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How to read a life insurance policy

How to read a life insurance policy

Most people who buy life insurance do so with the aim of providing financial resources for loved ones after they die.

But if you don't read and understand your policy, your loved ones may end up with less financial security than they need.

A life insurance policy is a contract with an insurance company in which you pay premiums in exchange for a lump-sum amount of money after you die. The money, also called a death benefit, goes to your beneficiary, a person or entity that you designate to receive it.

Even if your insurance agent explained your coverage, it's important to read your policy to make sure you have what you think you have, says Tony Steuer, an insurance literacy advocate and author of "Questions and Answers on Life Insurance: The Life Insurance Toolbook."

Here are eight tips for making sure you have all that you bargained for.

1. Check the length of coverage.

Life insurance is not a one-size-fits-all purchase. Different types of policies offer different types of coverage.

Term life insurance -- the least expensive type -- covers a set period of time, such as 10 or 20 years.

Permanent life insurance policies provide coverage for your entire life as long as you keep paying your premiums.

If you have permanent life insurance, your policy will include a face amount, which is how much your policy will pay out when you die, and a cash value amount, which is an amount that you'd be eligible for if you decide to cash out the policy before you die.

2. Read over how your death benefit is calculated.

The type of life insurance policy you have determines how your insurer comes up with the death benefit.

With term life insurance, you have a guaranteed death benefit for a set premium. So as you pay your premiums, your beneficiaries receive a designated amount if you die before the policy term ends.

When it comes to permanent life insurance, it gets a little trickier since there are different types of policies.

  • Whole life insurance provides a guaranteed death benefit for a set premium.
  • With variable life insurance and variable universal life insurance, the money that you pay in premiums is invested so the death benefit could change based on how the investments perform.
  • Finally, with universal life insurance, you can adjust your premium payments, as well as the amount of your death benefit, over time.

3. Learn the jargon.

A lot of people understand what life insurance is supposed to do, says Scott Kallenbach, director of strategic research for LIMRA, a research and consulting firm that focuses on the insurance industry.

But when it comes to words and phrases that are considered industry jargon, "that's where people run into trouble."

Your life insurance policy should include a section that contains definitions of industry terms that are used in the policy.

4. Don't bypass the illustrations.

Life insurance policies typically include tables that show how your death benefit, cash value and, in some cases, premiums may change over time. Review the illustrations and make sure they match what your agent told you and what the rest of the policy promises, Steuer advises.

5. Go over your rights.

As the owner of a life insurance policy, your privileges are laid out in the policy.

You typically have a short period of time, such as 21 days, to return the policy for any reason. You also have the right to change your beneficiary at any time.

However, there’s an exception to that rule. If you have what’s known as an irrevocable beneficiary, you must get that person’s consent before you can replace them as beneficiary with someone else. 

Depending upon the type of insurance policy you have, you may also have the right to withdraw from or borrow against the cash value of the policy.

Also check whether your policy has a grace period -- an amount of time, typically around 30 days, in which a payment can be late before the policy lapses.

6. Review the basics.

The Declarations Page or Schedule of Benefits is the part of your policy that summarizes your coverage. It includes such basic information as the name of the person insured, the amount of the premiums and the amount your loved ones will receive after your death.

The Insuring Agreement breaks down the coverage in more detail. This is where you'll find illustrations, definitions and information about how the death benefit will be distributed.

7. Look for exclusions.

As with most types of insurance policies, there are certain risks or perils that your insurance provider might not cover. For example, most insurance policies won't pay your beneficiaries if you commit suicide.

Your insurer also may not pay your beneficiaries if your death was caused by a risky lifestyle behavior that you did not inform the insurer about when you applied for the insurance. For example, if you died of a drug overdose and it was found that you regularly took recreational drugs, your insurer could refuse to pay if that information was not included on your life insurance application.

If you participate in extreme sporting activities such as skydiving, you may have to pay a higher premium in order to be covered. Check your policy to see if any other causes of death are excluded.

8. Go over settlement options.

Your settlement options are what your beneficiaries must do to file a claim and how the money will be distributed.

There are two types of beneficiaries:

  • Primary beneficiaries are those who receive the death benefit after you die.
  • Secondary beneficiaries are those who would receive the death benefit if the primary beneficiary dies before you do. 

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