Understanding Life Insurance and Its Mechanism and Principles

Discover the fundamentals of life insurance, its purpose, and how it protects your loved ones.
Check Life Insurance Policies
3 min
29-May-2025
Life insurance is an essential financial tool that provides security for your loved ones and helps you plan for a stable future. It acts as a safeguard, ensuring financial continuity even in unforeseen circumstances. Additionally, life insurance can be instrumental in retirement planning, offering a reliable income stream or a corpus to meet post-retirement needs. Understanding its mechanism and principles is crucial for making an informed decision about your financial planning.

What is the basic mechanism of life insurance?

Life insurance is a contract between a policyholder and an insurance company, where the insurer promises to pay a lump sum to the beneficiary in case of the policyholder’s death or upon policy maturity, in exchange for regular premium payments.

This mechanism ensures that:

Risk is shared:

The financial burden of the policyholder's demise or critical needs is distributed across the pool of insured individuals.

Premiums fund the policy:

Premiums collected from policyholders form a corpus to pay claims and cover administrative costs.

Coverage is conditional:

The claim payout depends on adherence to policy terms and conditions, such as regular premium payments and accurate disclosures.

Investment component:

Some policies also include an investment element, enabling policyholders to grow their wealth while enjoying insurance coverage.

This blend of protection and financial planning makes life insurance a versatile tool in securing a family’s future.

What are the fundamental principles of life insurance?

Life insurance operates on certain guiding principles that ensure fairness and reliability for both the insurer and the insured. These principles include:

Utmost good faith:

Both the insurer and the policyholder must provide honest and complete information. Misrepresentation can lead to policy nullification.

Insurable interest:

The policyholder must have a financial or emotional stake in the person being insured.

Indemnity:

While life insurance cannot replace a life, it provides a financial equivalent to the loss incurred.

Subrogation:

The insurer can step into the policyholder’s legal rights to recover compensation from a third party, where applicable.

Proximate cause:

The insurer is liable only for claims directly arising from insured risks.

Contribution:

If multiple policies exist, each insurer shares the liability proportionally.

These principles uphold the integrity of life insurance as a fair and effective financial instrument.

Key benefits of getting life insurance

Life insurance offers numerous advantages that extend beyond mere financial security, catering to both short-term and long-term goals.

Financial protection:

It ensures a lump-sum payout to dependents, mitigating financial hardships caused by the policyholder's demise.

Income replacement:

Provides steady income for dependents to maintain their standard of living.

Tax benefits:

Premiums paid and payouts received are eligible for tax exemptions under Section 80C and 10(10D) of the Income Tax Act, 1961.

Retirement planning:

Certain policies accumulate wealth over time, serving as a corpus or regular income during retirement.

Debt repayment:

Helps in settling loans or mortgages, reducing financial burdens on survivors.

Savings and investment:

Endowment and ULIP policies combine insurance with wealth creation, yielding significant returns.

These benefits highlight how life insurance supports financial stability and long-term planning.

Factors to consider when choosing life insurance

Selecting the right life insurance policy requires careful evaluation to ensure it aligns with your financial goals and needs. Key factors to consider include:

Coverage amount:

Assess the sum assured to ensure it adequately supports your family’s future needs.

Policy type:

Choose between term, endowment, ULIP, or whole life plans based on your financial objectives.

Premium affordability:

Ensure premiums fit within your budget without compromising essential expenses.

Policy tenure:

Align the policy duration with life stages such as child’s education, retirement, or mortgage repayments.

Riders and add-ons:

Consider additional coverages like critical illness or accidental death riders for enhanced protection.

Claim settlement ratio:

Research the insurer’s claim settlement record for reliability.

Tax benefits:

Understand the tax implications for premiums paid and benefits received.

A thorough assessment will help you choose a policy that offers maximum utility and peace of mind.

What happens if a life insurance policy lapses?

A life insurance policy lapses when premiums are not paid within the stipulated grace period. This termination of the policy nullifies its benefits, leaving the policyholder and beneficiaries without coverage.

