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Life Insurance Basics

Updated: Feb 16

Life insurance is an important financial concept to understand. In this article I will seek to introduce the concept of life insurance. In doing this, I will provide an overview of the concept, some key definitions, and how to best utilize it in one’s financial portfolio.

Insurance can be defined as the transfer of risk. Insurance is a contractual obligation, which means that there is a contract existing between two parties. A legal contract requires a couple of things: 

  • Legality: The contract must not break laws.

  • Consideration: What each party brings to the table.

  • Capacity: A legal person must make the contract, so a person in a coma cannot legally sign a contract.

  • Agreement: The parties must agree to the terms of the contract.

In the insurance world, legality would include insuring legal things (so one cannot insure contraband). The policy owner’s consideration is the monthly premium, and the insurer’s consideration is the death benefit. Life insurance is the transferring of financial risk at one’s death to the insurance company. When someone takes out a term life insurance policy, they will pay monthly (or annual) premiums to an insurance company which will then pay out a death benefit if one dies during the term of the policy. Agreement happens when the policy owner and the insurance company agree on the terms of the policy.

A few key terms to know concerning life insurance:

  • Insurer: The entity taking on the risk of the insured.

  • Insured: The entity transferring the risk to the insurer.

  • Policy Owner: The owner of the insurance policy.

  • Insurance Policy: A contract between the insurer and the policy owner in which risk is transferred from the insurer to the insured

  • Premium: The monthly (or annual) payment from the policy owner to the insurer.

  • Face Amount: The amount of risk that the insurer takes on.

  • Death Benefit: The total amount that will be paid out to the beneficiary.

  • Beneficiary: The one who benefits from the policy (usually family).

  • Term Life Insurance: A life insurance policy in which the insured is insured for a set period of time.

  • Term: The amount of time the insurer insures the insured (usually 10, 20, or 30 years).

  • Permanent Life Insurance: Life insurance that stays in place as long as premiums are paid and the insured is living.

  • Cash Value: The value the policy has accumulated (usually only permanent life insurance policies can have a cash value).

So now that we have seen a brief overview of life insurance and defined some key terms, we will now look at how to best utilize life insurance in one’s financial portfolio. Before we look into policies, we first need to determine one’s insurance needs. To do this we calculate something called a “DIME-F” number. Here is a breakdown of the “DIME-F” number:

  • D – Debts (consumer and credit card debt, student loans, etc.)

  • I – Ten years of income

  • M – Mortgage

  • E – Education for children (normally around $40K per child)

  • F – Final expenses (funeral and other expenses relating to one’s death)

Consider the following DIME-F number from a fictional man named Bob who is representative of the average American:

Bob’s total insurable need is $1,171,000. So if Bob had a $75,000 group life policy from his employer (one year’s salary), he would be under-insured by over $1,000,000! The average American is grossly under-insured or uninsured. The main reasons for this are misconceptions as to cost, debt forgiveness, taxes, and insurable need. Life insurance doesn’t have to be complicated. It is a wise financial transfer of risk for the vast majority of people, providing security and safety for one's family posthumously.

Schedule an appointment with anyone here at Dominion Wealth Strategists and we'd be glad to talk through life insurance with you.

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