Life Insurance with Indexation UK
When you purchase life insurance, you are buying peace of mind. You are securing a financial safety net to protect your loved ones should the worst happen. But have you considered how the rising cost of living could affect that safety net over time? A lump sum that seems substantial today might be worth significantly less in 10, 20, or 30 years.
This is where index-linked life insurance comes in. It's a powerful feature designed to "inflation-proof" your policy, ensuring the payout your family receives has the same purchasing power in the future as it does today. In this comprehensive guide, we'll explore exactly how indexation works, who it's for, and whether it's the right choice for your financial protection needs.
How Index-Linked Cover Keeps Pace with Inflation
Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. A pint of milk, a loaf of bread, energy bills, and school uniforms all cost more than they did a decade ago. According to the Office for National Statistics (ONS), the Consumer Prices Index including owner occupiers’ housing costs (CPIH) rose by 3.8% in the 12 months to April 2024.
While this might not sound like a huge amount in a single year, the cumulative effect over the long term can be dramatic. Let's imagine a £200,000 level life insurance policy taken out today.
- With an average inflation rate of 3% per year, in 25 years, the real-terms value of that £200,000 payout would have shrunk to just under £95,000. It would buy less than half of what it could today.
Index-linked cover directly combats this erosion of value. It works through a simple, yet effective mechanism:
- Annual Increase: Each year, on your policy anniversary, your insurer offers to increase your sum assured (the payout amount).
- Tracking an Index: This increase isn't arbitrary. It's linked to a recognised measure of inflation, typically the Consumer Prices Index (CPI) or, less commonly now, the Retail Prices Index (RPI).
- Premium Adjustment: To cover the higher level of insurance, your monthly premium also increases.
By automatically increasing your cover amount, an index-linked policy ensures your financial protection grows alongside the cost of living, providing a consistent and meaningful benefit for your family, no matter when they might need it.
The Mechanics of Indexation: A Closer Look
Understanding the practical details of how indexation works is key to deciding if it's right for you. It’s not just a case of everything increasing by the rate of inflation.
The Annual Review Process
Once a year, your insurance provider will write to you ahead of your policy anniversary. This letter will outline:
- The current rate of inflation being used (e.g., CPI for the 12 months to September).
- The proposed new sum assured.
- The new, increased monthly premium.
You are then given a choice. You can either accept the increase or decline it.
The Option to Decline
This is a crucial feature of index-linked policies. You are never forced to accept an increase. If your financial circumstances have changed or you feel the premium is becoming too high, you can simply say "no" to that year's increase.
What happens if you decline?
- Your sum assured and premium will be frozen at their current level.
- Your policy effectively becomes a 'level cover' policy from that point forward.
- Critically, for most insurers, if you decline the increase (often for two or three consecutive years), you will lose the option to index-link your policy in the future. The indexation feature is switched off permanently.
How Are the New Premiums Calculated?
This is the most misunderstood aspect of indexation. Your premium does not simply increase by the rate of inflation. The increase is typically much higher.
This is because the new premium is calculated based on two factors:
- The increased sum assured.
- Your age at the time of the increase.
Insurers use a multiplier to calculate the premium increase. A common formula looks like this:
Premium Increase % = Inflation Rate % x Age-Related Multiplier
This multiplier is often around 1.5, but it varies between insurers. So, if inflation (CPI) is 4%, your premium might increase by approximately 6% (4% x 1.5). The logic is that you are buying more cover at an older age than when you first took out the policy, and the risk of a claim increases with age.
Example: Indexation in Action
Let’s look at a practical example. Sarah, a 35-year-old non-smoker, takes out a life insurance policy with a £300,000 sum assured for a monthly premium of £25. She opts for indexation linked to CPI.
- Year 1: Cover: £300,000. Premium: £25/month.
- Year 2: CPI inflation is 3%. Her insurer uses an age-factor multiplier of 1.5.
- New Sum Assured: £300,000 x 1.03 = £309,000
- Premium Increase: 3% (CPI) x 1.5 (Multiplier) = 4.5%
- New Premium: £25 x 1.045 = £26.13/month
Over many years, the difference becomes stark.
The Long-Term Impact: Indexed vs. Level Cover
The table below illustrates the power of indexation over a 25-year policy term, assuming an average annual inflation rate of 3%.
| Year | Level Cover Payout | Real Value (at 3% inflation) | Indexed Cover Payout |
|---|---|---|---|
| 1 | £250,000 | £250,000 | £250,000 |
| 5 | £250,000 | £215,500 | £290,000 |
| 10 | £250,000 | £186,000 | £336,000 |
| 15 | £250,000 | £160,500 | £389,000 |
| 20 | £250,000 | £138,400 | £450,000 |
| 25 | £250,000 | £119,700 | £521,000 |
As you can see, after 25 years, the level cover policy has lost over half its purchasing power. The indexed policy, however, has maintained its real value, ensuring the financial support intended for your family is not diminished by time.
