A Life Insurance (or more accurately death insurance) is an agreement between you and the insurer company whereby you agree to pay an annual premium for a certain number of years (policy period) in lieu of which the insurer agrees to pay a lumpsum money (life cover) to your family in case of your death within the policy period.
For e.g. for Rs 5000 a year, you can get a life cover of about Rs 50 lakhs.
How does life insurance work?
Whenever you buy a financial product, it is very important to understand how it works and what's in it for the person providing the product i.e. the insurer in this case.
The business model of insurance is pretty similar to that of a lottery. 100 people buy lottery tickets for Rs 10 each, a 'lucky winner' is drawn at random who is given Rs 900. The balance Rs 100 (Rs 1000 - Rs 900) is retained by the lottery company as its revenue.
Similarly, there are thousands of people paying an annual premium to the insurance company. In any given year, there will be a small % of 'unlucky' people who will die and the company will have to pay out a big lumpsum (life cover) to their family.
The more accurately an insurer can estimate the death-risk of its policy holders and price its insurance premiums accordingly, the better off it will be. This is also the reason that smokers get charged more than non-smokers for the same life cover (their death risk is higher). Insurance companies use very sophisticated statistical models to work out the numbers. In fact, there is a separate term for this branch/application of statistics - actuarial science (and people who are good at it - actuaries - are paid quite well!)
Does everyone need to buy a Life Insurance policy?
Surprisingly, this is a question that is not discussed very often.
Life insurance is meant to replace your income stream after your death for people economically dependent on your income.
Often people substitute emotional attachment for economic dependence and think that if they love someone, a life insurance policy is a must.
But if you don't have an income stream currently or potentially (e.g. you are retired) OR if you don't have anyone economically dependent on you (eg earning but single with financially independent parents) you don't need to waste your money on buying a life insurance (I don't). You can always buy it later when the situation changes (e.g. you got married or had a kid).
This is ostensibly also the reason that most insurance companies don't offer term insurance plans for housewives - there is no income stream to insure (although I think that's somewhat regressive since home-makers also help their family financially by doing what they do).
Which life insurance policy to buy?
I will do a detailed post later on the various types of Life Insurance policies available and their pros and cons but the short answer is that do not mix insurance and investment - you will end up paying higher for both.
Always remember, insurance is not investment and the two should be kept separate.
Simply buy a good Term Insurance plan - the one which does NOT give you any money back if you don't die (like you car insurance). It is damn cheap (e.g. Rs 5000 per year for a Rs 50 lakh life cover), you can buy it online and is available from all leading insurance companies like LIC, HDFC Life and ICICI Prudential.
How much should the insured amount/life cover be?
It's a good rule of thumb to have a risk cover of at least 10-15 times of your annual income. E.g. if your annual income is 10 lakhs then have a risk cover of around 1-1.5 Crores. It would cost you around 10-15k per year.
You can also use our life insurance cover calculator to get a better estimate.
And for all your investments, you have the nice folks at Goalwise :)