Families buy life insurance for protection. In
the event of a family member's death, life insurance replaces the income
that the person earned and that his or her dependents relied on. Some families
also buy life insurance as a part of their retirement planning or when planning
how their assets and income will be distributed after death (estate planning).
Life insurance is based on the law of large numbers. A large number of families
share the common risk of losing a wage earner, and each family pays a certain
amount of money (called a premium) each year. Then the dependents of the insured persons
who actually die during that year receive a much larger amount of money
than the annual premiums they have paid. The life insurance company uses
mathemetical "mortality tables" to calculate the risk that those who are insured
will die during the year, collects premiums from the persons sharing the
risk, and pays proceeds
to beneficiaries of any insured individuals who die.
The type of life insurance a family needs varies with their income, resources,
goals, composition, and stage in the family life cycle. Used correctly,
life insurance can make a valuable contribution to family economic security.
Having too much life insurance or paying for insurance when it isn't needed
for financial protection can be an unnecessary drain on family finances.