RPI vs. CPI: Which Index Matters for Your Policy?
The inflation measure your policy is linked to has a direct impact on how much your cover and premiums increase each year. The two main indices used in the UK are the Retail Prices Index (RPI) and the Consumer Prices Index (CPI).
- Retail Prices Index (RPI): For many years, RPI was the standard index used for insurance policies and other financial contracts. A key difference is that it includes housing costs, such as mortgage interest payments and council tax, which can make it more volatile.
- Consumer Prices Index (CPI): This is now the UK's official measure of inflation. It is used for uprating state benefits and the State Pension. CPI does not include most housing costs associated with owning a home, and as a result, it tends to be lower and more stable than RPI.
- CPIH: A third measure, CPI including owner occupiers' housing costs, is now also widely used by the ONS. It offers a middle ground, but CPI remains the most common index for new insurance policies.
Historically, RPI has typically been higher than CPI. The government and regulators have been phasing out the use of RPI, and it is set to be fully aligned with CPIH from 2030.
For new life insurance policies today, the vast majority will offer indexation linked to CPI. If you have an older policy, it may be linked to RPI. It's crucial to check your policy documents to understand which measure is being used.
Comparing the Inflation Indices
| Feature | Retail Prices Index (RPI) | Consumer Prices Index (CPI) |
|---|---|---|
| Main Use | Historically used for policies, some contracts | Official UK inflation measure, state benefits |
| Housing Costs | Includes mortgage interest, council tax | Excludes most owner-occupier housing costs |
| Typical Rate | Generally higher and more volatile | Generally lower and more stable |
| Current Status | Being phased out | Standard for most new policies |
The Pros and Cons of Index-Linked Life Insurance
Choosing indexation is a significant decision. It's essential to weigh the benefits against the potential drawbacks.
Advantages of Indexation
- Protects Real Value: This is the primary benefit. It ensures your life insurance payout has the same purchasing power in the future, safeguarding your family against the rising cost of living.
- Automatic and Simple: The process is automatic. You don't have to remember to review your cover levels or shop for new policies to top up your protection.
- No Further Medical Underwriting: This is a hugely important benefit. The annual increases to your sum assured are granted without any new medical questions or examinations. If your health were to deteriorate after taking out the policy, you would likely find it very expensive or impossible to get more cover. Indexation locks in your ability to increase your cover regardless of your future health.
- Peace of Mind: Knowing your cover is keeping pace with inflation provides long-term reassurance that your family will be properly looked after.
Disadvantages of Indexation
- Increasing Premiums: The main drawback is the annually increasing cost. While the initial increases may be small, they compound over time and can become substantial in the later years of the policy, potentially straining your budget.
- Premiums Rise Faster than Inflation: As explained, the age-related multiplier means your premiums will rise by a higher percentage than the inflation rate itself. This can come as a surprise if you're not prepared for it.
- Budgeting Difficulty: The variable nature of the increases can make long-term financial planning more difficult compared to the fixed cost of a level cover policy.
Summary: Pros vs. Cons
| Pros | Cons |
|---|---|
| Protects the real value of your payout | Premiums increase every year |
| Increases are automatic | Premiums rise faster than inflation |
| No new medical questions for increases | Can make long-term budgeting harder |
| Essential for very long-term policies | May become unaffordable in later years |
Who Should Consider Index-Linked Life Insurance?
Indexation isn't necessary for everyone, but for certain individuals and situations, it is almost essential.
- Young Families with Long-Term Needs: If you're taking out a policy to protect your children until they are financially independent (a term of 20-25 years), indexation is vital. Over this period, inflation will significantly erode the value of a level payout.
- Anyone on a Long Policy Term: The longer the policy term, the more crucial indexation becomes. For a 40-year policy, the effects of inflation are profound.
- Income Protection Policyholders: For Income Protection, indexation ensures the replacement monthly income you would receive keeps pace with the cost of living, which is critical if you are unable to work for many years.
- Business Owners: For company directors and business owners, index-linking protection policies like Key Person Insurance and Relevant Life Plans ensures the benefit remains meaningful and sufficient to protect the business or the director's family.
