Should we Index our Life insurance?

Savvy_Saver1

Hi all,

We will shortly be concluding missives (Scotland) on our first home. As such, we're looking to take out life insurance for the first time.

We have decided to take out a joint policy of level term cover for 41 years until we retire. We want to it not only cover the mortgage, but also have an extra amount on top of this to replace the deceased partner's income. We went for level so that as the mortgage decreases (but the pay-out doesn't) the amount 'left over' after paying of the mortgage would actually increase, in part to help to off set against inflation.

For the amount of cover, we have done the total mortgage amount, plus my wage (as the higher earner) x 10.

However, I am wondering whether we should index the policy too, given that it is for 41 years. I looked and inflation over the last 40 years have been about 500%. Should I die in say 30 years, I wouldn't want inflation to mean that the amount 'left over' after the mortgage has decreased due to inflation to the point that it isn't sufficient to support my family.

Of course, as the mortgage is paid off, the 'extra' after it has been paid off will proportionally increase, but given the effect inflation can have, I wondered what people's thoughts on Indexation were. Originally I was keen on the idea, but now understand that our premiums will increase more than the amount we would be paid (RPI versus RPI x 1.4-1.6). As such the amount payable on death would not increase as much as the premiums, and so I'm now unsure.

Any help greatly received!

Thanks!

Aretnap

Over that length of time a measure of indexation is probably not a bad idea. OTOH as time went by it could mean you ended up paying for more cover than you actually needed - if you died a couple of years short of retirement, would your OH actually need 10 times your salary (plus inflation) to make ends meet - given that you'd only have been earning for a couple more years anyway?

An alternative to a level term policy would be a Family Income Benefir policy, whereby in the event of one of you dying, rather than paying out a fixed sum it would pay an ongoing income of £X every month until (date). Usually you'd set £X as the higher earning partner's monthly income, or a decent fraction of it, and (date) as your expected retirement age, or something close to it. With that type of policy it certainly makes sense to index link £X. It could be combined with a smaller decreasing term policy to cover the mortgage.

Weighty1

Whilst indexing the policy would mean it retains its value, if this a needed? For example, imagine the scenario........a parent wants to provide life insurance which is enough to cover their newborn until they are 21. They ascertain that £1,000/month would be enough to cover this need. They therefore arrange a £252,000 lump sum (£1,000 x 12-months x 21years).

If not indexed and the parent died after 10-years the policy would still pay out £252,000 but that money would only be needed over an 11-year term so equates to £1909/month. In this regard it is in effect countering the effects of inflation anyway.

Indexing a lump sum can be useful but isn't always necessary......

Savvy_Saver1

Thanks guys, useful advance.

If I do go for the Level Term cover however, given what Weighty1 points out, then I won't be indexing. I didn't think too much about the exact figures (your example was very useful here, thanks Weighty1!), and the fact that having less time until retirement would effectively increase the 'per month' figure anyways. I built a spread sheet based on £1000 per month for 41 years (£492k). If I died in 20 years time, without indexing the per month figure would have almost doubled to 1952 anyways. Generally, we're more likely to die, the older we get, and so it's likely the 'per month' figure of the lump sum would be considerable higher given the reduced number of years to retirement.

I am going to look into Family Income Benefit, alongside a separate decreasing mortgage policy too. If the level term needed to achieve the desire 'per month' payout is cheaper, then I'll go for it. If the FIB + Mortgage Insurance is cheaper, than I'll do that one instead!

Thanks both - now I just need to work out what a realistic 'per month' figure is - I'm thinking to keep costs low it may be worth starting off with a fairly low figure, given that it increases each year as the time remaining to retirement reduces.

Weighty1

Since the figure you have used for the level term (£492k) is the amount needed if you died today then the FIB is likely to be significantly cheaper since it is a form of decreasing term assurance rather than level.

I'd suggest that it's almost essential to index link an FIB plan due to it only paying an income and not a lump sum.