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Why Insurers Push Life Insurance Indexation (and why you should avoid it)

October 8 2019 5 min read Blog Life Insurance

 

inflation protection is deflating text on a deflated balloon image

You’ll be in the bank when they hit you with the big one: if you don’t go with Life Insurance indexation, you’ll leave your family with less money than you intended to.

They’ll face a life of poverty.

Ending up sweeping chimneys and begging for scraps on the streets.

Okay, so I’m exaggerating – but the guilt trip is a mean trick for the bank to play on you.

Life Insurance indexation might seem like a good – even necessary – thing to add to your policy, but is it really in your best interest?

Here’s the thing: those who are selling you insurance, let’s not forget – love Life Insurance indexation because they get more commission from selling it.

Up to 20 per cent more!

Hear that? That’s the sound of your wallet emptying.

What is Life Insurance indexation?

If you look up a definition in a business dictionary, you get the wildly helpful: 

Life Insurance with a premium rate that’s linked to changes in the consumer price index.

Righttttt… so this means?

Pull up a chair and let me try to explain:

Indexation offsets inflation. 

Inflation, as we all know from being living and breathing pawns of capitalism, is a thing in economics where the price of stuff goes up because of the economy. 

Prices generally go up for two reasons: 

1. Demand is high (think of the housing crisis) or 

2. Because the costs of making things increases 

Add indexation to your life insurance and the insurer will hike up your cover by 3 per cent each year, to protect your dear family against inflation, and your premiums by 4%.

That’s a 1% cha-ching for the insurer. 

Let’s say you take out €100,000 index-linked cover (say that three times into a mirror and a rich man in an ill-fitting suit appears in your bathroom). 

You’ll be paying a tenner a month for the first year. In year two, your cover and premium increase giving you €103,000 cover for a premium of €10.40. In year three, it’ll go up again, unless you opt-out.

And it’ll keep going up, forever and ever until you die. 

 

That’s a lot of 3 per cents, that’s all I’m saying.

You probably think it could be a useful way to increase your cover as you make a few extra bob over time – and this way you get those increases without a new policy or having to do a life insurance medical exam  (which can catch you out big-time, price-wise, down the line).

But as I’ll explain below, the amount of cover you need reduces over time because you have fewer years of income to replace.

Let’s say you’re 40 and earn 50k with 28 years to retirement. You’ll make €1.4m over the rest of your career.

But when you’re 50, you’ll only have 18 years income to replace, i.e. €900,000, so you won’t need as much cover as your younger self.

So why is Life Insurance indexation a bad idea?

Currently, Ireland’s rate of inflation is quite low.

inflation rate chart ireland

It’s been bobbing around between -2 and +2% since The Recession and is forecast to stabilise over the coming years at around two per cent. Brexit is keeping a lid on Irish inflation because weakness in sterling lowers the price of Irish imports from the UK, leading Irish retailers to pass on this reduced cost by lowering prices for these goods.

Brexit – yey 😕

Our inflation is notably low, compared to say a country in a crisis like Venezuela. Their inflation rate is expected to reach 8 million per cent this year – so g’luck to the poor chaps there trying to buy the basics.

Inflation isn’t a trivial thing – and it’s also not necessarily bad. A small amount of inflation (1-2 per cent) keeps things ticking over. Deflation (the opposite of inflation) can be a bad thing – over here if you want to nerd out.

But to answer the question: why is Life Insurance indexation a bad idea – or, at least, not a necessity?

1. Ireland has had a low amount of inflation for the last few years

Ireland’s inflation rate for August 2019 was 0.7 per cent.

Why is any of this ‘economics for dummies’ relevant?

Well, our inflation rate is quite low. And indexation is meant to balance out inflation. But indexation can increase your cover by up to 4.5 per cent EVERY YEAR (depending on the insurer, I’m looking at you Irish Life and you Zurich Life)

So, you’re paying extra for protection against something that isn’t causing an issue. 

2. Life Insurance indexation can be expensive

Remember, as you cover increases, so does the cost you’re paying.

Your premiums can get expensive.

VERY EXPENSIVE.

Why?

And that’s the real kicker.

If your insurer increases your cover by 3 per cent annually, the premium you pay can go up by up to 4.5 per cent every year.

That’s a cushty 1.5% margin your insurer can play with.

Don’t be fooled by the low initial premium.

It will go up and up and up.

Let’s say your initial premium is €100 a month. Sound. 25-year policy. Whopper.

By year 25, indexation will have you paying €307 a month!

 

Oh dear.

And, lest we forget, the sales guys are getting up to 20 per cent extra commission. Of course, they’re gonna push it — more mon for them.

That’s why the Life Insurance industry loves indexation

3. You don’t need more cover as you get older

Life Insurance’s core purpose is to replace your future income on the day you die.

So you need less of it as you age because:

  • You get closer to retirement (less income to replace).
  • Your kids become financially independent. 🤞
  • You’ll have paid off your mortgage.
  • You’ll have more savings/investment/access to pension fund.

If you add inflation protection, your premiums are gonna be way, waaaay more expensive – but you’ll have a massive wedge of money to leave behind. Your kids would be delighted by that wedge, but will the premiums cripple you as you get to retirement age? Likely, when you’re not earning nearly as much at that stage of life.

Life Insurance is most valuable when you’re younger, are earning, have debts and bills, and a family to look after. That’s probably not when you’re 65.

You don’t want to die the wealthiest person in the graveyard.

Does that mean that absolutely no one should buy indexation?

Nope.

Indexation suits those on rocket-fuelled career trajectories, medical consultants, for example. Their income increases like the clappers so they can afford the higher premiums. And they can always opt-out of the indexation.

If that makes sense for you, then go for it. If that’s not you, then don’t.

If you’re not sure if your policy has indexation, ask.

Most policies automatically include it for free for the first year, so you have to opt-out when you are applying.

Best Provider of Index Linked Life Insurance

Not all the insurers increase your cover and premium by the same percentage so you should choose the one that will cost you the least in the long run:

  • New Ireland cover and premiums increase at 3%
  • Royal London cover increases at 3% and premiums increase at 4%.
  • Aviva cover increases at 3% and premiums increase at 4% p.a.
  • Zurich Life, cover increases at 3% and premiums increase at 4.5%
  • Irish life cover increases at 3% and premiums increase at 4.5%

Over time, if you’re looking for the best value index linked life insurance, you should choose Royal London.

Why?

They don’t initially charge extra for adding indexation to your policy.

With New Ireland who offer an identical increase in cover and premium,  you pay extra from day one for the privilege of having index linked life insurance. 

Over time, and I’ve crunched the numbers, Royal London offer the best value as they usually have discounted rates that are lower than Aviva.

Over to you

I hope that clears up what can be a confusing topic. If you’d like me to take a look at where you are in life and make a recommendation on the types of cover you should consider (life insurance, income protection and mortgage protection are the usual suspects) please complete this questionnaire and I’ll be right back.

Alternatively, if you’d prefer a quick chat first, you can schedule a time that suits here.

Chat soon 🙂

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