How does life insurance work?

Life insurance provides a way for people to insure their life - particularly if they are the main breadwinner in a family - so that some or all of the debts normally covered by their income are paid off with a cash lump sum if they die within the terms of the policy. Although it can't prevent the trauma associated with the death of a loved one it can provide a 'financial cushion' at a difficult time. Life insurance policies can also include cover that pays out on diagnosis of a critical or terminal illness as an added option or a standalone policy.

The cost of all life insurance policies are based on the amount of 'risk' you are perceived to be by the insurer. Insurance providers decide the cost of your premiums by calculating the likelihood of them having to pay out. That's why if you are younger, in good health, and don't smoke, for example, you're more likely to get a better rate than 'higher-risk' candidates.

When you're looking for life insurance there are three key factors to take into consideration: What you want the insurance to cover, how long you need it for and what monthly premium you are prepared to pay.

What do you want your life insurance to cover?

If you have a mortgage, debt repayments or other longer-term commitments you might want to make sure that these repayments are paid off by your policy. By getting the right amount of cover you could maintain your family's standard of living and provide for them - even after you've gone.

How long do you need the cover to last?

You can choose how long you want your cover to last, but bear in mind that the longer the term, the higher your premiums are likely to be. This is because the probability of you claiming increases the longer the insurance runs for.

How much can you pay towards your life insurance?

Look at the monthly payments you wish to cover to get an idea of the total amount and length of time you'll need your insurance to last. Next, decide how much you can put towards your life insurance each month so that when you ask an insurance agent to compare quotes you'll have a benchmark to compare each one against.

Image © iStockPhotos / Courtney Keating

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