Consequences of policy lapse:

Loss of coverage:

No financial protection is available during the lapsed period.

Forfeiture of premiums:

Previously paid premiums may be non-refundable.

Reinstatement costs:

Reviving a lapsed policy may require additional charges and updated health assessments.

Reduced benefits:

The reinstated policy might not offer the same benefits as the original.

To avoid these issues, always pay premiums on time or explore automatic premium payment options.

Conclusion

Life insurance serves as a cornerstone for financial planning, offering security, savings, and peace of mind. By understanding its mechanism and adhering to its principles, you can maximise its benefits to meet life’s uncertainties and secure your retirement. This life insurance guide underscores the importance of proactive planning, ensuring that you and your loved ones remain financially stable throughout life’s journey.

Frequently asked questions

What are the fundamental concepts behind life insurance?
Life insurance operates on principles such as utmost good faith, insurable interest, indemnity, and proximate cause. These ensure fairness and clarity in contracts, protecting both the insurer and policyholder while establishing trust in claim settlements.

How are life insurance premiums calculated?
Premiums are determined based on factors like age, health, lifestyle, policy type, coverage amount, and tenure. Insurers assess risk levels and coverage requirements to set an appropriate premium amount, ensuring financial security for the policyholder and beneficiaries.

Can life insurance plans be tailored to individual requirements?
Yes, life insurance policies offer customisation through riders and add-ons like critical illness or accidental death benefits. Additionally, policyholders can choose coverage amounts, payment modes, and durations to align with their unique financial goals and circumstances.

Do life insurance policies offer tax advantages?
Yes, life insurance provides tax benefits under Section 80C for premiums paid and Section 10(10D) for payouts. These exemptions reduce taxable income, making life insurance a valuable tool for financial planning and savings in India.

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Disclaimer

*T&C Apply - Bajaj Finance Limited (‘BFL’) is a registered corporate agent of third party insurance products of Bajaj Allianz Life Insurance Company Limited, HDFC Life Insurance Company Limited, Life Insurance Corporation of India (LIC), Bajaj Allianz General Insurance Company Limited, SBI General Insurance Company Limited, ACKO General Insurance Company Limited, HDFC ERGO General Insurance Company, TATA AIG General Insurance Company Limited, ICICI Lombard General Insurance Company Limited, New India Assurance Limited, Chola MS General Insurance Company Limited, Zurich Kotak General Insurance Co. Limited , Star Health & Allied Insurance Co. Limited, Care Health Insurance Company Limited, Niva Bupa Health Insurance Company Limited , Aditya Birla Health Insurance Company Limited and Manipal Cigna Health Insurance Company Limitedunder the IRDAI composite CA registration number CA0101. Please note that, BFL does not underwrite the risk or act as an insurer. Your purchase of an insurance product is purely on a voluntary basis after your exercise of an independent due diligence on the suitability, viability of any insurance product. Any decision to purchase insurance product is solely at your own risk and responsibility and BFL shall not be liable for any loss or damage that any person may suffer, whether directly or indirectly. Please refer insurer's website for Policy Wordings. For more details on risk factors, terms and conditions and exclusions please read the product sales brochure carefully before concluding a sale. Tax benefits applicable if any, will be as per the prevailing tax laws. Tax laws are subject to change. BFL does NOT provide Tax/Investment advisory services. Please consult your advisors before proceeding to purchase an insurance product. Visitors are hereby informed that their information submitted on the website may also be shared with insurers. BFL is also a distributor of other third-party products from Assistance Services providers such as CPP Assistance Services Pvt. Ltd., Bajaj Finserv Health Ltd. etc. All product information such as premium, benefits, exclusions, sum insured, value added services, etc. are authentic and solely based on the information received from the respective insurance company or the respective Assistance service provider company.

Note – While we have made all efforts and taken utmost care in gathering precise information about the products, features, benefits, etc. However, BFL cannot be held liable for any direct or indirect damage/loss. We request our customers to conduct their research about these products and refer to the respective product’s sales brochures before concluding their sale.

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