You will get a form from 1099-misc from the insurance company sometime in January, you will use this when doing your taxes the same way you would a W-2.

http://www.irs.gov/pub/irs-pdf/i1099msc.pdf

No it's not included in your income, nor is it taxable.

Proceeds of life insurance policies are usually exempt from estate and income tax. As far as income tax goes, only if proceeds are above and beyond the coverage amount would the interest be taxable. This happens with cash value policies when the insurer uses part of the premium for investment and increases the death benefit by the accumulated cash value. For example, if your death benefit is $100,000, but the cash value is $5,000, then the coverage amount ($100,000) is not subject to income tax. However, the $5,000 accumulated cash value should be reported as income.