with special needs
- Would like to set up a charitable gift
- Would like to start a policy for a child and gift it to them as an adult
- Are looking at final expense coverage
You get the picture. If you want to buy a whole life policy, you should have some cash.
But there are exceptions, and this is one of the most important! If you are looking to cover the costs emanating from your death, final expense plans are very affordable and help many of my clients protect their families.
Universal Life Insurance
Universal life insurance is another form of permanent insurance similar to whole life insurance because it has a cash value feature.
…but that’s where the similarities end.
It’s a complicated product with different products. If you think this is the route you want to take, it’s best to consult an independent agent. Click here for my article about universal life insurance to find out more now.
Term 100 Life Insurance
I bet you wonder why I write about term coverage in the permanent insurance section. Well, that’s because Term 100 is permanent insurance. It covers you until the day you die.
A term 100 policy has no cash value. You pay the pure cost of the insurance, and your monthly premiums are guaranteed never to increase.
While it does adhere to the term insurance template, your beneficiaries will receive death benefits.
What Happens When You Die?
Well, this is a great question. If you have a term policy and die during your term, your beneficiaries receive a tax-free cheque from the insurance company. This is one of the most significant benefits of life insurance.
The payment is made in one lump sum, but there are ways to distribute the money over time.
If you pass away AFTER your term has expired or BEFORE your two-year waiting period is over (this may be part of your policy, but it’s not always the case, so be sure to read the fine print)…
….your beneficiaries won’t receive a payout because you are not covered.
If you have a permanent policy, your family receives a payout, provided you’ve kept up with all your payments.
Are Payouts Ever Denied?
Not usually. That said, there are rare exceptions for the following:
- Fraud: If you lied on your application or left something out, the insurer may investigate the claim and deny a payout if they find something awry
- Suicide: If you commit suicide in the first two years, your claim will be denied
- Lapse of Payment
Rest assured, life insurance is a regulated industry, so this doesn’t happen often. For the most part, claims go off without serious issues.
If You Are Wondering How Life Insurance Works
You Need to Speak to an Independent Agent
Now that you know some of the basics, it’s time to call an independent life insurance agent (hint, hint, Policy Architects is good at this).
Why? We can save you thousands! It’s essential to pick the correct type of insurance, choose adequate coverage, and select the right company for your needs.
Remember, not all life insurance companies are created equal. They all offer different products and specialize in different areas. That’s why you must consult someone knowledgeable before signing the dotted line.
This is especially true when things are uncertain. Call us today with questions about your insurability or how the coronavirus impacts the insurance industry. We can help!
