What is the Basic Principle of Life Insurance?
Life insurance is used all around the world to provide financial protection and act as a tool of investment. While there are dozens of different types of life insurance policies on the market, the principle behind them all is much the same. Life insurance is a contract that exists between a policy owner and an insurer, normally in the form of an insurance company.
The person who owns the insurance policy agrees to make ongoing financial payments to the insurer at regular intervals, in exchange for a promise on behalf of the insurer to pay a designated beneficiary a sum of money upon the occurrence of the insured person's death. While this is the basic principle behind all life insurance contracts, things do get more complicated when life insurance is used as an investment, and when the person who owns the insurance policy is not the same person as the insured party.
Life Insurance Categories
The basic division between different types of life insurance splits up policies into either protection policies or investment policies. Protective life insurance is the original form of life insurance, and is designed to provide people with a lump sum payment at the time of death. While all life insurance includes this protective element, investment policies also allow people to facilitate the growth of capital by drawing from their policy proceeds in the form of withdrawals or loans. The most common type of protection based life insurance is known as term insurance or temporary insurance, while the most common investment policies include whole life insurance, universal life insurance, variable life insurance, and endowments.
In terms of the mechanisms of a life insurance contract, it is easiest to understand how it works in terms of the individual parties involved in a life insurance contract. There is either three of four entities involved in a life insurance policy, depending on whether there is a difference between the policy owner and the insured person. Apart from these two entities, the other parties involved are the policy beneficiary and the insurance company. While the policy beneficiary is not a party to a life insurance contract per se, they are a necessary and important part in any life insurance agreement. Life insurance is based on the principle of risk management, where a person pays a premium in order to manage the risk of death and receive financial protection in the case of death.
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