How does life insurance work?

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Life insurance is one way you can provide financial support for loved ones after you die. When you open a policy, you will pay a regular premium – often monthly or annually – in exchange for coverage. As long as your policy is active when you die, the insurance company will pay out a lump sum, also known as a death benefit, to the policy beneficiaries.

Even though many life insurance policies work the same way, each type has significant differences that further define how they work, including how long the coverage lasts, if the policy includes an investment component, and whether or not you can access funds before your death. Understanding these differences can help you select the best policy for your needs.

What Does Life Insurance Cover?

Unlike other insurance policies, which typically dictate how the policyholder can use a claim payout, life insurance benefits can cover a wide variety of expenses. In many cases, policyholders invest in a policy to replace their income and ensure that their beneficiary can meet financial obligations, including

End-of-life expenses, such as funeral and burial costs
Mortgage payments
Tuition payments
Personal debt, including outstanding loans or credit card bills
Day-to-day expenses, like groceries

Financial obligations aren’t the only way to use death benefit funds, however. Some individuals choose to open a life insurance policy to build an inheritance for their children or make a charitable donation to the policyholder's organization of choice.

Depending on the policy you choose, you may also be able to use the funds to manage expenses while you’re alive. For instance, if you have a whole or universal life policy, your insurer will likely let you borrow against it to fund expenses like your child’s college tuition or make a down payment on a house. However, keep in mind that if you do borrow against your account, the full death benefit may not be available if you die before paying back the funds.

What Doesn’t Life Insurance Cover?

Life insurance covers most causes of death, including natural and accidental causes, suicide, and homicide. However, some caveats may prevent your beneficiaries from receiving their payout.

There are two common reasons why an insurer may deny a life insurance claim: a lapse in payment or misrepresentation of the insured’s health.

If health information is misrepresented or omitted, insurance providers may deny a claim. That is particularly true during the contestability period, which is typically a two-year window after the policy begins.

In addition to those common causes, an insurer may deny a claim based on the circumstances of the death. For instance, if the insured dies by homicide, the insurer may not cover the claim if the beneficiary is responsible for or involved in the victim’s death.

Life insurance policies also frequently include what’s known as a suicide clause, which voids coverage if the covered individual dies by suicide within a specific period, often two years, after opening a policy.

Finally, some insurance providers will deny claims if the insured dies while engaging in a high-risk activity, like skydiving, at their time of death. As such, it’s important to discuss life insurance coverage limitations with your agent or broker before purchasing a policy.