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How Does Life Insurance Work?

Life insurance plays a major role in financial planning as it bestows a safety net for your loved ones in the event of an unfortunate event. It ensures that your family is financially secure even in your absence. But how does life insurance work? Understanding this concept is essential for making an informed decision.

  • 10,487 Views | Updated on: May 15, 2025

At its core, life insurance acts as a contract between a policyholder and an insurer. You pay regular premiums, and in return, the insurer provides a lump sum payout, referred to as the death benefit, to the nominees in case of the policyholder’s demise. The payout can help cover expenses like outstanding loans, children’s education, or daily living costs. By learning how life insurance works, you can explore different policies, including term insurance, whole life insurance, and ULIPs, each catering to specific financial goals.

Purchasing a Life Insurance Policy

The first step in securing financial protection for your loved ones is deciding to buy a life insurance policy. But how does life insurance work when it comes to purchasing the right policy? It starts with assessing your family’s long-term financial needs, including their lifestyle, existing debts, and future expenses like education or retirement.

Key factors to consider include policy tenure, coverage amount, premium payment options, and the claims process. Life insurance policies provide various options, such as term insurance, whole life insurance, retirement and pension plans, and ULIPs. As a rule of thumb, your life cover should be a minimum of 10-15 times your annual income to ensure comprehensive financial security.

How Does Life Insurance Work In India?

Gaining insight into how life insurance works in India can help you choose the right policy to secure your family’s future. The workings of life insurance are similar to those of any other insurance type. You, as the policyholder, must pay the premium to the insurance company for a specific period as agreed in the policy. The premium helps the insurer to cover your family’s financial needs after your demise.

This allows your family to get financial support in the event of any emergency. The insurer pays the death benefit and other accrued benefits (if any) to the nominee allowing your family to meet their everyday expenses and manage their usual lifestyle even in your absence.

What Does Life Insurance Cover?

Life insurance provides coverage in case of a policyholder’s demise, ensuring financial security for their family. However, many policies include a suicide clause that limits or denies death benefits if the policyholder passes away due to suicide within a specified period, typically within the first two years of purchase. Before selecting a policy, it’s important to ask - how does life insurance work and gather details about premiums, benefits, inclusions, and exclusions to make an informed decision. Generally, life insurance covers death caused by:

  • Accidents, such as car crashes, falls, or unforeseen incidents
  • Prolonged illnesses or diseases like heart attacks, strokes, or cancer
  • Murder, except in cases where the beneficiary is involved
  • Natural causes, including old age

Note: These conditions are assessed during the underwriting process and must be disclosed when purchasing a policy to avoid claim disputes.

What Does Life Insurance Exclude?

To fully understand a life insurance policy, it is essential to ask key questions like - how does life insurance work and what exclusions apply. Being unaware of exclusions can lead to claim rejections in the future. Common exclusions include death caused by:

  • Suicide within the first few years of purchasing the policy
  • Engaging in high-risk activities like adventure sports
  • Pre-existing illnesses that were not disclosed at the time of application
  • Accidents caused by drunken driving
  • Participation in illegal activities
  • Murder cases where the beneficiary is found involved in the crime

Note: These are some of the exclusions. For a detailed list, please check the policy document thoroughly.

How is the premium decided?

When you submit your insurance applicant, the insurers carry out an underwriting process to determine the premium amount based on the risks involved. After assessing the risks, based on age, gender, profession, medical history, and lifestyle habits, they determine the premium amount you must pay to get the life cover.

Now that you know how life insurance works, you must know about the different types of life insurance policies in India.

Types of Life Insurance

Understanding the varied types of insurance policies is important to selecting the right one for your financial goals. But how does life insurance work across different plans? Each type of policy offers unique benefits, catering to diverse needs such as financial protection, savings, or retirement planning.

Term Insurance

Term plan is one of the most popular types of life insurance in India. As the name suggests, a term plan provides coverage for a specific period, and after that, the policy expires.

One of the reasons many people prefer buying a term plan is that it offers high coverage at an affordable premium. Also, it is one of the simplest life insurance policies. In a term plan, the insurer pays the death benefit to the nominee in the event of your demise during the policy term. But, if you survive the policy period, you don’t get any survival or maturity benefits.

