Introduction to life insurance | Insurance | Financial literacy | Khan Academy

So let's talk a little bit about what's probably not your favorite subject. It's definitely not mine, and that is death. Uh, and uh, it's not something a lot of us think about. I remember when I was a kid and I used to see these ads on TV for life insurance, and it used to boggle my mind. I used to say, "Why would I?" I don't even want to think about life insurance. And if I'm dead, well, you know, who cares? You know, I I won't need the money anymore. Who are they going to pay? Etc.

Then I got married, I had kids, and I completely got why life insurance matters. Because once you have other people in your life that you might be helping support, then you do start to wonder if you care about them. You wonder, "Well, what if something were to happen to me? What if I were to die? We would have our loss of income. They might have other things that they might have to do above and beyond that because maybe I'm helping out at home, and you're going to need more support at home." So you're going to have even more costs at the same time that you have loss of income.

You might have a mortgage to pay, and the last thing you want your family to have to deal with if you die is not only they're hopefully grieving for you a little bit, but they're also having to move, or they can't pay their house, or they're going to have to, you know, change their standard of living in a significant way. So as soon as I had kids, I got a life insurance policy.

Now, the basic idea of life insurance is you pay a premium. You pay a certain amount every year, and if you were to die, then the life insurance company will pay whoever you say is the beneficiary. It's oftentimes someone's partner or your children or some other family member; usually, people that you're already helping support in some way. When I thought about how much life insurance I needed, I remember I first got it when my first child was born. I think I was 30, 32 years old at the time.

I said, "Well, we have a mortgage. I want, at the time we only had one kid. I want him to be able to go to college if something were to happen to me." So I got a policy that was large enough that would, uh, be able to pay off the rest of our mortgage, pay for his college education, and then maybe have a little bit extra to help my wife support her if she needed extra help with whatever it might be. And so that's how I thought about it.

More recently, I got another health insurance—sorry, I got another life insurance policy with that same idea. I now have three kids. I want all of them—I want to be able to afford for all of them to go to college. I want all of, uh, you know, I want my wife and other folks in my family that I take care of to still be taken care of if I were to lose my income. So, or by dying. There's other ways for ensuring loss of income for other reasons, but this is by dying.

Now, there are a couple of different life insurance flavors that you can get. The biggest distinction is term life versus whole life policy. Now, term life insurance only covers a certain number of years. You can get a term life policy for, say, 10 years or 20 years. While a whole life policy will cover the rest of your life. You might be saying, "Well, why would I ever want a term life when I could get one that's whole life?" Well, it turns out that a term life policy is usually cheaper.

And why is that? Well, if you're, say, 32 years old like I was, and you got a 10-year term policy because you're like, "Okay, over the next 10 years, my family's going to need help paying the mortgage or whatever it might be," or let's say over the next 20 years if you get a 20-year term that could help cover my family through college, through the mortgage, etc. And then after that, my kids are going to be on their own; they might not need it as much.

From an insurance company's point of view, if you look at a 32-year-old who's in good health, they say the probability of them dying in the next 20 years by the time they're 52 is fairly low. So we could, uh, we can give them a pretty low premium. So I didn’t have to pay that much per year. Now, if you've got a whole life policy back when you're 32, the insurance company is going to say, "Well, Sal's going to die eventually, and it's just a matter if he's going to die sooner or is he going to die later."

And so they price it accordingly so that even if you, you know, when they pay it out, you know, maybe you're 80 or 90 years old when you die, but that payout is still probably going to be less than the amount that you put in over the years, especially if you last till 70 or 80 or 90 years old. Because not only are they taking those premiums you're giving them, but the insurance company is investing it. So they're also getting the returns on that premium.

They do the numbers; they do the statistics to see, "Okay, if someone, let's say the average life expectancy is 75 or 80 years old, if they paid this premium all the way to that and were able to invest that premium, are we going to get more money than we have to pay out?" But they're still probably going to ask for more money for a whole life policy because they have to do that. In fact, almost always they'll ask for more money for a whole life policy than for a term policy. So you have to decide what you are trying to de-risk, what are you trying to cover, and then act accordingly.

And, you know, one of the things that's a little bit depressing as you get older is I had gotten at the time a 10-year term policy because, "Oh, that'll cover my family." And then once I turned 42 and I wanted to get another 10-year policy, well, then it was a lot more expensive. And the reason why it was a lot more expensive is, well, the probability of a 42-year-old dying in the next 10 years is a good bit higher than the probability of a 32-year-old dying in the next 10 years.

Now, there's also this notion about insurability because they're not just going to look at your age; they're going to look at your health. They're going to look at your lifestyle. If you like doing dangerous things, if you have things that increase your risk of death, well, they're going to charge you more. If you lead a very, very risky lifestyle, then they might not insure you at all. So, that's this notion of insurability.

When I got my last health insurance, someone came and literally took tests. They checked my blood pressure; they checked my BMI, my body mass index, to just kind of figure out what the risk was. And there's all this, you know, questionnaire about my lifestyle, etc., etc. Now, the last thing I'll talk about is—and this isn't just applies to life insurance, but it definitely does apply to life insurance—which is the notion of an individual plan versus a group plan.

A group plan usually comes through, say, your employer, where your employer says, "Hey, we're going to give every employee we have a life insurance policy." They might do other types of policies as well, and that's— they're just paying usually a fixed amount for every employee. And, you know, they're not—the insurance company isn't trying to differentiate because they're just averaging everyone out. Sometimes they might do a little bit of that, and, um, that's nice; it's a benefit you might get from your employer.

But if you leave your employer, that policy might not be effective anymore. So if it was a life insurance policy, if you die after leaving your employer, well, then it's not going to be so beneficial. While on the other hand, if you have an individual plan, one that you pay directly, well, that's just going to be tied to you. It's not going to be tied to where you happen to work.

So if you’re young, you're probably not thinking a lot about life insurance. Maybe you want to talk to your parents, make sure they have life insurance. They might, they may or may not appreciate the conversation, but it is an important thing to think about. If we want to make sure those that we care about are taken care of, um, if anything really bad happens.