How Does Life Insurance Work?
Life insurance is designed to give peace of mind. It is a policy that pays a cash lump sum if you die during the cover term, helping your loved ones manage financially. But how does it actually work in practice? In this guide, we explain how premiums are set, what happens when a claim is made, and the different options available.
How do you set up life insurance?
When you apply for life insurance, you choose:
The amount of cover (the payout your family would receive)
The policy length (how many years the cover lasts, unless it is a whole-of-life plan)
The type of cover (for example, level term or decreasing term)
The insurer then asks for information about your health, lifestyle and age. This helps them calculate your monthly or annual premium. In some cases, a medical check may be required.
How do life insurance premiums work?
Premiums are the regular payments you make to keep your policy active. They can be:
Guaranteed premiums, which stay the same for the whole term.
Reviewable premiums, which may change after a set number of years, often increasing as you get older.
Generally, the younger and healthier you are when you apply, the lower your premiums will be. Smokers, people with certain medical conditions, or those in high-risk jobs may pay more.
What happens if you die during the policy?
If you die while your cover is active, your insurer pays the agreed lump sum to your chosen beneficiaries. They can use this money however they need, such as paying off a mortgage, covering household bills, or securing your children’s future education. If you outlive the policy term, the cover simply ends with no payout. Whole-of-life policies are different, as they guarantee a payout whenever you die.
What happens if you stop paying?
If you miss payments, your policy usually lapses and your cover ends. You would not get back the premiums you have already paid. For this reason, it is important to make sure your life insurance fits comfortably within your budget.
Are claims always paid?
The vast majority of life insurance claims are successful. According to the Association of British Insurers (ABI), well over 95% of claims are paid out each year. The most common reasons for a claim being declined are non-disclosure (not sharing important health or lifestyle details when you applied) or the policy not being active at the time of death.
How do you choose beneficiaries?
Beneficiaries are the people who will receive the payout on your death. Many people choose their spouse, partner, or children. You can nominate your beneficiaries through your Will or alternatively you can also write the policy into a trust, which can help with inheritance tax planning and make the payout quicker.
How does life insurance fit into financial planning?
Life insurance is one piece of a wider financial safety net. Alongside it, you may consider:
Critical illness cover, which pays out if you are diagnosed with a serious condition.
Income protection insurance, which provides regular payments if you cannot work due to illness or injury.
Together, these can provide comprehensive protection for different scenarios. For more context, see our related blog: What is Life Insurance?
Key takeaways
Life insurance works by paying regular premiums to keep your cover active.
If you die during the policy term, your beneficiaries receive a tax-free lump sum.
The amount you pay depends on your age, health, lifestyle, and type of cover.
Claims are usually paid as long as accurate information was given when applying.
Life insurance works best when considered alongside other types of protection.
FAQs
Do you get your money back if you do not die during the policy? No, standard life insurance policies do not refund premiums if the term ends.
Can you change your cover once a policy starts? Some insurers allow changes such as increasing cover when you move house or have children, but it depends on the policy terms.
Is the payout taxable? The payout is usually free from income tax, but inheritance tax may apply if the policy is not written in trust.
Do I need a medical exam? Not always. Many policies are agreed based on a questionnaire, but some applications may require a medical check.