ULIP

Unit Linked Insurance Plans are invest-cum-insurance plans. In ULIP, you get life cover as well as investment opportunities. Typically, the ULIPs have a five five-year lock-in period, and it is considered one of the best long-term investment plans.

A part of the premium you pay for ULIP is used for provided life cover. The remaining amount is invested in different money market instruments to generate returns for you. It functions as per the market dynamics, so you must invest carefully based on your risk appetite and financial goals.

Retirement Plans

Retirement plans help secure your post-retirement financial needs by covering living and medical expenses. These plans, including PPF, NPS, Deferred Annuity, and Immediate Annuity, ensure that you have a steady income stream after retirement, helping you maintain financial independence.

Savings Plans

Savings plans encourage disciplined saving habits while ensuring stable returns to help you achieve financial goals. These policies also provide life coverage, safeguarding your family’s financial future while helping you accumulate wealth over time.

Health Insurance

Health insurance plans deliver financial protection against medical expenses, covering hospitalization, surgeries, doctor consultations, and prescription costs. These policies reduce out-of-pocket expenses and ensure access to quality healthcare during medical emergencies.

Child Insurance Plan

Child insurance plans are specially meant for safeguarding your child’s future. Apart from providing life cover, it allows you to build a corpus for your child’s future needs like education, marriage, etc. Child insurance plans are a great way to help your child realise their dreams and aspirations. You can buy child insurance plans as soon as they are born so that you can leverage time benefit to build a sizable corpus.

Benefits of Life Insurance

Life insurance presents an array of benefits that go beyond just financial security. But how does life insurance work when it comes to protecting your family and planning your future? Here are some of its key advantages:

  • Financial Security for Dependents: Provides a financial safety net to your family in your absence, helping them cover essential expenses such as education, healthcare, daily living costs, and outstanding debts.
  • Tax Benefits: Premiums paid qualify for deductions under Section 80C, and payouts may be tax-exempt under Section 10(10D) of the Income Tax Act, 1961, helping you save on taxes while securing your family’s future.
  • Flexible Fund Usage: The payout received by the nominee can be used as per their specific needs, such as handling emergencies, long-term investments, or repaying loans, providing financial autonomy.
  • Peace of Mind: Knowing that your loved ones are financially protected offers reassurance and confidence, allowing you to focus on your present without worry.
  • Retirement Income: Certain life insurance plans, such as annuity plans and ULIPs, allow you to build a retirement corpus, ensuring a stable income stream and financial security during your golden years.

Conclusion

Grasping how life insurance works helps you make the right financial choices for your family’s future. By selecting an appropriate policy, you can ensure financial security, tax benefits, and long-term stability for your loved ones. Investing in life insurance today means securing peace of mind and financial independence for tomorrow.

FAQs on How Does Life Insurance Work

1

What is life insurance, and how does it work?

Life insurance is a contract wherein the policyholder pays premiums, and in return, the insurer provides a payout to beneficiaries upon the policyholder’s demise, ensuring financial security.

2

What are the different types of life insurance?

Life insurance includes term insurance, ULIPs, retirement plans, savings plans, health insurance, and child insurance plans, each serving different financial needs.

3

How does a life insurance policy provide financial security?

Life insurance provides a lump sum payout or periodic benefits to the nominee, covering expenses like debts, education, and daily costs in the policyholder’s absence.

4

Who needs life insurance?

Anyone with dependents, financial responsibilities, or long-term goals can benefit from life insurance for security and stability.

5

How do premiums work in life insurance?

Premiums are periodic payments based on factors like coverage amount, policy term, and age, ensuring continuous protection.

6

What happens if I stop paying my life insurance premiums?

If premiums stop, the policy may lapse, reducing or eliminating benefits unless there is a grace period or paid-up value option.

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The content has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Further customer is the advised to go through the sales brochure before conducting any sale. Above illustrations are only for understanding, it is not directly or indirectly related to the performance of any product or plans of Kotak Life.

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