- Inheritance Tax (IHT) Planning: For those using policies like Gift Inter Vivos cover to handle potential IHT liabilities, indexation helps ensure the payout keeps pace with the growing value of the estate or gifted assets.
What About Other Protection Policies? Can They Be Indexed?
Indexation is not just for standard life insurance. It is an available and highly recommended feature on several other types of protection policies.
Critical Illness Cover: A critical illness diagnosis can bring significant unforeseen costs, from private medical treatments and home adaptations to specialist equipment. These costs will all rise with inflation. Indexing your critical illness cover ensures you have a lump sum that is sufficient to cover these expenses, whenever you might need to claim.
Income Protection: This is arguably where indexation is most important. Income Protection pays a regular monthly income if you're unable to work due to illness or injury.
- Indexation before a claim: This increases your potential monthly benefit each year, helping it keep pace with your salary and the rising cost of living.
- Indexation during a claim: If you are claiming on the policy for an extended period, this option will increase the monthly payments you receive each year, typically by RPI or CPI. This prevents your income from losing its purchasing power over a long-term claim.
Family Income Benefit: This type of policy pays out a regular, tax-free income rather than a lump sum. Indexing it ensures that the annual income your family receives doesn't shrink in real terms, allowing them to maintain their standard of living.
At WeCovr, our expert advisers can help you compare policies from across the market, explaining the specific indexation options available for life, critical illness, and income protection cover.
Alternatives to Indexation
If you are concerned about the rising cost of index-linked premiums, there are other ways to manage your cover levels over time.
-
Level Cover: This is the simplest option. The sum assured and the premium are fixed for the entire policy term. It is cheaper and more predictable, but as we've seen, the real-terms value of the payout will decrease over time. It can be suitable for covering a fixed debt, like a repayment mortgage, where the amount you owe is also decreasing.
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Guaranteed Insurability Options (GIOs): Many policies come with GIOs. These allow you to increase your sum assured without further medical underwriting at specific major life events, such as:
- Marriage or civil partnership
- Birth or legal adoption of a child
- A significant increase in your mortgage
- A significant salary increase
GIOs are a great feature, but they are reactive, not proactive. You have to remember to exercise the option, and the increases are capped at a certain amount. They don't provide the same automatic, inflation-matching protection as indexation.
-
Regular Manual Reviews: You could take out a level policy and commit to reviewing it every 3-5 years. If you feel you need more cover, you can apply for a new policy to top up your existing one. The major risk here is that your health may have changed, making new cover much more expensive or even unavailable.
Comparing Your Options
| Feature | Indexation | Level Cover | Guaranteed Insurability Options |
|---|---|---|---|
| Sum Assured | Increases annually with inflation | Stays fixed | Can be increased at life events |
| Premiums | Increase annually | Stay fixed | Increase when you add cover |
| Medical Evidence | Not required for increases | N/A | Not required for increases |
| Main Benefit | Protects against inflation | Predictable and affordable | Flexible increases when needed |
| Main Drawback | Rising cost over time | Value erodes over time | Relies on you taking action |
Indexation for Business Protection: A Director's Guide
For company directors and business owners, protecting the financial health of the business is paramount. Indexation plays a crucial role in ensuring business protection policies remain fit for purpose.
Key Person Insurance: This covers the financial loss a business would suffer if a key employee died or became critically ill. The cost of recruiting and training a replacement, along with the lost profits and disruption, will increase over time. Indexing the sum assured ensures the payout truly reflects the cost to the business when a claim is made.
Relevant Life Plans: These are tax-efficient, company-paid death-in-service policies for directors and employees. As an employee's salary and the general cost of living rise, a level benefit can quickly become inadequate. Indexing a Relevant Life Plan ensures the benefit paid to the employee's family remains a substantial and meaningful amount, reflecting their value to the business.
Executive Income Protection: If a director is unable to work long-term, this policy pays a replacement income via the business. Indexing this benefit is vital to ensure that the income replacement keeps up with personal and business inflation, protecting the director's financial stability throughout their absence.
Shareholder Protection: This provides funds for the remaining shareholders to buy out a deceased or critically ill shareholder's stake in the company. As a successful business grows, the value of its shares will increase. While standard CPI/RPI indexation might not keep pace with rapid business growth, it provides a crucial baseline of protection. This type of cover should be reviewed regularly alongside business valuations.
Making the Right Choice: Is Indexation for You?
Deciding whether to add indexation to your policy depends on a careful assessment of your personal circumstances, long-term goals, and budget.
Ask yourself these key questions:
- What is the purpose of the cover? Is it to pay off a decreasing repayment mortgage (where level cover might suffice) or to provide an income for your family for the next 30 years (where indexation is essential)?
