There are three parties in a life insurance transaction: the insurer, the insured, and the owner of the policy, although the owner and the insured are often the same person. For example, if John Smith buys a policy on his own life, he is both the owner and the insured. But if Mary Smith, his wife, buys a policy on John’s life, she is the owner and he is the insured.

The policy, like all insurance policies, is a legal contract specifying the terms and conditions of the risk assumed. Special provisions apply, including a suicide clause wherein the policy becomes null if the insured commits suicide within a specified time for the policy date (usually two years). Any misrepresentation by the owner or insured on the application is also grounds for nullification.

The face amount of the policy is normally the amount paid when the policy matures, although policies can provide for greater or lesser amounts. The policy matures when the insured dies or reaches a specified age. The most common reason to buy a life insurance policy is to protect the financial interests of the owner of the policy is the event of the insured’s demise. The insurance proceeds would pay for funeral and other death costs or be invested to provide income replacing the deceased’s wages. Other reasons include estate planning and retirement. Because the insured’s death will be to the financial betterment of the policy owner, the owner, by law, must have an insurable interest (i.e., a legitimate reason for insuring another person’s life.)

The insurer (i.e., life insurance company) prices the policies with an intent to recover claims to be paid and administrative costs, and to make a profit. Claims to be paid are determined by actuaries using mortality tables. Actuaries are professionals who use actuarial science which is based in mathematics (primarily probability and statistics). Mortality tables are statistically based tables showing average life expectancies. Normally, the only three considerations in a mortality table are the insured’s age, gender, and whether or not they use tobacco.

The insurance company receives the premiums from the policy owner and invests them, using the time value of money and compound return principles to create a pool of money from which claims are paid. Therefore, rates charged for life insurance are sensitive to the insured’s age because the insurer will have less premium dollars to invest and less time to invest them for an older person.