Life Insurance: What is Index-Linking?
Life insurance is there to provide for your loved ones when you die. It is financial stability in an unknown sea, giving those who you leave behind a lifeboat to help them get back to shore.
So, imagine how upsetting it is to discover that the expected safety vessel designed to carry everyone safe to land is smaller than was promised, less a fully-equipped lifeboat and more a floating plank in the cold water – it’s there, but it’s not doing the job as well as expected.
With inflation making the value of money drop every single year, that’s exactly what can happen. After all, a £15,000 life insurance policy taken out in the mid-seventies represented enough to buy a reasonable house at the time.
What would it do for your loved ones today?
What is index linking in insurance?
Enter the retail price index (RPI) or consumer price index (CPI) – two similar sides of a single coin.
The RPI and CPI are tracking systems that use real world information to determine the real level of inflation in the country.
These are not vague theories – they really measure the price of essentials such as milk, bread, washing powder and even your council tax to form an idea of how much more expensive it is this year compared to last, and the year before that, and the year before that…
The retail price index can be used to look at that £15,000 from 1975 and tell us that the equivalent level of money today would be £124,787.32!
That’s what you want your life insurance to represent – and you can through index-linking.
Maintaining the cash value of your life insurance in the UK
Index linked life insurance means the sum assured (or sum insured - the total amount your life insurance will pay out if you pass away) gets a boost year-after-year to keep it inline with the RPI.
Those incremental changes may seem small on a single-year basis (averaging a little under 5% per year) but add it up over the length of a level term life insurance policy and it can be huge!
The benefits of an index linked life insurance policy are obvious – you leave behind the amount of money you really intended to, and not just a figure that has long lost its meaning over the passing of time.
You maintain the real cash value of your life insurance which is surely the point.
Index-linking and housing – does life insurance for a 3-bed today guarantee three beds tomorrow?
Many life insurance policies are taken out to provide housing for your children – and if not enough to give them the full value of a house, certainly the value of a sizeable deposit.
Today’s market is quite reasonable, and a 10% deposit for a mortgage will get most people on the ladder, but tomorrow could be different and planning for a 20% or even 25% boost is preferable.
If you take out an index-linked term life insurance policy today for £50,000, are you guaranteeing that deposit for your children in 15- or 20-years’ time?
Index-linking with the CPI or RPI means that an overall view of price increases is considered, and the price of a four-bedroom semi-detached in South London increased by a far greater percentage in the last quarter of a century than six pints of milk.
The price index becomes an average rise in inflation, rather than a top end rise that it would become if it tracked housing as a primary factor.
You will have the same spending power with your index linked insurance policy in 2050 as you do today, but that’s not to say housing will not continue stretching out of the reach of normal families.
Besides, by then we’ll all be living in floating space domes made out of leaves.
Index linking is still the best way to keep your insurance policy in line with inflation, but it’s not a guarantee of housing.
Why is increasing term insurance not the default?
Index-linking is optional, and if you don’t ask for it, the chances are high that you won’t get it.
There’s a fair argument that states it should be the other way around, and index-linking should be an ‘opt-out’ clause on your life insurance, however the confusion that index-linking brings for some potential life insurance customers means that insurance companies are unwilling to force anyone into it without their explicit agreement.
And rightly so.
When you index link your life insurance, not only are you making the sum assured (payout amount) grow over time, you are doing the same to your policy premiums.
Used to paying £50 per month? Next year it becomes £53, and then £56… it wouldn’t be long before customers are ringing up and complaining about what looks like an unfair price hike.
By opting-in to index-linking once you fully understand it and its implications (which by now, you do!) puts control of your life insurance policy in your hands and not that of the broker or insurer.
Of course, at Unite Life, we do recommend index-linking to our customers and are happy to discuss the finer points of the system to make sure you understand fully what you are signing up for.
Can I cancel my index-linking?
Each year, you will be asked if you want to stop keeping your policy in line with the RPI and if you come off the scheme, your life insurance will be locked at the height it has reached and no further increases will be applied.
Plus, if at a later date you want to go back to index-linking, simply let your insurer know and it’ll be reapplied from that point on.
When is index-linking not the right thing to do?
Decreasing term life insurance policies designed to fall in line with the remaining balance of your repayment mortgage are typically unsuitable for index-linking.
In fact, paying off your mortgage takes advantage of inflation in the opposite way, as fixed repayments don’t increase with the RPI yet your income will increase accordingly – making it a little easier to pay your mortgage each year!
Any non-decreasing policy, however, will benefit greatly from index-linking.
Getting life insurance with Unite Life
At Unite Life we are experts in all aspects of life insurance and will work with you to build a policy to suit you and your family.
Give us a call today with any questions you might have, or even for an in-depth discussion regarding the insurance indexation definition! We want you to understand your life insurance in full and have the specialist advisors to cover any part of the process.
Fill out our contact form to have one of the team call you back at a convenient time or simply pick up the phone and give us a ring to get that lifeboat prepared and ready to sail.