What Are All the Parts of a Life Insurance Policy?
A life insurance policy is a somewhat complex financial product. Each part of the contract must function as it is designed, otherwise the insurance company cannot pay the promises outlined in the contract. With that said, there are only a handful of "parts" that make the policy function as a mechanism to transfer risk.
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Death Benefit
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The death benefit is the amount of money that is paid out to a beneficiary. The death benefit represents an amount of money that the insurance company must accumulate over the term of the policy in order to pay for the promises outlined in the contract. In a sense, the death benefit represents a future savings that the insurer is obligated to provide to the beneficiary.
Mortality Function
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The mortality function is the cost associated with providing the death benefit. This is also called the "cost of insurance." This amount may fluctuate over time, and, therefore, must be dealt with so that the insurance company can meet its promises. It accounts for the variable nature of death by collecting premiums and investing those premiums.
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Premium
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A premium is an amount of money the insurance company must collect to pay for the cost of the death benefit. Without a premium payment, the insurance company could never raise the capital necessary to meet its promises of the contract. Premiums are collected by a policyholder, who insures the life of himself or someone else, for the benefit of a third-party beneficiary.
Investment Function
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The insurer uses various investments since the premium alone is insufficient to pay for the promises of the policy. The insurance company may rely on bonds or bond-like investments to meet its obligations. The investment function also consists of a cash reserve. This cash reserve represents money that is not invested so that it is available to pay out claims immediately. This cash reserve prevents the insurer from losing money by selling off securities prematurely to pay death benefit claims.
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