How Does Life Insurance Work? What It Is and What It Covers

Life insurance is a contract where you pay premiums and the insurer pays a tax-free death benefit to your beneficiaries when you die. The death benefit covers funeral expenses, outstanding debts, mortgage payments and income replacement. Your beneficiaries can use it for any financial need.

Life insurance comes in two main types: term and permanent. Both pay death benefits if you die while covered. Premiums stay the same throughout the policy period. Most people just need term life.

Rates are based on average monthly quotes for 40-year-old nonsmokers with average weight and health across insurers, based on MoneyGeek's analysis of composite quotes for a $500,000 policy. Term life figures use a 20-year term length.

Variable life insurance is another type of permanent coverage. It lets you invest your cash value in market-based subaccounts, so your cash value and potential death benefit can grow faster than whole life insurance, or shrink if the investments perform poorly. Indexed universal life insurance works differently: it ties growth to a stock market index with a cap on gains instead of direct market investment. 

Guaranteed universal life guarantees the death benefit to a set age, often 100 or 121, with little or no cash value growth. Final expense insurance is a small, guaranteed permanent policy sold without a medical exam.

You pay premiums to keep your policy active. When you die, your beneficiaries submit a death certificate and the insurer pays the death benefit within 14 to 60 days.

Your age, health, coverage amount and policy type determine your cost. Insurers assess your risk through a medical exam and health questionnaire. Younger, healthier people pay less. Your rate locks in once approved and stays the same as long as you pay on time.

Term life insurance covers you for 10, 20 or 30 years. Your beneficiaries get the death benefit if you die during the term. If you outlive the policy, coverage ends with no payout. Term policies cost less because they cover a shorter timeframe.

You can name anyone with an insurable interest in your life as your life insurance beneficiary: your death would create a financial loss for them. Common choices include a spouse, children, a trust or a charitable organization. 

Naming a trust as a life insurance beneficiary, rather than a person, directly controls how and when a minor child receives the money, rather than as a lump sum at 18. You can name more than one beneficiary and set the percentage each one receives, and you can change your beneficiary at any time by submitting a new form to your insurer.

Life insurance covers death from illness, accidents and natural causes. Your beneficiaries get a tax-free lump sum they can use for:

• Immediate expenses: Funeral and burial costs ($7,000 to $15,000)
• Outstanding debts: Mortgage balance, car loans, credit cards
• Ongoing expenses: Monthly bills, groceries, childcare
• Future needs: College tuition, income replacement for five to 10+ years

Insurers pay the death benefit no matter how you die, as long as the cause isn't listed in the policy's exclusions.

Every life insurance policy excludes specific circumstances. Common exclusions include:

• Suicide within two years: A suicide clause blocks payout if death occurs by suicide within the policy's first two years. After that period, suicide is covered like any other cause of death.
• Misrepresentation on your application: If you die from a condition you didn't disclose, the insurer can deny the claim, particularly within the first two years.
• War and terrorism: Policies exclude deaths from acts of war or terrorism.
• Criminal activity: If you die while committing a felony, the insurer may deny the claim.
• Risky activities: Some policies exclude deaths from high-risk activities like skydiving or BASE jumping unless you add extra coverage.
• Beneficiary involvement: If a life insurance beneficiary causes the policyholder's death, that beneficiary loses the right to collect the death benefit. Proceeds go to contingent beneficiaries instead.

Life insurance underwriting is the process insurers use to evaluate your risk and determine whether you qualify for coverage and how much you'll pay. The insurer reviews factors like your age, health history, medical exam results, prescription history, tobacco use, occupation and lifestyle.

This review takes two to six weeks for policies requiring a medical exam, while some no-exam policies can approve applicants within 24 to 48 hours.

You can file a life insurance claim in three steps:

1. Get a certified copy of the death certificate. The funeral home can order multiple copies. Request at least two, one for the insurer and one for your records.
2. Notify the insurer. Call the claims department or submit an online notification. Have the policy number ready.
3. Submit the claim form. Complete and return the insurer's claim form along with the death certificate and the original policy document if available.

A few things can slow the process down:

• Contestability period. Deaths that occur within the first two policy years trigger an investigation before the insurer pays.
• Missing beneficiary designation. No named beneficiary means the death benefit goes to the estate, which must clear probate and can delay payment for months.

Many states require insurers to pay or deny a claim within 30 days of receiving a complete submission, though timelines vary. Keep policy documents and insurer contact information somewhere your beneficiaries can find them.

Life insurance rates average $30 per month for a 20-year-old woman and $36 for a 20-year-old man on a term policy, which is the most affordable policy type across all age groups. Whole life costs the most, averaging $303 per month for a 20-year-old woman and $337 for a 20-year-old man. 

Age drives costs up sharply regardless of policy type. A 60-year-old woman pays $286 per month for term coverage, nearly 10 times what a 20-year-old pays. The table below shows average monthly costs by policy type, age and gender for a nonsmoker in average health with $500,000 in coverage. Rates vary widely by provider, so request multiple quotes before purchasing your policy.

Once you know the policy type and coverage amount that fits your situation, the path forward is straightforward. Get quotes from at least three insurers, as rates for the same coverage can vary by hundreds of dollars annually across carriers.

When you're ready to apply, name a specific person as your beneficiary and store your policy documents somewhere your beneficiaries can find them. Review your coverage after any major life change.

If you're still weighing your options, our tools and guides can help you take the next step with confidence:

• Life Insurance Calculator: Estimate your coverage need based on income, debts and dependents.
• Best Term Life Insurance: Find the top-rated term policies for your age and health profile.
• Best Whole Life Insurance: Find the best whole life insurance companies for your needs.
• How to Buy Life Insurance: Learn the step-by-step process and what you’ll need to get life insurance.