- What is the policy term? For any term over 15 years, the impact of inflation becomes significant. The longer the term, the stronger the case for indexation.
- Can you afford the increasing premiums? You need to be comfortable with the fact that the cost will rise each year, and often by more than the headline inflation rate.
Choosing the right protection isn't just about getting the cheapest quote today; it's about securing a policy that will deliver on its promise when it matters most. At WeCovr, we specialise in helping our clients understand these nuances. We can provide detailed illustrations showing the projected future premiums and cover amounts for both level and indexed policies, allowing you to make a truly informed decision.
We believe in a holistic approach to your wellbeing. That's why, in addition to finding you the right protection, all WeCovr customers get complimentary access to our AI-powered calorie and nutrition tracker, CalorieHero, helping you stay on top of your health goals. A healthier life is not only more fulfilling but can also lead to lower insurance premiums.
Ultimately, indexation is a trade-off between a higher long-term cost and the certainty of a future-proofed payout. For most people taking out long-term protection, it's a price well worth paying for true peace of mind.
What happens if I can't afford the premium increase for my index-linked policy?
Is the percentage increase in my premium the same as the rate of inflation?
Can I add indexation to an existing life insurance policy?
Does my life insurance for a mortgage need to be indexed?
Is indexation always linked to RPI or CPI?
Why life insurance and how does it work?
What is Life Insurance?
Life insurance is an insurance policy that can provide financial support for your loved ones when you or your joint policy holder passes away. It can help clear any outstanding debts, such as a mortgage, and cover your family's living and other expenses such costs of education, so your family can continue to pay bills and living expenses. In addition to life insurance, insurance providers offer related products such as income protection and critical illness, which we will touch upon below.How does it work?
Life insurance pays out if you die. The payout can be in the form of a lump sum payment or can be paid as a replacement for a regular income. It's your decision how much cover you'd like to take based on your financial resources and how much you'd like to leave to your family to help them deal with any outstanding debts and living expenses. Your premium depends on a number of factors, including your occupation, health and other criteria.The payout amount can change over time or can be fixed. A level term or whole of life policy offers a fixed payout. A decreasing term policy offers a payout that decreases over the term of the cover.
With critical illness policies, a payout is made if you’re diagnosed with a terminal illness with a remaining life expectancy of less than 12 months. While income protection policies ensure you can continue to meet your financial commitments if you are forced to take an extended break from work. If you can’t work because you’ve had an accident, fallen sick, or lost your job through no fault of your own, income protection insurance pays you an agreed portion of your salary each month.
Income protection is particularly helpful for people in dangerous occupations who want to be sure their mortgage will always be covered. Income protection only covers events beyond your control: you’re much less likely to be covered if you’re fired from your job or if you injure yourself deliberately.
Questions to ask yourself regarding life insurance
Just ask yourself:👉 Who would pay your mortgage or rent if you were to pass away or fall seriously ill?
👉 Who would pay for your family’s food, clothing, study fees or lifestyle?
👉 Who would provide for the costs of your funeral or clear your debts?
👉 Who would pay for your costs if you're unable to work due to serious illness or disability?
Many families don’t realise that life, income protection and critical illness insurance is one of the most effective ways to protect their finances. A great insurance policy can cover costs, protect a family from inheriting debts and even pay off a mortgage.
Many would think that the costs for all the benefits provided by life insurance, income protection insurance or critical illness insurance are too high, but the great news is in the current market policies are actually very inexpensive.
Benefits offered by income protection, life and critical illness insurance
Life insurance, income protection and critical illness insurance are indispensable for every family because a child loses a parent every 22 minutes in the UK, while every single day tragically 60 people suffer major injuries on the UK roads. Some people become unable to work because of sickness or disability.Life insurance cover pays out a lump sum to your family, loved ones or whomever you choose to get the money. This can be used to secure the financial future of your loved ones meaning they would not have to struggle financially in the event of your death.
If it's a critical illness cover, the payout happens sooner - upon diagnosis of a serious illness, disability or medical condition, easing the financial hardship such an event inevitably brings.
Income protection insurance can be very important for anyone who relies on a pay check to cover their living costs, but it's especially important if you’re self-employed or own a small business, where your employment and income is a bit less stable. It pays a regular income if you can't work because of sickness or disability and continues until you return to paid work or you retire.
In a world where 1 in 4 of us would struggle financially after just four weeks without work, the stark reality hits hard – a mere 7% of UK adults possess the vital shield of income protection. The urgency of safeguarding our financial well-being has never been more palpable.
