In this installment we will be discussing Premium Patterns and Cover Increases. This determines whether you can afford your cover in years to come, knowing what to expect helps you to budget better. It is also important to be aware of the differences in order to make the correct decisions. A good financial advisor will explain these differences in detail especially when comparing your existing cover.
Once you have read this blog and the previous ones you will be able to go through your own income protection policy and understand what it is you are covered for. And if you don’t have income protection cover you will be better equipped for that conversation with a Financial Advisor. Income protection forms the foundation of your financial plan.
Premium Patterns
Each year you have a policy anniversary where premiums are readjusted based on your premium pattern and the claims experience. The 3 standard premium patterns are level, 5% compulsory and age rated. There are several other variations but these are the 3 standard options.
Level starts out the most expensive but because your premium stays level each year over time because of inflation the cost becomes less over time. Level is easy to compare products because there is no variation in how to calculate the premium going forward. Important to note that when comparing insurance it is very important to make sure you are comparing a similar premium pattern.
5% compulsory means each year you have a compulsory increase in premium of 5%. If you are unable to afford this premium increase, the insurer is forced to reduce your cover amounts or you have to cancel the policy. This has an initial lower premium and over time continues to increase at 5% year. Still relatively simple to compare products and interpret the premium projection going in to the future as it is growing at a consistent 5%.
Age rated is the most aggressive premium increase. The basic concept is that as you get older your premiums increase more aggressively. This means it often starts as the most affordable but eventually it will become the more expensive option. This is the most difficult to compare as almost every company has different percentage increases and different definitions on when the increases occur. Some insurers use age profiled some have aggressive age rated while other companies have a yearly age rated increase. Basically making comparing each product and being able to project premiums going forward at times near impossible.
Some advisors in the industry are advising their clients to take the most aggressive option so that when the policy does eventually become more expensive you could cancel that insurance and take out a new policy. This is not necessarily poor advice but many advisors and clients are not aware of the risk that should your health or circumstances change you may not qualify for insurance later. At the end of the day insurance is a product that is designed to mitigate risk, when taking on more risk with your insurance you need to be aware it.
Cover Increase
Separate to the premium increases a cover increase relates to the benefit amount increase per year. You have a few options when consider this increase, firstly, no increase for things like a bond or other debt insurance where the amount needed is not going to increase. Secondly, you can select a fixed increase usually between 5-10% and this would automatically increase your cover for each benefit. The norm for income protection is to use the third option and this is an inflation increase. You can also elect to alter the increase each year but each insurer has different contractual rules depending on the policy.
This increase will add to your premium increase as you are purchasing additional cover each year. Below are some examples of what premium increase you can expect when considering the premium pattern and cover growth.
If you have a level premium like mentioned above your premium in theory will remain the same each year until the insurer does a risk re-rate (some companies have been known to do this regularly and have a reputation for under-pricing their insurance initially only to enforce one of these increases later.) Staying with a simpler example, a level premium and a 5% increase to cover you could expect a premium increase above 5% as the increased cover costs more.
If you have a 5% compulsory premium pattern and you select a 7% cover increase your premium would increase each year by more than 12%. You can’t simply add the premium increase and the cover increase as the new cover is purchased at your new age meaning it is fractionally more expensive.
Inflationary increases have pros and cons, the positive is that your cover will linked to inflation and all adjustments occur automatically, the negative is that you will not be able to know the cost of your cover in the future.
If you have a dependable financial advisor you should be reviewing your financial position whenever there is a significant change or at the least meet once a year for a review. In summary your premium pattern is chosen at the inception of the policy, cover increases have a little more flexibility in that some insurers allow you to adjust the increase or even avoid the increase in a particular year. One must remember that Income Protection is an insurance contract and very often some insurers’ policies are inflexible and do not permit many changes.
Unfortunately there are still many “sales-men” who will present their product with a different premium pattern, it looks more affordable, more flexible and he is even trying to save you money, what a great guy… what this Sales-man always fails to mention is that the premium pattern he quoted for you is the most aggressive and will most likely be unaffordable in a few years’ time.
Many clients are also not aware that someone marketing one or two products is a salesman and he will try and squeeze your situation into one of his product boxes. While an independent advisor is unbiased and able to provide the best option for you. With all decisions around insurance and investments it is well worth your time to meet with an expert.
If you would like to consult with an advisor in our network to get a second opinion on your existing cover or to assess your income needs please contact us. Our network of advisors are all qualified and come highly recommended.
Disclaimer
All information provided in this article is provided for information purposes only and does not constitute a legal contract between the party delivering this document, the client and any other person or entity unless otherwise specified. Nothing contained herein is intended to be, or should be construed as advice, guidance or a recommendation.