Life Insurance and Inflation UK

Life insurance is the cornerstone of financial planning for millions of families across the UK. It's a promise that, should the worst happen, your loved ones will have a financial cushion to help them navigate a difficult time. But in an era of rising costs, a silent threat can erode the value of that promise: inflation.

A policy taken out a decade ago may not provide the same level of security today. The lump sum you carefully calculated to cover the mortgage, pay for childcare, and replace your income could fall short, leaving your family vulnerable. The question is no longer just if you have life insurance, but whether your life insurance is fit for the future.

This comprehensive guide will explore the impact of inflation on your protection policies and provide actionable strategies to ensure your cover remains robust and relevant for years to come.

How to make sure your policy keeps up with rising costs

The single most effective tool for protecting your policy's value is to opt for index-linked cover, also known as increasing cover. This feature automatically increases your sum assured each year to counteract the effects of inflation, ensuring the future payout has the same purchasing power as it did when you first took out the policy.

However, there are other strategies, including regular policy reviews and choosing specific types of cover for different needs. Let's delve into the mechanics of how inflation affects your policy and what you can do about it.

Understanding Inflation's Corrosive Impact on Your Life Insurance

First, let's be clear about what we mean by inflation. In the UK, the most commonly cited measure is the Consumer Prices Index (CPI). The Office for National Statistics (ONS) uses it to track the average change in prices paid by consumers for a basket of goods and services. When CPI is high, your money buys less than it used to.

This directly impacts your life insurance. A standard 'level term' life insurance policy pays out a fixed lump sum. For example, you might take out a £250,000 policy over a 25-year term. Whether a claim is made in year 2 or year 22, the payout is still £250,000.

The problem? £250,000 in 20 years will not have the same value as £250,000 today.

A Real-World Example:

Imagine you took out a £150,000 life insurance policy in 2015 to protect your young family. At the time, this felt like a substantial sum.

• Based on Bank of England inflation data, due to the cumulative effect of inflation, that £150,000 from 2015 would only have the purchasing power of approximately £110,000 by 2025.
• To have the same real-terms value in 2025, the policy would need to be worth over £204,000.

This shortfall of nearly £94,000 could be the difference between your family clearing the mortgage and having to find extra funds, or between your children's university fees being covered or not. Inflation doesn't just reduce your policy's value; it fundamentally undermines its purpose.

The Primary Solution: Index-Linked Protection

Index-linked cover is specifically designed to solve this problem. When you choose this option, both your sum assured (the payout) and your premiums will increase annually.

How does it work?

The increases are typically tied to a measure of inflation. In the past, this was often the Retail Price Index (RPI), but now it is more commonly the Consumer Prices Index (CPI).

• CPI-linked: If CPI was 3% over the last year, your insurer would offer to increase your sum assured by 3%. Your premium would also increase, but by a slightly higher percentage, as you are now older and insuring a larger amount.
• Fixed Percentage: Some insurers offer a fixed annual increase, for example, 5% per year, regardless of the inflation rate. This can be simpler to understand and budget for.

Most insurers cap the annual increase, often at 10% for the sum assured. This prevents your cover and premiums from spiralling out of control during periods of very high inflation. You will also typically have the option to decline the annual increase, though if you do, you often lose the right to accept future increases.

Level vs. Index-Linked Cover: A 20-Year Comparison

Let's see how this plays out over time for a 30-year-old non-smoker taking out £200,000 of cover over 30 years.

Note: Premium increases are illustrative. The actual increase is calculated based on the new sum assured and your age at the time of the increase.

As the table shows, the index-linked policy maintains its real-terms value, providing a significantly larger payout later in the term. The trade-off is the steadily increasing premium.

Is Index-Linked Cover Always the Best Choice?

While powerful, an index-linked option isn't automatically the right choice for everyone. It's essential to weigh the pros and cons.

Who should strongly consider Index-Linked Cover?

• Parents with young children: Your policy term is likely to be long (20-25 years), a period over which inflation will have a major impact.
• Younger individuals: You will likely hold the policy for several decades, making inflation protection essential.
• Those protecting a family's lifestyle: If the payout is intended to replace an income and cover living costs for many years, its value must be preserved.
• High earners and business owners: Your financial value and the needs of your family/business will likely grow over time.

Alternatives and Strategies for Inflation-Proofing

If index-linking doesn't feel right for your budget, or you want more control, other strategies can help mitigate the effects of inflation.

1. Regular Reviews and 'Topping Up'

This is the manual alternative to index-linking. It involves setting a reminder to review your financial situation every 3-5 years, or after any major life event:

• Getting married
• Buying a new home or increasing your mortgage
• Having a child
• A significant salary increase

During the review, you recalculate your needs and take out a new, separate, smaller policy to bridge the gap. For example, if you determine you need another £50,000 of cover, you simply apply for a new policy for that amount.

Pros: You have complete control over when and by how much your cover and premiums increase. Cons: It requires discipline. More importantly, each new application requires fresh medical underwriting. Your age will be higher, and any new health conditions developed since your first policy could make the new cover much more expensive or even unavailable.

2. Using Different Policy Types Strategically

Not all protection needs are the same, and different policies can be used.

• Decreasing Term Assurance: This is designed to cover a repayment mortgage. The sum assured reduces over time, roughly in line with your outstanding mortgage balance. Because the debt it's covering is also shrinking, it has a built-in hedge against inflation for that specific purpose. However, if you add extra cover for family living costs onto a decreasing policy, that portion will still lose value over time.
• Family Income Benefit: This is an often-overlooked but brilliant product. Instead of a lump sum, it pays out a regular, tax-free monthly or annual income to your family until the end of the policy term. This is arguably easier for a family to manage than a large lump sum. Crucially, Family Income Benefit can be index-linked. This means the income your family receives will increase each year, protecting them directly against the rising cost of living.

