Should your insurance have ‘level’ premiums?

It sounds good: Lock in higher income protection or trauma insurance premiums now and reap rewards later. But are so-called ‘level’ premiums really advisable?

FOR level premiums

Lock in savings

Level premiums for income protection and trauma insurance do not increase with the age of the policyholder, while “stepped” premium policies do. So if you take a level premium at, say, age 35, you will pay more than a stepped one.

But it’s generally held that after six or seven years the premiums will be about the same, after which point the level policy becomes cheaper. That makes level premiums a handy way to lock in long-term costs and manage your cash flow. Stepped policies can be many times more expensive than level premiums at older ages, which could leave you underinsured just when you need cover the most.

Patience pays off

Sure, it can take a long time for you to come out ahead on level premiums. That said, and especially if you are taking out the insurance through your super, isn’t the long term what we should all be thinking about? The chart shows that it will be worth the wait: by the time you’re approaching 65 you’ll have saved more than $50,000 over the life of the policy – and even more if you’re earning a good return on your invested super dollar.

The self-insure fantasy

There is a theory that in the ideal world you pay the cheaper stepped premiums early, and then cancel your policy when it starts to get too expensive, at which point you rely on your accumulated savings. For most of us it’s a fantasy to believe that when we are older we will have sufficient cash to self-insure. The reality is that retirement savings of the average Australian are well short of what is needed to retire comfortably. Often the money tagged for retirement will only pay off the outstanding mortgage, leaving little left over for a retirement income stream – let alone cash for a rainy day.

Cunning research

Some of the pitfalls of level premiums can be avoided by paying careful attention to the terms of the policy. You need to make sure that the indexation is reasonable and that you can replace the policy (for example, to move it out of super) without penalty and that the insurer is solid and has a history of including upgrades into its existing policies.

AGAINST level premiums

A lengthy process

Insurers may advertise the fact that it only takes a half-dozen years for stepped premiums to equal level, but don’t be misled: it can take 15 years to make up the lost money in higher premiums paid in those years, and more than 20 years if you include the “opportunity cost” of the returns you could have made on the cash you dropped on the level premiums in the early years. Assuming that your level premium is paid through your super fund, it’s indexed at 5 per cent and that you manage an investment return of 5 per cent, then, as you can see from the chart, it will take 22 years from the age of 35 before you are in the black.

Locked in

Those kind of pay-off periods mean that you need to commit to be with the same insurer and on the same policy for decades. But as your circumstances change you might find that you want to alter your policy. However, you feel locked in and unable to move.

A classic example is that you start with the insurance in your super. Then your children grow up and are no longer financially dependent. You want to move your insurance out of super for tax reasons, only to find that the level premium resets at your higher age, thus negating the long-term benefits of the level option. Or the insurer could go out of business. Or the policy could become uncompetitive.

Not ‘level’ at all

The name “level” is a red herring: these policies are actually indexed to inflation. They will also go up as you increase the sum insured (for example, in the case of income protection as your salary increases – this is not included in the actuaries’ numbers). Additionally – and this takes the cake – the very base of the level premium is not guaranteed. The insurer can increase the premiums for whatever reason.

It’s all over once you hit 65 anyway

Amid the angst of deciding which of the two options is best for you, remember that the level premiums are extinguished at age 65. So even after 30 years’ commitment you reach retirement age and then face the higher, age-based premiums anyway.

If you would like to evaluate your insurance needs or discuss which policies best suit your situation call us or email now to arrange a free Insurance Check up.