Why Insurers Push Life Insurance Indexation (and why you should avoid it)
Your man in the bank will lay it on pretty thick:
You’re not adding indexation to your Life Insurance? Without it, your family will face a life of poverty, end up sweeping chimneys and begging for scraps on the streets.
Okay, so I’m exaggerating slightly – but the guilt trip is a mean trick for the bank to play on you.
Life Insurance indexation might seem like a good – even necessary – addition to your policy, but is it really in your best interest?
Here’s the thing: those who are selling you insurance, let’s not forget – love Life Insurance indexation because they get extra commission for selling it.
Up to 20 per cent more!
Hear that?
That’s the sound of your wallet emptying.
What is Life Insurance Indexation?
If you look up a definition in a business dictionary, you get this:
Life Insurance with a premium rate that’s linked to changes in the consumer price index.
Righttttt… so this means?
Pull up a chair and let me try to explain:
Indexation offsets (beats the shit out of) inflation.
Inflation, as we all know, because we’re living and breathing pawns of capitalism, is where the price of stuff goes up because of the economy.
Prices generally go up for two reasons:
1. Demand is high (think of the housing crisis) or
2. Because the cost of making things increases
If you add indexation to your life insurance, the insurer will increase your cover and premium yearly.
But this is where it gets interesting.
Only one insurer, New Ireland, increases your cover and premium by the same rate.
All the others increase your premium more than your cover, so be careful.
If you really want indexation, New Ireland is the only show in town.
How Does Inflation Protection Work?
Let’s say you take out €100,000 index-linked life insurance policy at an initial premium of €10 per month in the first year.
You’ve read this blog, so you choose New Ireland, which will increase your coverage and premium by 3% annually.
In year two, your coverage and premium increase, giving you €103,000 in coverage for a premium of €10.30.
In year three, it’ll go up again unless you opt-out.
And it’ll keep going up, forever and ever, until your policy ends.
That’s a lot of 3 per cent; that’s all I’m saying.
You probably think it could be a useful way to increase your cover as you make a few extra bob over time.
But as I’ll explain below, the amount of cover you need reduces over time because you’re closer to retirement and have fewer years of income to replace.
Let’s say you’re 40 and earn 50k with 28 years to retirement. You’ll make €1.4m over the rest of your career, which you need to replace should you exit the stage left.
But when you’re 50, you’ll only have 18 years of income to replace, i.e. €900,000, so you won’t need as much cover as your younger self.
So Why is Life Insurance indexation a bad idea?
Premium Creep
Remember, as your coverage increases, so does the cost to you.
Your premiums can get expensive.
VERY EXPENSIVE.
Let’s say your initial premium is €100 a month.
Sound.
25-year policy.
Grand.
By year 25, indexation will have you paying €307 a month!
Oh dear.
And, lest we forget, the sales guys are getting up to 20 per cent extra commission.
Of course, they’ll push it — more mun, more fun for those lads.
That’s why the Life Insurance industry loves indexation
You don’t need more cover as you get older
Life Insurance’s core purpose is to replace your future income when you die.
So you need less insurance as you get older because:
You get closer to retirement (less income to replace).
Your kids become financially independent. (hopefully)
You’ll have paid off your mortgage.
You’ll have more savings/investment/access to your pension fund.
If you add inflation protection, your premiums will be way, waaaay more expensive.
Will the premiums cripple you as you get to retirement age?
Likely, when you’re not earning nearly as much at that stage of life.
Life insurance is most valuable when you’re younger, have debts and bills, and have a family to look after.
Instead of indexing your policy, you could buy more coverage now than you think you now and fix the premium 👌
Does that mean that absolutely no one should buy indexation?
Indexation suits those on rocket-fuelled career trajectories, such as medical consultants.
Their income increases like the clappers, so they can afford the higher premiums.
If that makes sense for you, then go for it.
If that’s not you, then don’t.
If you’re not sure if your policy has indexation, ask.
Most policies automatically include it for free for the first year, so you have to opt out when you apply.
Free is good, but keep an eye on it, or the premiums can get out of hand.
Best Provider of Index-Linked Life Insurance
Not all insurers increase your cover and premium by the same percentage, so you should choose the one that will cost you the least in the long run:
New Ireland cover and premiums increase at 3% (sound – but their initial premiums are higher than the competition)
Royal London cover increases at 3%, and premiums increase at 4%.
Aviva cover increases at 3%, and premiums increase at 4% p.a.
Zurich Life cover increases at 3%, and premiums increase at 4.5%
Irish Life cover increases at 3%, and premiums increase at 4.5%
Over to you
I hope that clears up what can be a confusing topic.
If you’d like me to assess your situation and recommend the types of cover you should consider (life insurance, income protection, and mortgage protection are the usual suspects), please complete this questionnaire, and I’ll be right back.
Alternatively, if you’d prefer a quick chat first, you can schedule a time that suits here.
Thanks for reading
Nick
Editor’s Note: We published this article in 2017 and have regularly updated it.
