What Is Life Insurance And Why Is It So Important?

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What Is Life Insurance And Why Is It So Important?

We all owe life a death, an inevitable death which we will (surely) meet…

Laura Bohannan

The subject of the inevitability of death hits hard, and while many shy away from the fact that sooner or later death will come knocking, its certainty is undisputable.

It is therefore important that while focusing on living whilst still alive, there is need to plan for what happens when the inevitable happens, which brings us to the subject of life insurance.

In terms of definition, life insurance is a contract in which a policy-holder pays regular premiums (money) in exchange for a lump-sum death benefit paid to the policy-holder’s beneficiaries or dependents.

Life insurance and private pensions are major sectors of the world economy.

In 2016, total life insurance premiums amounted to USD 2.6 trillion, that is 3.5% of the global GDP. Private pension assets in Organization for Economic Co-operation and Development (OECD) countries reached their highest level in history at over USD 38 trillion (126% of the OECD area GDP) in the same year, and are growing faster than the GDP in most countries7.

The sizeable proportion of the industry reflects the crucial role of life insurers in providing financial security to individuals and households across the world.

By fulfilling their basic functions of pooling risks and mobilising savings from the population, the sector has the ability to channel significant volumes of long-term funds into a wide range of financial markets and various sectors of the economy.

Thus, under the right conditions, it can have an important contribution to the financial stability and overall growth of the economy.

The fundamental function of life insurance is to provide financial protection to individuals and families against three major risks: mortality (death), morbidity (disability due to accidents) and longevity (long life after retirement).

Through risk pooling, the industry is providing vital support to the society by dampening the effects of adverse events that are severe for the individuals and helping stabilize their financial situation, without creating large immediate costs to others.

By fulfilling its basic role of protecting individuals in the face of adversity, a well-functioning, mature life insurance sector that offers stable and affordable products generates benefits that extend beyond the individual, to the overall economy:

• It helps reduce poverty at the society level through effective quantification, aggregation and distribution of risks;

• As most products offered by life insurers have a saving component, they enable greater savings by the population;

• It enhances access to credit, as most credit providers require or provide better credit terms when the individual has life insurance coverage, especially for longterm credit such as housing loans;

• It can act as a complement or even a substitute for the social security and assistance programmes run by the government (for example the benefits paid by a life insurance to a family in case of death of the main income earner may keep the family above the poverty threshold), helping thus reduce the overall fiscal burden of such programmes.

Worldwide, the life insurance and pension funds industry is an important segment of the financial system. The industry channelsthe large volumes of household savings into a wide range of financial markets and acts as a direct and indirect provider of long-term, stable funding for various sectors of the economy.

Longer term investments play a key role for the stability of financial markets and for the financing of large-scale projects supporting sustainable growth, such as investments in infrastructure and cleaner energy, therefore they are an important component of a healthy economy.

In the more advanced economies, life insurers and pension funds are large institutional investors that contribute to the development of well-functioning capital markets, by careful screening of investments which facilitates efficient allocation of capital, diversification of holdings and exercise of market discipline on the management of the companies in which they are investing.

In conclusion, having life insurance is an essential part of financial planning. It can save you from financial hardship in case of any unforeseen circumstances. However, the decision to buy insurance should be determined by three factors – requirement, the benefits you get from the policy, and your ability to pay the premium.

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