Let’s face it, life is unpredictable. That’s why insurance is so important – it’s our safety net when life throws a spanner in the works. But here’s something you may not have thought about: how to make sure your safety net is as strong as it can be, even as the economy ebbs and flows.
The secret? It’s all about something called indexation. When it comes to insurance, indexation is a bit like upgrading your safety net to a trampoline. It gives your policy a boost so that it keeps up with life’s ups and downs.
What is Indexation in Relation to Insurance?
Think of indexation like an insurance policy booster. It’s a special feature you can add to your policy that makes sure its value doesn’t lag behind the rest of the economy, even as inflation rises.
In simpler terms, if you have a policy that’s index-linked, the amount you’re insured for goes up a little bit each year. This rise could match inflation or a fixed percentage – whatever is stated in your policy. This means your payout should buy just as much in 10 years as it can today, ensuring your policy works like the investment account it’s supposed to, and not just like a savings account with no interest.
What is Inflation?
Recently, you will have likely heard the term “inflation” thrown around everywhere you go. It sounds like a complicated term, but it’s just a fancy way of saying that prices for things we buy – like food, clothes, or fuel – are going up. For instance, if inflation is at 2% this year, something that costs you £100 now will cost about £102 next year. So, over time, the same amount of money buys you less and less. That’s inflation for you, always nibbling away at the value of our money.
It, unfortunately, gets worse when we put this in real-world terms. Why? Because inflation is at an all-time high at a huge 11.1%, as of April 2023. That means something that cost you £100 a few years ago will now cost you £111.10. That’s the main reason you will have certainly seen all your bills go up. It’s also the reason why our money doesn’t go as far, even when we get a raise.
How Does Indexation Work?
Alright, let’s break down how indexation works. As we just talked about, things have been getting expensive. But imagine that, instead of what most of us experience as our reality, all our income (whether it be from work, side jobs, businesses, investments, or pensions) also rose by 11.1% – without us having to lift a finger.
We wouldn’t all be feeling the pinch, would we? Our lives and our buying power would be the same as they were years ago. That’s what indexation does for your insurance policy – it raises the amount of money your life insurance will pay out to keep the value the same in line with inflation.
Every year, indexation tweaks the amount you’re insured for, keeping it in step with a recognised index (like the Consumer Price Index) or a fixed percentage agreed in your policy. For a life insurance policy, this means the payout your loved ones would receive grows over time, maintaining its “buying power” even as the cost of living goes up.
Effect of Inflation on Different Types of Policies
Now, let’s talk about how inflation plays with different types of insurance policies.
For term life insurance, which lasts for a specific period (say, 20 years), inflation can be a serious hindrance. For example, If you bought a policy worth £200,000 today, that amount will certainly not go as far in 20 years, thanks to rising costs.
Whole life and universal life policies last for your entire life and often come with a savings or investment component. These policies may offer ways to offset the effects of inflation, especially if they’re index-linked. But, they’re like first-class seats of policies, typically much more expensive than term life insurance.
Each policy type has its pros and cons, and inflation impacts them differently. It’s all about finding the right fit for your lifestyle and financial goals. And remember, an insurance advisor can help you weigh your options and choose the best policy for you.
Are All Life Insurance Policies Index-Linked?
Just like not all cars come with heated seats, not all life insurance policies come with index-linking. The more straightforward term life insurance policies often keep the payout, or “death benefit”, the same no matter what.
But here’s the good news: index-linked policies are becoming more common, especially with whole-life or endowment policies. Usually, it’s an optional extra – like choosing to add coloured ambient internal lights when you order a new car. You need to opt for it when you first get your policy (or, sometimes, at the annual renewal), otherwise, you won’t get the benefits.
Do You Have to Have an Index-Linked Life Insurance Policy?
No, but it is definitely handy. Without indexation, your policy will certainly lose its luster over time due to inflation. So if you want to make sure your policy gives your loved ones a solid payout, even decades into the future, then index-linking is a smart idea. It’s all about ensuring your safety net keeps its strength, no matter what the economy is doing.
Comparison with Non-Indexed Policies
At this point, you may be wondering why anyone would choose not to have an index-linked policy, so let’s compare index-linked policies with their non-indexed siblings. You can think of non-indexed policies like a sturdy bicycle – reliable, with a fixed benefit that doesn’t change over time. You pay your premium, and if anything happens, your loved ones get a fixed payout, simple as that.
On the other hand, an indexed policy is more like a car with cruise control. It adjusts the payout, so it keeps pace with rising costs. This means that, over time, the amount your loved ones will get is likely to be higher than with a non-indexed policy. But remember, just like a car is pricier than a bike, index-linked policies come with higher premiums. The best one for you depends on your budget, financial health, and your family’s future financial needs.
How Do I Know If My Insurance Policy Is Index-Linked?
Want to know if your policy has this index-linked superpower? The best way to find out is by checking your insurance policy documents. It’s like reading the ingredients list on a food packet – the details will all be there, they’re just a bit boring to wade through. If your policy is index-linked, it’ll clearly state how the indexation works and how much the insured amount will increase each year.
Should My Insurance Policy Be Index-Linked?
As we touched on earlier, whether or not your insurance policy needs to be linked depends on your budget, general financial health, and your family’s future financial needs.
If you want a one-and-done answer, then yes, we recommend having an index-linked insurance policy.
If you want a more considered answer, then here’s what you should consider:
- Can you afford the premium on an index-linked insurance policy?
- Do you have other savings or assets your family would inherit? If so, is it worth paying more for an index-linked policy, or less and having a non-index-linked policy as a bonus?
- Will your family need the money if/when you pass? Some people buy life insurance to ensure their loved ones get some money to enjoy when they pass, regardless of their personal financial health. But for some, such as parents that are 30-50 with young kids and are the sole breadwinner, the life insurance policy may be to ensure lives can continue as normal if the worst was to happen. If that’s the case, then an index-linked policy may prove more beneficial.
It’s important to weigh up whether the extra cost now is worth the extra coverage later. If you’re unsure, it might be a good idea to chat with an insurance advisor – our friendly team are independent advisors and will be happy to chat with you for as long as necessary to ensure you come to the right decision.
What Should I Do If I’m Not Happy With My Life Insurance Policy?
If you discover your current life insurance policy isn’t (or is) indexed, and aren’t happy with it, don’t worry, you’re not stuck with it. You can start shopping around and find a policy that suits you better. Our independent insurance advisors are like (free!) personal shoppers for insurance and can help you understand what options are available and which policy best suits your needs. You can click here to learn more.
So, there you have it. Inflation and indexation might sound like boring topics, but when it comes to life insurance, they’re like the villain and the hero – one making your policy weaker, and one ensuring it stays healthy, no matter what.
If you’re feeling a bit overwhelmed or are not completely happy with your current policy, don’t worry. That’s what we’re here for. As independent insurance and mortgage advisors, we can help you find the perfect fit. So, reach out to us – let’s make sure you have a policy that gives you the safety net you need, no matter what life throws at you. Click here to get started.