Indexation automatically increases your cover to help fight inflation. Here’s what it means for your cover and your premium.

Indexation is an optional benefit on life insurance policies designed to ensure you’ll always have the same financial freedom in the event of a claim.

Not all insurance policies offer indexation. But for those that do, it works by offering you an increase to the sum insured in your policy at each policy anniversary.

This increase is designed to help your insurance benefit keep up with the rising cost of living.

Insurers differ slightly, but generally speaking the benefit increase is calculated at policy anniversary, the benefit ‘sum insured will automatically increase by the greater of either;

•      The applicable current Consumer Price Index (CPI), or

•      by a fixed percentage the insurer has published in their PDS, generally between 3% and 5%.

One thing that’s important to know is that as your cover increases, the premium you pay will generally also increase.

Indexation is optional and whether you accept it is up to you.

If you’d like to decline it in any given year, you simply need to let your insurer know, usually within 30 days of your policy anniversary. You may even be able to stop indexation permanently, but bear in mind you may need additional medical checks if you wish to turn it back on.

Ever wondered how insurers work out the cost of your life insurance?

There are many factors that can impact the premium you pay, but there are 4 factors in particular you need to be aware of.

1. Your personal risks

• Dangerous occupations can attract a higher base rate for your insurance, even before any loadings are applied.

• Poor health (such as a high Body Mass Index, or BMI) as well as dangerous hobbies, may add what’s called a ‘premium loading’ to your cover – which means you pay a higher premium than someone who doesn’t have those risk factors.  Any loadings like these are recorded on your Policy Schedule

• In terms of your health and lifestyle, the core factors that can contribute to your risk, and therefore a potential premium loading or higher set of rates, include:

  • Smoking – past and current smoking behaviour

  • Medical history – any conditions you currently suffer from, or have previously suffered from, or hereditary factors that increase your risk of claim

  • Occupation – the danger posed by your job on your physical wellbeing

  • Hobbies – the danger posed by any high risk personal activities.

If your health improves or your lifestyle has changed recently, get in touch with your adviser to review your policy and determine if these loadings can be removed to help lower your premium

2. Your age and gender

• Life insurance premiums are predominantly based on the risk of certain events happening to you.  These risks increase with age as serious illnesses become more common as you get older

• Age-related risks can also differ for men and women, which is why premiums for men and women of the same age may be different. For example, women live longer than men on average, which is why in most cases life cover premiums are cheaper for women. 

3. The more protection you have, the higher the cost of your cover

Your cost is influenced by these important factors of your policy:

• The type of benefits that are payable on your policy (trauma, disability, death)

• The sums insured of those benefits

• How long you would receive those benefits for (i.e. your benefit period for income protection)

• The waiting period you’ve selected before your benefits are paid out (for income protection)

• Any optional extras you may have selected

4. Whether you’ve chosen to pay stepped or level premiums

For most policies, two premium structures are offered:

• A stepped premium is one where the cost of your cover is recalculated each year based on your age at each policy anniversary. Generally this means your premium will increase each year as you get older.

• A level premium is one where premiums are calculated based on your age when any cover started. Your premium is generally averaged out over a number of years, which means you avoid increases in your premium due to age at each policy anniversary. This means your cover is more expensive than ‘stepped premiums’ at the beginning of your policy, but generally gets cheaper (relative to stepped premiums) as your policy continues.

• It’s important to note that at policy anniversary the premium may still increase (even with level premiums), because age is just one factor that determines your premium. Other factors that impact premium (such as claims trends in Australian population) can result in a repricing of your insurance cover.

• When insurers reprice stepped or level premiums, they don’t do it for an individual policy within a specific group unless they do it for every policy in that group.

• Regardless of whether stepped or level premium is selected, premium rates and premium factors are not guaranteed or fixed and insurers have increased premium rates in the past and may increase in the future.

A number of other factors may influence your premium, including:

1. Where you live, because different state governments levy stamp duty differently.

2. The structure of your cover, such as whether you select to have your insurance as a ‘stand-alone’ product, or whether you have it linked.

3. The number of lives covered, you may be eligible for a group discount on your premium if your policy covers family or business partners.

4. The frequency you want to pay your premium, where paying your premium monthly can attract a loading which wouldn’t apply if you pay your premium annually.

5. Whether you’ve selected indexation, as a way of pegging your cover against cost of living increases.

Whether you’ve chosen any extra cost options for your policy, including things like accidental death covers, child covers and others.

Life insurance premiums are predominantly based on the risk of certain events happening to you.

Because health risks increase with age, life insurance premiums will generally increase over time. That’s why most insurers offer two common ways of paying for, and managing, the costs of your cover over time:

1. Stepped premiums: when the cost of your cover is recalculated each year based on your age at your policy anniversary. Generally this means your premium will increase each year as you get older

2. Level premiums: where premiums are calculated based on your age when any cover started. Your premium is generally averaged out over a number of years, which means you avoid increases in your premium due to age at each policy anniversary. This means your cover is more expensive than ‘stepped premiums’ at the beginning of your policy, but generally gets cheaper (relative to stepped premiums) as your policy continues.

Regardless of whether your policy is on stepped or level premium, premium rates and premium factors are not guaranteed or fixed and many life insurers in Australia have repriced premium rates in the past.

Stepped or level premiums – which is right for you? 

Generally, this depends on how long you’re planning on keeping your insurance. If you’re planning on keeping your policy for longer than 10-12 years, level premiums may save you money over the life of your policy.

You may also be able to use a combination of stepped and level premiums.

For example, if you think you might want to reduce your level of cover down the track (e.g. when you're kids are grown up or you've paid down debt), you may be able to use level premiums for the portion of cover you think you'll keep longer and stepped premiums for the additional cover.

This is something your financial adviser can help you with.

Repricing is a possibility regardless of which structure you choose

It’s important to note that at policy anniversary the premium may still increase (even with level premiums), because age is just one factor that determines your premium. Other factors that impact premium (such as claims trends in Australian population) can result in a repricing of your insurance cover.

When insurers reprice stepped or level premiums, they don’t do it for an individual policy within a specific group unless they do it for every policy in that group.

To decide whether you’re better off on stepped or level premiums going forward, we recommend you speak to your financial adviser. They can help you understand your policy as well as any repricing activity that’s recently occurred, so you can make an informed decision.

A graphical example

Here is an illustration of stepped v level premiums, showing the difference between the two when you look at increases due to age. Other types of premium increases aren’t shown on this graph.

For illustrative purposes only. This graph illustrates age-based premium increases for stepped against level for all covers. This premium comparison has been calculated, assuming all other factors affecting the premiums are excluded.

Both stepped and level premiums can increase due to factors other than age.

Premium rates and premium factors are not guaranteed or fixed, and insurers have increased premium rates in the past and may increase in the future.

We recommend that you refer to the relevant product disclosure statement and policy documentation, and speak to your financial adviser, to understand other factors affecting your premiums.