As rises in the cost of living continue to squeeze our finances, some insurance policyholders have noticed their monthly premiums have also hiked. We explore the reasons for this, what it means for you, and what can be done.
For a lot of people, the reason for the rise in their insurance costs is due to a feature that I often recommend to my clients – Indexation. Indexation is a feature commonly offered on long term insurance policies such as life insurance and serious/critical illness cover (which pay out a lump sum) as well as income protection policies (which pay a monthly income).
Indexation is recommended in response to one of the potential risks when taking out a long term insurance policies – inflation. Because the cover runs for such a long period of time, even if the amount of cover you have stays the same, the value of your cover can be eroded by inflation – i.e. that everything else costs more over time.
For example: Think about what you could buy if you took £100 into your local shopping centre today. Now imagine if you climbed into a time machine and took that same £100 with you back to the 1960’s. A quick look on Inflationtool.com tells us that you’d now have £2,167 to spend on 1960’s memorabilia! The only thing that has changed across that span of time is the value of your money and how much it can buy you.
Which leads us to a problem posed by long term insurance policies. What if you took out an income protection policy for £1,000 per month, you were healthy for the first 30 years of your policy, then had to make a claim? Would the £1,000 per month that you asked for 30 years ago still be sufficient to cover your finances? Or would the cost of living have increased so much that your £1,000 per month is merely pocket change by that time?
In comes indexation. A feature designed to “future proof” your insurance policy by allowing the amount of cover you have to increase over time in line with the cost of living. Most insurers use either the Retail Price Index (RPI) or Consumer Price Index (CPI) to work out how much to increase your cover by to ensure that your payout keeps its value. Both indexes are ways to measure the cost of living by tracking things such as by how much everyday household or supermarket items increase by each month.
Of course, indexation is not something that insurers offer for free! Once a year – usually on the anniversary of taking your policy out – your insurer will check the RPI/CPI and increase your cover amount to match the rising cost of living. They will then increase the amount you pay each month to reflect the increase in cover.
Which leads us to present day. The Office for National Statistics states that the RPI has increased by 14.8% in the last 12 months. For reference, it increased by just 3.8% across the 12 months before. As a result of the sharp hike in the cost of living, those with index-linked insurance policies have seen a much steeper annual increase in their level of cover (and cost of cover) than they did historically. And at a time when our pockets are feeling well and truly pinched, the increased outgoing doesn’t feel very welcome!
But before cancelling that direct debit and leaving yourself with no cover at all, it’s worth weighing up your options carefully. It might be better to tweak your cover slightly, or even pause the indexation increase for the year. Although this comes with its own potential drawbacks, depending on your insurers rules.
As always, it’s a good idea to get some advice from the experts to ensure that you make the best possible financial decisions, as well as making sure your insurance is going to keep giving you the peace of mind that you’re paying for!
If this has got you thinking feel free to get in touch or sign up to our monthly newsletter. We’ll be happy to talk about your situation and our independent advisers offer free protection reviews with no obligation.
Helen Peel – 27th September 2022
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