Let's face it – relying on savings isn't a solution for everyone. Almost 25% of people have no savings at all, and a whopping 50% have £1,000 or less tucked away. Even more concerning, 51% of Brits – that's a huge 27 million people – wouldn't last more than one month living off their savings. That's a 10% increase from 2022.
And don't even think about state benefits being a safety net. The maximum you can expect from statutory sick pay is a mere £109.40 per week for up to 28 weeks. Not exactly a financial lifeline, right?
Now, let's tackle a common objection: "But I have critical illness insurance. I don't need income protection too." Here's the deal – the two policies apply to very different situations. In a nutshell:
- Critical illness insurance pays a single lump sum if you're diagnosed with or undergo surgery for a specified potentially life-threatening illness. It's great for handling big one-off expenses or debts.
- Income protection, on the other hand, pays a percentage of your salary as a regular payment if you can't work due to illness or injury. It's the superhero that tackles those relentless monthly bills.
Types of life insurance policies
Common reasons for getting a life insurance policy are to:✅ Leave behind an amount of money to keep your family comfortable
✅ Protect the family home and pay off the mortgage in full or in part
✅ Pay for funeral costs
Starting from as little as a couple of pounds per week, you can do all that with a Life Policy.
Level Term Life Insurance
One of the simplest forms of life insurance, level term life insurance works by selecting a length of time for which you would want to be covered and then deciding how much you would like your loved ones to receive should the worst happen. Should your life insurance policy pay out to your family, it would be in a lump sum amount that can be used in whatever way the beneficiary may wish.
Decreasing Term Life Insurance
Decreasing term life insurance works in the same way as level term, except the lump sum payment amount upon death decreases with time. The common use for decreasing term life cover is to protect against mortgage repayment as the lump sum decreases along with the principal of the mortgage itself.
Increasing Term Life Insurance
Increasing term life insurance aims to pay out a cash sum growing each year if the worst happens while covered by the policy. With increasing term life cover amount insured increases annually by a fixed amount for the length of the policy. This can protect your policy's value against inflation, which could be advantageous if you’re looking to maintain your loved ones’ living standards, continue paying off your mortgage in line with its repayment schedule and cover your children’s education fees.
Whole of Life Insurance
Whereas term life insurance policies only pay out if you pass away during their term, whole of life insurance pays out to your beneficiaries whenever this should happen. The most common uses for whole life insurance are to cover the costs of a funeral or as a vehicle for your family's inheritance tax planning.
Family Income Benefit
Family income benefit is a somewhat lesser-known product in the family of life insurance products. Paying out a set amount every month of year to your beneficiaries, it is the most cost-effective way of maintaining your family's living standards to an age where you'd expect them to be able to support themselves financially. The most common use would be for a family with children who are not working yet so are unable to take care of themselves financially.
Relevant Life Insurance
Relevant Life Insurance is a tax-efficient policy for a director or single employee. A simple level term life insurance product, it is placed in a specific trust to ensure its tax efficiency. The premiums are tax deductible and any benefit payable should a claim arise is also paid out tax free, which makes it an attractive product for entrepreneurs and their businesses.
Important Fact!
We can look at a more suitable option mid-term!
Why is it important to get life insurance early?
👉 Many people are very thankful that they had their life, income protection, and critical illness insurance cover in place before running into some serious issues. Critical illness and income protection insurance is as important as life insurance for protecting your family's finances.👉 We insure our cars, houses, bicycles and even bags! Yet our life and health are the most precious things we have.
Easily one of the most important insurance purchases an individual or family can make in their lifetime, the decision to buy life, income protection, critical illness and private medical health insurance can be made much simpler with the help of FCA-authorised advisers. They are the specialists who do the searching and analysis helping people choose between various types of life insurance policies available in the market, including income protection, critical illness and other types of policies most suitable to the client's individual circumstances.
It certainly won't do any harm if you speak with one of our experienced FCA-authorised insurance partner experts who are passionate about advising people on financial matters related to life insurance and are keen to provide you with a free consultation.
You can discuss with them in detail what affordable life, income protection, critical illness or private medical health insurance plan for the necessary peace of mind they would recommend! WeCovr works with some of the best advisers in the market.
By tapping the button below, you can book a free call with them in less than 30 seconds right now:
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WeCovr is an insurance specialist for people valuing their peace of mind and a great service.👍 WeCovr will help you get your private medical insurance, life insurance, critical illness insurance and others in no time thanks to our wonderful super-friendly experts ready to assist you every step of the way.
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