Life cover indexation - what a rip off !

property.advert

Just looking at level term assurance and working out the maths for indexation and I came across the magic formula that many companies subscribe to. And what a rip off it is.

Say inflation is 5%, well you'd think that after a year your sum assured would increase by 5% and you'd be right. But what about your premium ?

You could be forgiven for thinking that that would also go up by 5%. For sure you are another year older but the term of the increase is also a year less than your original policy, which you might think sort of balances it out. Wrong !

Many companies have a multiplier of 1.5 or 150% of inflation when it comes to increasing premiums. Some are higher and some have a flat percentage increase on top of inflation.

So what does that mean to you ? well, it means that your £100 premium does not go up to £105 as you would imagine but rather to £107.50. Your sum assured however only goes up by the 5%.

Add in the magic of compounding and at 5%, you'll see your premiums double after 10 years, quadruple after 20 years and after 25 years, you'll be paying 567% of your original premium yet your sum assured will only have increased by 339%. Go longer term and it gets worse.

I reckon it might be better to get more cover on a flat rate and let inflation eat into it a little rather than pay a 50% premium to have it inflation proofed.

ExpertAdvice

Hi,

I absolutely agree with you. I'm never in favour of increasing term assurance due to the fact that the premiums go soaring high.

The premium does increase higher in proportion than the sum assured.

dunstonh

You could be forgiven for thinking that that would also go up by 5%.

I wouldn't have thought that as an increasing sum assured each year has to factor in the cost of you being older each year. So, you would expect the indexation cost to be higher than the indexation rate.

I know someone with an annually indexed plan who cant get insurance now. So, he is very pleased he has that. It's certainly not a mainstream option but you shouldnt rule it out for the right person.

kingstreet

I tend to agree.

It was explained to me by my network's compliance officer that the initial premiums would need to start higher without this additional factor, making it less competitive in the early years.

As most plans don't make it past seven years, life offices consider it more important for the plan to be competetive at the outset than later in the term for this very reason.

I've just had a play with a quote to see the effects. I'm a 45 year old male and I've done a £100k LTA over 20 years. The premium (eg) for L&G is £15.98 and this is the starting premium for both level and increasing cover.

Using the indexation option (RPI for SA and RPI x 1.5 for premium) and allowing for 5% inflation, the sum assured and premiums would be;-

£100,000 and £15.98 in year one
£105,000 and £17.14 in year two
£110,250 and £18.43 in year three
£115,763 and £19.81 in year four and so on.

As a comparison, taking new cover each year would have the following effects;-

£100,000 and £15.98 in year 1 for 46nb for 20 years
£105,000 and £17.54 in year 2 for 47nb for 19 years
£110,250 and £19.33 in year 3 for 48nb for 18 years
£115,763 and £21.05 in year 4 for 49nb for 17 years

This would suggest indexation still being a better option than taking out a new plan each year, ignoring other issues like deterioration of health and ability to obtain cover at normal rates.

Bright Grey takes a different stance;-

If you choose increasing cover, we’ll increase your
cover each year by the rate you’ve chosen. Your
payment will also increase. The increase in your
payment is based on:
• the amount of the increase in your cover;
• your age at the time of the increase; and
• the remaining term of the cover.
This means that your payment may increase by a
higher rate than your amount of cover.

with a starting premium of £16.31 and (increasing age/sum assured and reducing term) year two, year three and year four premiums of £17.26, £19.03 and £20.97 respectively.

I tend not to do increasing life cover, unless the client really values the option. Addressing a finite need for a finite term using a level term normally means there's a potential surplus later on. I prefer family income benefit as it fits the bill better in providing the income needed for that period at the cheapest possible cost.

ACG

I noticed something similar with increasing Income Protection.

Some companies (major companies included) have rates that go up at 1.x times the premium. Not all companies do this but it came as a bit of a shock to say the least when i found out.

property.advert

I think Prudential has a rate plus 2.5% which would be roughly 1.5 now with inflation around 5% but would normally indicate a multiple of around 2.

property.advert

dunstonh wrote: »

I wouldn't have thought that as an increasing sum assured each year has to factor in the cost of you being older each year. So, you would expect the indexation cost to be higher than the indexation rate....

I appreciate that but the offsetting factor is the reduced term length, which would give a lower premium from the same starting point. Add in ever greater life expectancy and you have another balancing factor.

The fact is that you have an industry which prides itself on minute mathematical adjustments to reflect real life risk simply using an unwieldy tool with a fixed multiplier to rake in additional profits over the longer term. In fact they make a mockery of wanting to do business long term.

dunstonh

The other thing to remember is that volume of business also affects pricing. Annually indexed plans are a very small minority of the cases. Insurance works by pooling risks. The wider the pool, the lower the cost of cross subsidy. The smaller the pool, the higher the cost.

This is most obvious nowadays in car insurance where TPF&T is typically more expensive than fully comp. It should be less generically but the ability to cross subsidise is smaller due to market forces.

OshayAway

property.advert wrote: »

Just looking at level term assurance and working out the maths for indexation and I came across the magic formula that many companies subscribe to. And what a rip off it is.

Say inflation is 5%, well you'd think that after a year your sum assured would increase by 5% and you'd be right. But what about your premium ?

You could be forgiven for thinking that that would also go up by 5%. For sure you are another year older but the term of the increase is also a year less than your original policy, which you might think sort of balances it out. Wrong !

Many companies have a multiplier of 1.5 or 150% of inflation when it comes to increasing premiums. Some are higher and some have a flat percentage increase on top of inflation.

So what does that mean to you ? well, it means that your £100 premium does not go up to £105 as you would imagine but rather to £107.50. Your sum assured however only goes up by the 5%.

Add in the magic of compounding and at 5%, you'll see your premiums double after 10 years, quadruple after 20 years and after 25 years, you'll be paying 567% of your original premium yet your sum assured will only have increased by 339%. Go longer term and it gets worse.

I reckon it might be better to get more cover on a flat rate and let inflation eat into it a little rather than pay a 50% premium to have it inflation proofed.

If you had taken advice at the time of arranging your policy rather than using cavendish you would have been told how the insurer works their ITA. You would also have been told which providers increase the premium by the exact same percentage as your benefit rather than load it.

Just one example of a false economy. The worst is finding out your policy isn't valid at all, perhaps due to non-disclosure around foreign travel and residency?

financialguerilla

This option is taken at outset of a policy and can usually be declined if premiums become unaffordable or if the sum assured reaches a level which is sufficient to do the job it's designed to do. I don't think many widows or widowers would say it was a rip off.