What is Life Insurance?
Life insurance, also called life assurance, is used to safeguard the financial security of dependents and loved ones should you pass away.
You enter into a life insurance contract or policy, which is a legal agreement between you and an insurance company. The policy owner agrees to pay a monthly or annual insurance premium in return for a lump sum of money paid out upon the insured’s death, known as the death benefit.
Types of life insurance
Although there are many variations, there are three basic forms of life insurance: term, permanent, and guaranteed.
Term life insurance can be purchased for a set period of time, and exists to take care of temporary needs like mortgages, business obligations, taking care of small children, and other debt. There are several variations of term life insurance:
- Renewable term life insurance: At the end of a set term, your coverage automatically renews. For example, if your coverage expires after five years, you are automatically renewed into another five-year term. Be sure to compare life insurance quotes before your term expires, as your premiums will increase upon renewal.
- Convertible term life insurance: This form of term life allows you to convert your term life insurance policy into a permanent life insurance policy. You typically do not have to pass a medical exam to convert to permanent life insurance through this route.
- Term to a specified age: This type of term life insurance gives coverage to a given age, typically to between 65 and 100. Term to 100 can also be categorized as a permanent plan.
There are also term life insurance policies that allow a combination of both renewable and convertible, giving you more choice.
Permanent life insurance is designed to provide protection for the duration of your life. It’s to cover needs you may have at any point in your life or consistently throughout your life, such as funeral expenses, lifelong dependents, supplementing a survivor’s income, or covering capital gains taxes at death.
Unlike term life insurance, you can accumulate investments inside a permanent life insurance policy. It’s a tax-free shelter, similar to an RRSP or TFSA. A portion of your overall premium goes towards investments that grow over the time of your policy, leaving a larger dividend upon your death.
There are several variations of permanent life insurance:
- Whole life insurance: If you want consistent coverage for your entire life, this is for you. Your premiums stay the same and you have guaranteed cash value accumulation. The investment portion of a whole life policy is chosen for you by the insurance company.
- Universal life insurance: Also called adjustable life insurance, universal life insurance offers more flexibility in payments, payouts, and savings. You can grow or reduce your death benefit, depending on the policy.
- Basic permanent life insurance: There is also basic permanent life insurance that lasts the duration of your lifetime but doesn’t have an investment portion. Premiums are lower than other permanent options, making this a simpler lifelong solution.
Guaranteed life insurance is a separate policy that can be issued to people who are middle-aged or older. (The exact age is dependant on the company.) Essentially, this type of insurance is available with no medical questions asked, including no medical exam. The amount can be less than other types of life insurance, but it’s much easier to get, and can last nearly as long as Term to 100.
How much life insurance is enough?
There is a general rule that five to seven times your annual income should be sufficient for your beneficiaries. However, to be sure, you should take a financial needs analysis. Essentially, this will look at your existing debts, current the financial needs of your survivors—including ongoing assistance, not just at the time of death.
There are many specific factors to consider:
- What is remaining on your mortgage?
- What other loans and outstanding credit do you have?
- What expenses will have to be taken care of, like burial and uninsured medical costs?
- What percentage of your income will your beneficiaries need?
- For how many years will your survivors need financial support?
- Do you need to include specific funds, like an emergency fund, a child-care fund, or an education fund?
- What other assets—stocks, real estate, savings—do you have that could be deducted from the amount you need?
It’s also common for your life insurance needs to shift throughout your life, as you have children and expenses change. A financial needs analysis will keep you on track and should occur every few years to make sure you insurance matches your needs.
What factors influence life insurance rates?
To determine the details of your policy and premiums, the company will ask you a number of questions. Factors that insurance companies take into consideration include:
- Age: The older you are, the more likely it is that you’ll pass away within your term.
- Gender: Men are more likely to be involved in accidents and tend to live riskier lifestyles, so they’re more expensive to insure.
- Coverage amount: The more coverage you want, the more you’ll pay.
- Smoking: Smokers pay significantly higher rates. Most insurance companies will define you as a smoker if you’ve used tobacco, nicotine replacement products, or marijuana within the last 12 months.
- Health: People who are overweight and people who regularly drink alcohol typically pay more for life insurance.
- Illness: Some chronic illnesses will make it more difficult to get life insurance, and some may prevent you from getting coverage altogether. Your mental health will also be a factor.
- Family history: If you’re genetically predisposed to certain conditions, you could pay more for life insurance.
- Job: Some occupations are considered more dangerous than others and can impact how much you pay for insurance.
There are a few factors companies can’t take into account when setting your rates, including illnesses that develop or are discovered after your policy takes effect.
There are some reasons insurance companies could deny you life insurance, including:
- Chronic or terminal illnesses, such as diabetes, multiple sclerosis, HIV/AIDS, cancer, heart disease, stroke, or others
- Mental illness, including severe depression and addiction
- Older than the maximum enrolment age
- Participating in dangerous activities
- Convicted of impaired driving
If you’re turned down for term or permanent life insurance, you could still qualify for guaranteed life insurance.
Be sure to know your policy inside and out, and ask your broker tons of questions; insurance companies could also refuse to pay the death benefit in certain circumstances for a number of reasons, including:
- Non-payment of premiums
- Providing inaccurate information on your application
- If you die due to your own actions, such as suicide or driving impaired by drugs or alcohol
- If you die while doing a dangerous activity, like skydiving or participating in a riot
Should you buy life insurance even if your employer is offering it?
You may notice that in your work benefits, life insurance is included. It’s a nice perk but it may not be exactly what you’re looking for.
To start, look into your policy and the details within. The most glaring downside to employer-provided life insurance is that you’re only covered as long as you’re employed with the company. If you retire or leave the company, your insurance likely disappears immediately.
A company plan is a group plan, meaning the policy is looking at a number of people with different factors than an individual or joint plan. Whereas your own plan only considers your health and age, a group plan considers risk on a broader scale, which could negatively affect you if you’re young and healthy.
Also, most employer life insurance only covers one year’s salary and we stated above that you’ll typically want five to seven years to cover all expenses and ongoing costs after your death. Some plans do allow you to add on more coverage to your existing employer coverage, but this could be more expensive than simply having your own plan.
Generally, you should consider life insurance through your employer a bonus on top of your current plan, not something to rely on.
How to buy life insurance
You can buy life insurance from three main sources:
- Direct underwriters, who work for specific insurance companies.
- Insurance agents, who are independent but only sell the products of one insurance company.
- Insurance brokers, who sell the products of multiple insurance companies.
- Some forms of life insurance are available online.