An investigation revealed that customers with protection policies linked to inflation, such as life insurance and critical illness coverage, could see their fees rise faster than potential payments.
Research by the personal finance podcast ‘In For A Penny’ shows policyholders could be stung by hundreds of pounds more for their insurance than they initially anticipated thanks to extra charges on protection policies.
It found that insurance companies add additional fees besides inflation to index-linked policies, sometimes as high as 5 percent of the monthly premium.
The added fees mean that customers may end up paying more than they initially expected
An “index-linked” protection deal increases the level of coverage for life, income protection or critical illness insurance in line with retail or consumer price indices.
Policyholders can choose to have their level of coverage increased each year by the rate of inflation – or sometimes through other measures – to ensure that their insurance is in line with the cost of living.
While the amount of coverage goes up, so does the monthly premium.
However, the research found that in many cases, the insurance company will add additional costs to the premium either in the form of a “multiplier” surcharge – meaning that the policyholder will pay more in the long run than they might expect from the start.
For example, while the amount of coverage provided for an Aviva Index Linked Income Protection Policy will simply rise with inflation, the premium will rise by 1.5 times the RPI.
If the monthly premium linked to the index is £100 and the level of cover is £100,000, the policyholder might expect that at 2 per cent inflation the premium will rise to £102 and the cover increase to £102,000.
But with the addition of a multiplier such as the Aviva multiplier, the premium would rise to £103.
After 20 years, the premium would have risen to £256 a month, more than £95 if it had risen with inflation.
Other insurance companies will add additional fees depending on how much inflation occurs throughout the year.
With Whole Life Vitality Bay, r for example, if inflation increases by up to 2 percent, the premium will go up by RPI plus 1.5 percent, whereas if inflation rises between 2 and 8 percent, the premium will go up by RPI plus 2.5 cent cents.
If you take Vitality’s whole life coverage, once you reach 80, your monthly premium will increase by RPI plus 5 percent if inflation goes up.
A VitalityLife spokesperson said: “Vitality uses a tiered approach as this allows us to better align increases with underlying risk, resulting in fairer outcomes for clients.
“Our approach means that we don’t pass unnecessarily higher premium increases on to clients in times of high inflation. For example, at an RPI of 7 per cent, the premium increase would be 9.5 per cent, rather than 10.5 per cent or 14 per cent under the 1.5 multiplier approach. x or 2x.
Most major insurers add an additional fee, which varies for different providers, but some friendly communities like Exeter do not.
“Most people will assume that if inflation is 2 percent, your coverage and premiums will go up at the same rate,” said Joshua Gerstler of The In For A Penny Podcast. Many insurance companies add additional fees. It doesn’t seem fair.
“If we want to see a change and insurance companies treat people fairly, clearly and transparently, then we have to see insurance companies treat premium indexing like indexing the guaranteed amount.”
Insurance companies argue that adding a multiplier means they can charge lower premiums to begin with
What’s going on?
The policyholder’s risk of claiming a protection policy increases as they get older, and insurers say adding a compounding fee or surcharge on inflation means they can charge a cheaper monthly premium at the start of the policy to properly reflect that.
They argue that if this were not added, the client would have overpaid at the beginning of the policy and would have underpaid at the end.
In this case, if you cancel halfway through, you will end up paying more than you need for the risk you took on the claim.
For example, until last year LV didn’t add a multiplier, but it has since added a multiplier 1.5 above the RPI on all protection policies associated with the index.
However, the insurance company claims that this actually benefits the customer as it allows them to collect a cheaper monthly premium from the start while still offering the same level of coverage.
Below is a chart that is an internal analysis by LV that looked at how the multiplier could be used to change its prices in a typical policy.
The blue line represents a premium rising at 2 percent from inflation over 20 years. The orange line is inflation with a multiplier of 1.5x.
Although the doubled premium goes up faster, it starts out lower, and it doesn’t become more expensive than a non-compounded premium until the 16th year of the policy.
In this example, over the full 20-year period, the policyholder would actually pay less with twice the premium than if it had increased with inflation.
Level cap is still cheaper than index linked policies
A non-inflationary cap, known as a level cap, does not rise with inflation and usually starts at the same rate as index-linked inflation.
But unlike index-linked cap, level cap payments will remain the same.
The effect is seen in the long run, both in payments and level of coverage.
For example, if a Level Cover of £100,000 costs £100 per month during the Plan, and a Level Cover of £160,000 costs £160 per Month throughout the Plan, using the index-linked cover offered by Royal London with a multiplier of 1.2x will start the indexed cover of £100,000 from £100 per month and gradually increasing to £176 per month when the cap reaches £160,000.
However, the term client level is also aging and becoming riskier at the same rate as the index related client. So what is going on here?
Insurers say this is because risks on index-linked policies are higher — increases in coverage on indexed policies are offered each year regardless of clients’ changes in health.
A non-indexed cap does not rise with inflation and usually starts at about the same price
So in a life insurance policy, if someone is diagnosed with cancer, for example, the level of coverage offered in an indexed policy will continue to rise each year, while a term-limited customer will struggle to buy or “scalp” more coverage.
This adds more risk to the policy and makes it more expensive than a level policy. Adding a multiplier allows insurers to charge the same level term and index-bound term from the beginning, but forms the additional expense of the index-linked policy later.
A spokesperson for Zurich, which subtracts index-linked premiums of 1.5 per cent for every 1 per cent increase in coverage it offers, said: When they took out the policy, they were likely to claim that, and the fact that no additional underwriting checks were carried out, despite the fact that the customer’s health have deteriorated.
These risks increase faster than the rate of inflation, which is why premiums are higher than the coverage rate. If there is no increase in the rate of inflation, the starting premiums for these types of policies will be higher than for policies with a level premium.
A VitalityLife spokesperson said: ‘As a customer’s coverage is increased each year to keep pace with inflation, premiums also increase to reflect the higher cover amount. If we do not take this approach, we will need to charge a higher premium upfront. Our indexing approach allows clients to increase their coverage each year without the need for any additional underwriting.
Do customers know what they are buying?
While extra fees may not mean insurance companies are ripping you off, it does mean that index-related deals are actually much more expensive than they first appear.
If you don’t read the fine print, then at the end of the line you could end up paying a lot more each month than you originally thought you would.
While the initial premium may seem reasonable, it’s actually offset by heavier monthly fees later on.
A Zurich spokesperson said: “We make our rates completely transparent to customers before and after the policy is drawn up. This includes providing an explanation of the increase and the total premium amount over the expected life of the policy.
Customers will know their premiums, relative to the chosen index rate, at any time in their plan. Indexing is optional each year, and can be stopped by the customer at any time, after which the plan continues with the same premium and coverage amount.
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