What to know when taking out a life insurance policy on someone else

life insurance e1715088419509

Life insurance is meant to provide a safety net for those who depend on another person financially. If that person were to die, life insurance can pay out benefits that cover end-of-life expenses like a funeral, as well as ongoing expenses such as a mortgage or tuition, so their loved ones aren’t burdened by the costs.

If you want to purchase a life insurance policy for someone else, you have to accomplish two things. First, you must prove to the insurance company that you would face a significant financial hardship in the event the insured person dies. Second, you have to get consent from the insured person to take out a policy on their life. 

So while it’s certainly possible to take out life insurance on someone else, it can’t be just anyone. Here’s a closer look at how life insurance works and who qualifies to be insured.

How life insurance policies work

A life insurance policy is a contract between a life insurance company and policy owner, according to Joshua Police, executive vice president at Boston Mutual Life Insurance. “The policy owner pays a premium, which is the cost of the insurance, in exchange for a death benefit,” he says. The death benefit is the money that gets paid to the policy’s named beneficiaries if the insured dies.

Generally, there are three parties involved in a life insurance policy: 

  1. Policyholder: This person owns the policy and is responsible for making premium payments to the life insurance company. They have the power to make changes to the policy, including adjusting the coverage, changing beneficiaries, and surrendering or selling the policy.
  2. Insured: This is the individual whose life is covered under the contract. If this person dies while the policy is active, the death benefit is paid out. It’s common for the policyholder and the insured to be the same person, but it’s not required.
  3. Beneficiary: This is the person (or people) who receive the death benefit after the insured person dies. The beneficiary can also be an estate, trust, or organization. 

There are two main types of life insurance plans to choose from: term and permanent. Term life insurance provides coverage for a specified time period (typically, 10–30 years). If the insured party dies while the coverage is active, the policy pays a death benefit. If they outlive the policy, it expires and no money is paid out. 

Permanent life insurance coverage lasts for the insured’s lifetime, as long as the policy remains in good standing, and pays out upon their death. It also comes with a cash value component that allows the policy to gain value over time. Policyholders can withdraw or borrow against the cash value, though this can impact the death benefit amount. Permanent life insurance is usually much more expensive than term coverage.  

Both types of insurance require the policyholder to pay a premium. This is commonly paid on a monthly basis, but can also be paid as a lump sum for the entire year, says Police. 

How much you pay in premiums depends on many factors, including the type of policy and amount of coverage. During the underwriting process, insurance companies also evaluate factors such as the insured person’s age, gender, outstanding health conditions, and occupation to determine the cost of the premium, says Police. In many cases, the insured needs to undergo a medical exam as part of the process.

The policyholder can elect how the death benefit will be paid and how often. The most common payout option is a single lump sum, typically paid to the beneficiary through a check or electronic wire. This option is beneficial for families who have lost a significant source of income following a loved one’s death and need help paying immediate bills and funeral costs. 

On the flipside, the policy owner may elect an annuity payout option. This places the funds into an investment account that pays the beneficiary a portion of the benefit, plus any interest, on an annual basis. This option may help provide financial security over a longer period of time than a lump sum payment. 

Can you take out a life insurance policy on anyone? 

You may purchase a life insurance policy to provide financial coverage for yourself in the event someone else dies. However, you must be granted permission by this person and be able to prove that their death would have a significant financial impact on your life. 

What is the insurable interest test?

In a nutshell, having an insurable interest in someone’s life means you would face a serious financial loss if that person were to die. In other words, you are financially dependent on them or would otherwise experience significant financial hardship without them.

For instance, say one spouse is a stay-at-home parent and the other earns 100% of the family’s income. If the working partner dies suddenly, the other parent would have a difficult time meeting their monthly expenses without financial assistance. Therefore, they have an insurable interest in their spouse’s life. 

Someone outside of a family can also have insured interest. For example, partners in a small business might buy life insurance on each other since the company could suffer financially if one of them dies.

To prove insurable interest, life insurance companies will often conduct interviews with the policy owner, insured, and beneficiary to confirm their relationship to one another and determine if there is a valid financial interest in the insured’s life. 

Who qualifies as the insured party under your policy?

Family members, such as your spouse, child, sibling parent, or grandparent, can qualify as the insured party on your life insurance policy. You may also be able to buy a policy that insures a business partner or former spouse. Remember: as long as you can prove that a person’s earning potential impacts your financial security—and they provide consent—you can buy a policy on their life. 

That means you can’t purchase a life insurance policy for a casual friend, acquaintance, or someone you don’t actually know. Your relationship would not pass the insurable interest test, since you would not directly experience financial difficulty when they die. Additionally, you cannot purchase a policy on someone without their knowledge.

When it makes sense to buy life insurance for someone else

The main reason for purchasing life insurance is to financially protect your loved ones in the event you, or the insured party, passes away. 

“If a person is a primary income earner within a household, you would want to take out some form of life insurance on that loved one because if their income was lost, it could create significant financial strain on the family,” says Police. 

You may also consider buying life insurance for caregivers. If you rely on a loved one to provide care to you or someone else—like aiding elderly family members or staying home with young ones—you may face financial setbacks if you suddenly have to take time off of work to care for them or hire additional help. 

Additionally, if you face a risk of losing your business without a key business partner or employee, it may make sense to purchase a life insurance policy. The funds can help you buy out their portion of ownership in the business, or assist you in hiring new talent to replace a uniquely skilled employee. 

Frequently asked questions

How can you find out if someone took a life insurance policy on you?

Online tools can help you locate life insurance policies that list you as the insured. The National Association of Insurance Commissioners (NAIC) created a free Life Insurance Policy Locator to assist you in finding a lost policy. If you know the state where the policy was obtained, you may also be able to use your state insurance department’s policy finder. 

Can you buy life insurance on a parent without consent?

No, you cannot buy life insurance on another person without their knowledge or consent, even if they are your parent. As the insured party, your parent may need to undergo a medical examination to determine what coverage they qualify for, the death benefit, and the premium. 

Source link

About The Author

Scroll to Top