How does life insurance work?
Life insurance offers protection for your loved ones after you die. Find out exactly how it works and if you need it.
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Life insurance is a form of financial protection that looks after your loved ones when you die or can't work anymore. With the right policy, life insurance can provide your family with enough money to pay off your debts and allow them to continue to enjoy their current standard of living.
What's in this guide?
How does life insurance work?
Life insurance helps your family cope financially after you die. It can pay off any loans and debts you have, such as a mortgage or car loan, as well as provide your family with enough money to pay for everyday living expenses. In exchange for this financial security, you pay a monthly payment (a premium) to the life insurance provider. Your premiums are calculated based on your chances of dying, so factors such as your age, health, occupation and sex are taken into account.
How do I get life insurance?
You can buy a policy online or through a broker. Check out the comparison table below to get started.
When should I get life insurance?
If you want it to be as affordable as possible, the best time to get life insurance is when you're fit, young and healthy. This is because you're more likely to get cover without exclusions and it'll be cheaper. Consider getting life insurance at the following important life stages:
- taking out a mortgage
- getting a new job
- getting married
- having children
If you wait until you're older, and perhaps have developed some health issues, your life insurance premiums are likely to be more expensive. There is also a chance that your medical condition will be excluded from cover. Many insurers exclude pre-existing conditions when you buy a policy, which means they won't pay out if you die because of that illness.
How much life insurance do I need?
How much life insurance you need depends on how much you earn and how many repayments and expenses you have. To give you an idea of how life insurance works and how much you may need, check out our free life insurance calculator.
Answer a few questions about your assets, debts and cover to get an estimate on how much life insurance you might need
How do life insurance claims work?
Unlike most insurance claims, a life insurance claim isn't made by you, the policyholder. When you take out a policy, you'll nominate a beneficiary – usually a loved one. They are the one(s) who will have to file the claim. To make a claim, they will need to do the following:
- Get a copy of the death certificate
- Let the insurer know by providing your policy information, date and cause of death
At this stage, your insurer will usually send your beneficiaries a claims form to complete and return. They will most likely need to provide a copy of the death certificate and any other documents that the insurer has requested. They will also be asked to provide the bank account they would like the payout to be deposited into.
How do life insurance payouts work?
With a standalone life insurance policy, the beneficiaries you nominate will receive the payout in one large lump sum after you die, deposited in the bank account(s) of their choice. If you outlive your beneficiaries and don't update your policy (you can simply do this by calling your insurer), your funds will be distributed to your estate.
Things can be a little different if you have a life insurance policy inside super. In these circumstances, you need to make sure that you make a binding nomination, which is a written notice given to the trustee of your super fund. Otherwise, your super fund decides who the lump-sum payment goes to.
How do the different types of life insurance work?
There are four different types of life insurance. Here's how they work:
Also known as term life insurance or death cover, life insurance pays out a lump sum of money when you pass away. This money goes to the people you nominate on your policy.
This is insurance for critical and terminal illnesses. If you're diagnosed with a critical illness, such as cancer, you will receive a lump sum so you can pay for medical and rehabilitation costs.
Total and permanent disability (TPD)
Often included with life insurance, this provides you with a lump sum for permanent loss of work due to serious illness or injury.
What should I look for in a life insurance policy?
When figuring out how life insurance works, part of the problem is not knowing what to look for. Here are the key terms to check and compare.
- Maximum cover. This is the most they will pay out, so if you need more than say, $1 million, don't go with a provider that caps it at this amount.
- Maximum entry age. Some insurers stop providing cover once you reach a certain age. This usually gets difficult around the age of 65.
- Funeral cover. Look for a life insurance policy that provides a funeral benefit. This often pays out quicker than the entire lump sum and ensures your loved ones don't need to worry about paying for the funeral.
- TPD cover. If you have a high-risk job, it's definitely worth buying a life insurance policy that also covers total and permanent disability. It will pay out if you need to permanently stop work due to injury or illness.
How does cancelling a life insurance policy work?
You are allowed to cancel your life insurance policy at any time. Many insurers also have a cooling-off period, meaning you can cancel within a set period without financial loss. However, it's important to know that your insurer doesn't need to refund any of the premiums you've already paid if it is outside of that period.
Also keep in mind that if you cancel and sign back up at a later date, you will probably be hit with higher premiums and possibly some exclusions. This is because you will be older than when you signed up to your initial policy and may have had health issues in that time.
However, if you've already done a bit of shopping around and found that you could be paying less for the same amount of cover, then switching might be a good idea. You can typically cancel your policy by getting in touch with your insurance provider by phone or email.
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