Your finances play a big role in determining how much life insurance coverage you should get and how much you can qualify for. Keep reading to learn why and how life insurance can protect your family’s finances.
In This Article
What is financial underwriting?
Financial underwriting is the evaluation of your personal or business background and current economic circumstances to assess whether the insurance you applied for is reasonable and in line with your needs.
Insurance companies may pull financial records from credit bureaus and databases like LexisNexis.
Financial underwriting is important in preventing being over-insured.
What does it mean to be over-insured?
Being over-insured means owning more coverage than necessary. You don’t want to be paying for excess coverage you don’t need and, more importantly, life insurance companies want to make sure you’re not worth more dead than alive. It sounds a little gruesome, but it’s an important step in preventing nefarious deeds.
See what you’d pay for life insurance
How Finances Impact Life Insurance
The amount of money you earn plus your financial history play a role in determining your life insurance eligibility and premium costs.
During the financial underwriting process, the insurance company runs a credit and background check on you. In addition, they’ll inquire as to your salary.
» Learn more: Can My Credit Score Affect Life Insurance Premiums?
The insurance companies want to make sure you have a good history of paying debt. They prefer their customers to pay their premiums on time.
When underwriting a history of bankruptcy, the main concerns are the financial and emotional pressures associated with the bankruptcy process. The more recent the bankruptcy and the more tenuous the financial situation there could be greater pressure to obtain life insurance with the belief that death would relieve the financial pressure on the family or business.
Life insurance companies are all about risk. If you pose a financial risk, your rates may be higher than the typical applicant with a similar age and health profile who has a stable financial history.
The amount of money you earn is how the insurance company determines what your insurability limit is. They don’t want their customers worth more dead than alive. They also want to ensure you can afford to pay the policy premiums.
Insurance companies use income replacement tables to calculate an applicant’s maximum amount of coverage. Below is one example.
|Ages||Income||Factor||Amount of Insurance Allowed|
|To 40||$||x 35||= $|
|41-50||$||x 25||= $|
|51-60||$||x 20||= $|
|61-70||$||x 10||= $|
|71-80||$||x 5||= $|
So, for example, if you’re 55 and you earn $100,000 annually this particular insurer would allow you to apply for up to $2,000,000. Larger amounts of coverage may be approved on a case-by-case basis.
How Life Insurance Pricing Works
Your risk classification is ultimately what determines how much you pay for your life insurance policy. The insurance companies determine an applicant’s risk class during the underwriting process.
The higher the risk, the higher the premium.
During the underwriting process, insurance companies will evaluate your risk factors to determine how much of a risk you would be for them to take you on as a client.
Risk factors include:
- Your Age
- Your Gender
- Personal Medical History
- Personal Financial History
- Smoker Status
- Marijuana Use
- Your Family Medical History
- Prescription Record
- Motor Vehicle Record
- Your Job
- Any Risky Hobbies You Participate In
- Medical Exam Results
You can’t control all of these factors, like your biological sex or family’s medical history, but you are in control of your own destiny in regards to most of them, like your smoking status and weight.
Types of Life Insurance
Term life insurance provides coverage for a specific period of time. This is the “term” of the policy. If the policyowner dies within the set term of coverage, their beneficiaries will receive a check from the life insurance company. Once the term is over the coverage terminates unless you convert or renew the policy.
A term life insurance policy can last anywhere from one year to 40 years with coverage amounts ranging from $50,000 to millions of dollars of life insurance coverage. For most people, term life insurance will be the best fit and most affordable option to make sure their family’s future is financially protected.
Permanent life insurance provides coverage for your entire life, as long as the premiums are paid. These policies are much more complex than term policies.
Many permanent life insurance policies have savings components which generate a cash value that you can borrow against as policy loans or withdraw from. Certain permanent policies also pay dividends to policyowners.
Because of the life-long coverage and savings component, permanent life insurance policies are typically 10-15 times more expensive than term life insurance policies.
Why Life Insurance Is Important
Life insurance is intended to protect against financial loss due to an unexpected and untimely death.
If you die without life insurance, your family may face financial devastation in addition to the emotional pain.
