What Is Life Insurance?

Insurance is a powerful thing. A lot of things in life can be disastrous to you and your finances: Your house could burn down, you could get sick, or you could total a rich guy’s Ferrari. These things aren’t necessarily likely, though, which is why insurance works. Generally, insurance functions by pooling risk and expenses. Everyone pays a premium each month, and when one person’s house burns down, all of those premiums are enough to pay for it — while leaving enough left over for the insurance company to make money, of course.

But not all forms of insurance are the same, and at least one important type of insurance seems not to fit this bill at all. We’re talking here about life insurance, which pays out when you die. How can any company survive while insuring its customers against something as inevitable as their own deaths? Let’s learn a bit more about how life insurance works and how you might want to use it.

How life insurance works

Life insurance looks a lot like other forms of insurance. Everyone pays a premium, and when a given event happens — in this case, a death — there’s a payout.

But how do life insurance companies make money? They get the premiums, of course, but every customer of theirs will presumably someday die. The math works out for a couple of reasons, though. Chief among those are lapsed policies. If you pay into a life insurance policy every month for 10 years, you’ll be covered all 10 of those years; but, if you cancel your policy (or the company cancels it because you stop paying), you won’t be covered anymore. Your past premiums will then be pure profit for the life insurance company.

It’s also worth noting that — speaking strictly from a financial perspective — life insurance is most cost-effective for the customer if the customer dies young. Live long enough, and you could end up making money for the insurance company instead of the other way around.

Of course, living long is the ideal outcome here. With that in mind, the best way to understand life insurance is as disaster insurance for an early death. Your life insurance will still pay out if you die many years from now (provided that you keep up with your premiums), but that’s just gravy.

And, in fact, it may even prove to be a bit of a headache. Live long enough, and you’ll have a lot of wealth in assets like your life insurance policy — assets that may not be particularly liquid. And you may find that you’d rather have cash than these assets, especially if you’re in a financial jam. Even carefully planned retirements can be derailed by things like medical debt, and your illiquid assets won’t help you pay bills that are due right now. In situations like these, you might ask: Can I sell my life insurance policy?

Actually, yes, you can.

Selling a life insurance policy

If you’ve been paying into a policy for years and are still around (congratulations!), then your beneficiaries may no longer be in dire need of financial assistance should you pass away. Meanwhile, you may need cash now to handle medical bills (and avoid growing debt, which could cost your heirs far more than the eventual insurance payout is worth). In these situations, you may want to sell your life insurance payout for cash now. And you can.

A life settlement or a viatical settlement are two similar methods by which you can sell your life insurance for cash (the difference is in the life expectancy of the person selling and in the tax status of the cash). If you no longer really need the life insurance payout but do need cash, this second way of getting money out of your life insurance can be a lifesaver.

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