Life insurance works as follows: you pay a regular sum (a premium) to an insurance company and then they pay out a lump sum, to a named person (beneficiary) in the event of your death.

It is typically used either to ensure that your loved ones are catered for, or to ensure that your mortgage is paid off. The key thing to be aware of is that it only pays out if you die. It won't pay out if you became too ill to work you'd need critical illness cover for that scenario.

There are several types of life insurance policies. I've listed some of the main ones below:

1. Level term life insurance. As a description, level term insurance is a bit jargony for my liking. How it works, though, is quite straightforward. You pay a flat monthly amount for a set period and, if you die during that period, the insurance company will pay out a pre-agreed amount.

An example of how it might be used is where a parent takes out a 20 year policy, with their aim being to make sure that their kids would be financially okay should the parent die whilst they're growing up. The person taking out the insurance hopes that there won't be a need for the policy to be paid out on, but has the peace of mind of knowing that, if the worst happens, their loved ones won't be left destitute.

2. Decreasing term life insurance. With this type of life insurance, your monthly payments stay the same for a set period but the amount that would be paid out decreases every year. This is commonly taken alongside a repayment mortgage, but may also be useful where dependants are expected to grow up and become financially solvent but where you would still want some cover to cater for your spouse should you die.

3. Whole of life policies. These policies are pretty much as the name implies, in that they provide cover right up until death, provided that you've kept up the premiums.

The type of life insurance that's best for you will depend on your personal circumstances and may change as you go through various life-stage events such as getting married, getting a mortgage, having kids, etc. Also, it's worth noting that if you have no mortgage and no dependants, then you probably don't need life insurance as who would you be looking to provide a payout to?

Life insurance is a very important part of many peoples' financial portfolios. It's tempting when we're young and healthy to think that it's not important but if you have a spouse or kids that are dependant financially on you, then it is irresponsible not to make sure that they would be okay in the event of your death. Typically the monthly payments aren't very big and the payment could make a big difference to the people you care for.

Learn more about this author, Simon Wright.
Click here to send author comments or questions.

---

Add your voice

Know something about Understanding life insurance policies?
We want to hear your view. Write now!