An index-linked Family Income Benefit policy is one of the most effective ways to create an inflation-proof replacement for a lost salary.

Special Considerations for Business Owners, Directors, and the Self-Employed

For those running their own business, inflation poses a dual threat: to your personal finances and to the health of your enterprise. Specialist protection products are available, and index-linking is just as critical here.

As expert brokers, we at WeCovr frequently advise company directors and freelancers on these tax-efficient and robust solutions.

Key Person Insurance

This policy pays a lump sum to the business if a crucial employee or director dies or is diagnosed with a critical illness. The money is used to cover lost profits, recruit a replacement, or repay business loans.

• The Inflation Risk: The value of a key person often increases over time. Their salary rises, they become more integral to the company's success, and the cost of recruiting their replacement grows. A £500,000 policy might be adequate today, but in ten years, the true cost of losing that person could be £750,000 or more.
• The Solution: An index-linked Key Person policy ensures the payout remains sufficient to protect the business's bottom line, preserving shareholder value and ensuring business continuity.

Executive Income Protection

This is a policy taken out and paid for by a limited company to provide a replacement income for an employee or director if they're unable to work due to illness or injury. It's a highly valued benefit and is treated as a business expense for tax purposes.

• The Inflation Risk: A long-term absence of five, ten, or even twenty years is possible. A fixed monthly benefit of £3,000 might be fine in year one, but by year ten its purchasing power could be drastically reduced.
• The Solution: Executive Income Protection can be indexed both before and during a claim. This means the potential benefit amount keeps pace with the director's rising salary, and if a claim is made, the monthly payments increase each year to combat the rising cost of living.

Relevant Life Cover

This is a tax-efficient death-in-service benefit for individual employees and directors, paid for by the company. It functions like personal life insurance but is treated as a business expense and doesn't count towards the employee's lifetime pension allowance.

• The Inflation Risk: Just like personal life cover, the lump sum is vulnerable to inflation.
• The Solution: Applying indexation to a Relevant Life policy ensures this valuable employee benefit maintains its real-terms value for the employee's family, without any extra tax burden.

What About Critical Illness and Income Protection Cover?

The principles of inflation-proofing extend beyond life insurance to other essential protection policies.

Critical Illness Cover (CIC)

CIC pays out a tax-free lump sum if you are diagnosed with one of a list of predefined serious conditions, such as some types of cancer, a heart attack, or a stroke. This money is often used to cover lost earnings during treatment, pay for private medical care, or make adaptations to your home.

The impact of inflation here is just as severe. The cost of care, specialist equipment, and everyday living only goes up. A £75,000 CIC payout might seem adequate today, but in 15 years, it may not stretch nearly as far, adding financial stress at an already overwhelming time. Applying an index-linking option to your CIC policy is therefore highly recommended.

Personal Income Protection

For freelancers, sole traders, and employees without a generous sick pay scheme, this is arguably the most important policy of all. It pays a regular income if you can't work due to sickness or an accident.

As discussed with Executive Income Protection, indexation is vital. You want to ensure:

1. The potential benefit increases before a claim: To keep pace with your earnings.
2. The actual benefit increases during a claim: To protect your income during a long-term absence.

Without this, you could find yourself trying to survive on an income that buys less and less each year.

Take Control: A Practical Checklist for Your Protection Policies

Feeling overwhelmed? Don't be. Taking control of your policies is straightforward. Follow this simple checklist.

1. Find Your Policy Documents: Locate the paperwork for your existing life, critical illness, and income protection policies.
2. Identify the Key Details: What type of cover is it (Level, Decreasing, Index-Linked)? What is the sum assured? What is the term?
3. Assess Its Current Value: Use the Bank of England's online inflation calculator to see what your sum assured is worth in today's money compared to when you took out the policy. You might be surprised.
4. Recalculate Your Needs: Don't just think about inflation. Have your life circumstances changed? Calculate what you would actually need today to cover the mortgage, debts, childcare, and future living costs.
5. Speak to an Expert: This is the most crucial step. An independent broker can provide a free, no-obligation review of your entire protection portfolio.

At WeCovr, we specialise in helping clients do exactly this. We can analyse your existing policies, assess their suitability against your current needs and the threat of inflation, and compare options from all the UK's leading insurers to find a solution that is both effective and affordable.

Beyond Insurance: A Holistic Approach to Wellbeing

Protecting your family's financial future is paramount, but it's part of a bigger picture: your overall health and wellbeing. Insurers increasingly recognise this, with many offering rewards and benefits for healthy living.

Taking proactive steps to manage your health—through a balanced diet, regular physical activity, and sufficient sleep—can not only improve your quality of life but also potentially lead to lower insurance premiums in the long run.

At WeCovr, we believe in supporting our clients' overall wellbeing. That's why, in addition to finding you the right policy, we are proud to offer our customers complimentary access to CalorieHero, our proprietary AI-powered calorie and nutrition tracking app. It's a small way we can help you stay on top of your health goals, showing that our commitment extends beyond just the policy documents.

Conclusion: Secure Your Future, Today

Inflation is a slow, silent, but powerful force that can systematically dismantle the financial safety net you've worked so hard to build for your family. A level term policy that was perfectly adequate five or ten years ago may now be dangerously insufficient.

But this is a solvable problem. By understanding the tools at your disposal—primarily index-linked cover—and committing to regular policy reviews, you can fight back. Whether it's inflation-proofing your personal life insurance, your Family Income Benefit, or your business's Key Person cover, taking action is essential.

Don't let your legacy be eroded by rising costs. Review your protection today and ensure the promise you made to your loved ones holds its value, no matter what the future brings.