Index-linked policies costing 'thousands of pounds' extra

Consumers could be paying thousands of pounds more for index-linked insurance products due to companies adding charges to premiums beyond the level of inflation, research by In For a Penny podcast has suggested.

Typically, the level of protection cover for index-linked life insurance, income protection (IP) or critical illness (CI) increases in line with inflation, with customers opting to increase their level of cover each year by the rate of inflation or other measures to ensure their insurance stays in line with cost of living.

However research by the personal finance podcast has found that in some cases this can be as high as £11,000 extra or more for some insurance companies, with extra charges ranging from 1.2% to more than 3% depending on the inflation rate and age of policyholder.

Most major insurers add an extra charge on top of the rising monthly premium, to cover new underwriting risk due to the policyholder being older, however some friendly societies such as The Exeter do not charge at all.

Example

Aviva's policy terms for its whole of life cover state: ‘We'll calculate the increase in premium by multiplying the percentage increase in the cover amount by no greater than 2.0. We'll then multiply that amount by the current premium to work out what the increase in your premium will be.'

With an inflation rate of 2%, this would increase cover for £100,000 index-linked policy with a £100 monthly premium to £102,000 in year two, but monthly premium would go up to £104 a month. If inflation increased at the same rate for 25 years and the extra 2% was applied, the policyholder would pay a total of £49,975 in premiums.

In contrast, if an insurer didn't add any extra fees and only increased the premium in line with inflation - 2% in this example - they would pay £38,436, a difference of £11,539.

According to In For a Penny, Royal London charge the lowest extra charge - at 1.2% - but policyholders would pay a total of £40,462 over a period of 25 years using the previous example.

"Most people would assume if inflation is 2%, your cover and premium would go up by the same rate," said Joshua Gerstler, co-presenter of the In For a Penny podcast. "A lot of insurers are adding extra charges. That doesn't seem fair.

"If we want to see a change and insurers treating people fairly, clearly and transparently, we have to see insurers treat indexation of the premium the same as the indexation of the sum assured."

‘Factor' approach

LV= - which charges 1.5% for both IP and CI (but no longer offers whole of life) - has used ‘indexation plus a factor' rather than ‘pure indexation' since last year, it said, to achieve better outcomes for customers.

The insurer told COVER not everyone will start at the same premium - something the In For a Penny research findings do not take into account - and its ‘indexation factor' approach allows providers to charge less at the outset of a policy.

It added that providers may price index-linked policies differently, for example, with age-linked premium increases.

"Indexation, or ‘inflation linked' protection cover is an important consideration in maintaining the buying power of the insurance benefits over a period of time, particularly with IP," Justin Harper, head of protection marketing at LV= told COVER. "The insurance benefit is increased each year by retail price index (RPI) (or a fixed %age). However, insurers adopt different approaches in their indexation pricing - what the client actually pays.

"We examined and updated our indexation approach last year," he added. "We believe our methodology is fair and allows for good customer outcomes."

Lower cost

Since LV= adopted its ‘indexation plus a factor' approach, policies taken out increase the client's cover by RPI each year, but now increase the premium by RPI multiplied by (1.5) factor. "For this additional slice we use the cost at outset - the original premium rate for cover when the client took out their policy, something that does vary in the market with a few others applying ‘age attained'; the extra slice of cover is based on the age of the client and cost of cover now - adding another layer of uncertainty of future cost," Harper explained.

He said that the ‘factor' approach enables clients to secure cover at lower cost at the outset, as the cost of increasing risk associated with age can be factored into future premiums. It provides some certainty over future cost - subject to the actual level of RPI - and can be explained clearly, said Harper.

When comparing its pure indexation approach to one with 1.5 factor for a typical IP case, LV= found that it would take 16 years for the ‘new' factor to meet with pure indexation premiums - indicating the customer is paying less over the course of 20 years, the insurer said.

Analysis

In an article for the IPTF website, Building Resilient Household's Richard Walsh wrote: 'Theoretically it should be simple, whether we are considering a guaranteed premium or reviewable premium policy. Many customers will want to review their level of cover if they have a change of circumstance eg they move to a higher or lower paid job. However for those in a settled job with a reasonable expectation of increased wages over time the simplest way of ensuring adequate cover is to inflation proof their cover using one of the official indexes from the Office of National Statistics, eg the Consumer Price Index (CPI), Average Weekly Earnings (AWE) or the Retail Price Index (RPI).

'One would then expect the level of premium to increase by the same percentage as the increase in cover. However for many insurers this in not the case because it also takes into account the likelihood of making a claim due to the increase in the customer's age - typically with the indexation multiplied by two, although this does vary. This moves us into murky territory.'

Read the full article here.

Below is a table showing what the major insurers charge:

Provider	Whole of life	Income protection	Critical illness
Aviva	If your cover amount increases, your premiums will also increase each year. We'll calculate the increase in premium by multiplying the percentage increase in the cover amount by no greater than 2.0. We'll then multiply that amount by the current premium to work out what the increase in your premium will be.	Current premium will increase at 1.5 times the rate of the RPI increase.	Multiply your current premium by 1.5 and the percentage increase in CPI.
LV	N/A	The premium will increase in line with inflation (RPI) multiplied by 1.5	The premium will increase in line with inflation multiplied by 1.5.
Royal London	On each anniversary of your plan starting, your premium will increase by the rate shown in the additional features section of your cover summary, multiplied by 1.2.	On each anniversary of your plan starting, your premium will increase by the rate shown in the additional features section of your cover summary, multiplied by 1.2.	On each anniversary of your plan starting, your premium will increase by the rate shown in the additional features section of your cover summary, multiplied by 1.2.
Vitality	Your premium increase will depend on your age and the RPI. Under 80: If inflation increases up to 2%  premium will  rise by RPI plus 1.5%. If inflation is up 2-8% then premium increases RPI plus 2.5%. If inflation is 8-10% then premium increases RPI plus 3.5% If over 80 then premium increases at RPI plus 5% if inflation rate is up.	Your premium increase will depend on your age and the RPI. Under 80: If inflation increases up to 2%  premium will  rise by RPI plus 1.5%. If inflation is up 2-8% then premium increases RPI plus 2.5%. If inflation is 8-10% then premium increases RPI plus 3.5%. If over 80 then premium increases at RPI plus 5% if inflation rate is up.	Your premium increase will depend on your age and the RPI. Under 80: If inflation increases up to 2%  premium will  rise by RPI plus 1.5%. If inflation is up 2-8% then premium increases RPI plus 2.5%. If inflation is 8-10% then premium increases RPI plus 3.5%. If over 80 then premium increases at RPI plus 5% if inflation rate is up.
Zurich	Your premiums will go up each year by 2% for each 1% increase in cover we provide.	Your premiums will go up each year by 1.5% for each 1% increase in cover we provide.	Your premiums will go up each year by 1.5% for each 1% increase in cover we provide.

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• Topics
• Individual Protection
• Income Protection
• Critical Illness
• Whole of Life
• Index-linked
• Inflation
• premium
• increase