How Does Life Insurance Work?

You get life insurance by buying a policy (a contract). When you do so, you join a risk sharing group. The company promises to pay, at the time of your death, a sum of money to the person or persons selected by you (the beneficiaries), who are named in the policy. This promise is given in return for your agreement to pay a sum of money (the premium) to the company over a specified period of time.

The principle governing life insurance is easy to understand. It is possible to determine approximately how long a group of people will live. For example, the average lifespan of a group of 37-year-old men who are non-smokers, who exercise regularly, aren't overweight and whose parents and grandparents lived normal life spans, can be foretold with reasonable accuracy. Mathematicians cannot tell when a specific person in the group will die, but they can estimate the approximate number of people who are likely to die the first year, the next year and so on, until the last of that generation. Insurers gather information about applicants -- such as age, gender, health, occupation and hobbies -- so that they can group together people with similar characteristics and calculate a premium based on the group's level of risk. Those with similar risks pay the same premiums. This process is known as risk classification or underwriting, and by providing equal treatment for equal risks, it allows insurers to treat all policyholders fairly.

Life insurance companies gather the information they use to determine premium levels by having potential policyholders complete an application. Understandably, insurance applicants and policyholders have concerns about the confidentiality of medical and other personal information given to insurers. The insurance industry has a long history of safeguarding sensitive information, such as evidence of chemical dependency or alcoholism, or cancer or some other life-threatening condition. This respect for personal privacy and medical confidentiality extends both to people applying for insurance and to policyholders.