Life insurance works by a) providing funds to family members to replace the value lost by the death of the insured, and/or b) providing funds needed at the death of the insured to avoid a family’s financial ruin.
Using Life Insurance as Income Replacement
The “right amount” of life insurance is different for everybody. Life insurance is not a one-size-fits-all product. The amount you need depends on your finances, financial goals, and family situation.
The main point of life insurance is to replace your income if you die so your family doesn’t financially suffer. Your family’s standard of living is provided by your paycheck. If that paycheck were to suddenly disappear, what happens to your family?
The rule of thumb is for providers to buy enough life insurance to cover ten times your income. But this number isn’t right for everyone.
» Learn more: Life Insurance: Do You Need Ten Times Your Salary?
Ten times your income may not be enough or it may simply be unaffordable for families on a budget. Multiplying your income by ten is a good starting point, however, and you can adjust as necessary from there.
Using Life Insurance to Cover Debt
One of the many reasons why people buy life insurance is to pay off debt. If you die unexpectedly, the death benefit from a life insurance policy can be used by your loved ones to pay bills.
A good rule of thumb is to buy life insurance with a term that lasts the length of your largest source of debt. This is usually your mortgage.
Even if you don’t personally have too much debt, your beneficiaries can use the death benefit however they wish. If they have their own personal debt, the death benefit can be used to pay this off as well.
Using Life Insurance as Supplemental Money
Some permanent life insurance policies have features that allow a policy owner to access money they can use while alive. These features can include dividends and cash value accumulation.
Participating whole life insurance policies are one type of permanent life insurance. The policy owner participates in favorable investment earnings and mortality savings by the insurance company.
These favorable earnings come in the form of dividends, usually paid out annually by the insurance company. You, as policy owner, have options on how you would prefer to receive these dividends. If you opt to receive the dividends as cash, you can use this cash however you wish.
Many types of permanent life insurance policies accumulate cash value. The cash value that accumulates can be used as surrender values, paid-up insurance, or extended term insurance. You can also take out policy loans against the cash value and make partial withdrawals. You can use these funds however you wish.
Term life insurance is designed as income replacement. There is no savings component or dividend payout. However, most term life insurance policies often include an accelerated death benefit rider at no cost.
If you are diagnosed with a terminal illness, an accelerated death benefit rider allows you to receive a portion of the death benefit early. You can use this money however you wish.
Life Insurance on a Budget
Term life insurance is the most budget-friendly type of life insurance, and it’s imperative you buy a policy that you can realistically afford because there aren’t any refunds.
While term life insurance policies do have a free-look period in which you can get your money back if you decide you no longer want the policy, this period is only the first 10-30 days. After the free-look period is over, if you cancel the policy or stop paying your premiums you do not get your money back.
Don’t let this limitation scare you away from term life insurance though. This insurance is vital for families, especially those with children. Even if you can only afford a $100,000 term policy, this coverage is better than none at all.
Because you can choose the policy’s term length and coverage amount, finding a policy that fits in your budget is relatively simple.
Term coverage choices range from $50,000 to over $25,000,000. Term length choices range from 10 years up to 40 years.
Typically, the more coverage you want, the more the policy will cost. But sometimes the premium difference is minimal compared to the change in coverage amount. As you can see in the example table below, this applicant could double their coverage amount from $50,000 to $100,000 for just 33 cents more per month.
Monthly Quotes for 20-Year Term Policy
for a Healthy, Non-Smoking Male Age 35
|Face Amount||Monthly Premium|
Work with a life insurance broker to find the most affordable coverage for you and your family.
About the writer
Natasha Cornelius, CLU
Senior Editor and Licensed Life Insurance Expert
Natasha Cornelius, CLU, is a writer, editor, and life insurance researcher for Quotacy.com where her goal is to make life insurance more transparent and easier to understand. She has been in the life insurance industry since 2010 and has been writing about life insurance since 2014. Natasha earned her Chartered Life Underwriter designation in 2022. She is also co-host of Quotacy’s YouTube series. Connect with her on LinkedIn.