An index-linked life insurance policy pays out a value, taking CPI into account, rather than just sticking to the set sum assured. With the index-linked policy the beneficiaries are protected against inflation.
Life insurance is a safety net for your loved ones that can help them get through possible financial hardships after you are gone – be it in the sense of education costs for your children or paying off a mortgage for your family home. It can also just be a nice financial legacy for your children or your spouse that provides an additional financial boost on their journey through life.
Life Insurance and Inflation
With inflation and the rising costs of living, the amount of the payout you decide on will be worth much less after a few decades than when you take out the insurance policy. Consider this: only 50 years ago, the price for a loaf of bread was, on average, a mere 14 pence, while today, one loaf of bread costs well over a pound.
The real-life value of a policy is bound to decrease over time, so how can you ensure that your beneficiaries will actually get the amount of money you intended to leave them and not just a figure that has lost its worth a long time ago? The solution for this is index-linking your life insurance policy.
What Is the Consumer Price Index?
When talking about index-linked life insurance, we must first mention the consumer price index (CPI). This is a tool, also used by insurance companies, that measures the real level of inflation in a country. Namely, it measures the percentage change in the price of a basket of basic goods and services consumed by a household, such as milk, bread, eggs, toothpaste, and other everyday necessities, in order to see how much more expensive life is, compared to the previous years.
How Is CPI Related to Index-Linked Life Insurance?
An index-linked life insurance policy is one that pays out a value, taking CPI into account, rather than just sticking to the set sum assured. The payout changes with inflation, thus ensuring that your family will actually be able to afford what you intended, despite the rising costs of living.
With an index-linked life insurance policy, your insured amount will automatically increase with the rising costs of living, and the total amount of your payout will get a boost from year to year to keep it in line with CPI. These changes might seem small at first glance, but they add up over the course of the years, and the end difference can be very significant.
Why Aren’t All Policies Index-Linked?
At this point, you may wonder why all policies aren’t index-linked. Well, index-linked life insurance is just one of the options, not the standard, because along with the amount of the death benefit rising, the premiums rise, too.
Some people prefer to keep their insurance costs fixed, or perhaps they know that their family will be well-off either way and therefore do not worry about the rising costs of living.
Some people may even find the whole idea of index-linking your life insurance policy to be too complicated. But in fact, it is just like any other policy, the only exception being that your payout and your premiums will rise over the years.
The Benefits of Index-Linking Your Life Insurance
The most important benefit of taking out an index-linked life insurance policy is the fact that the payout reflects the actual value you intended to leave behind, instead of an exact amount set at the very beginning, the value of which has likely decreased severely by the time the death benefit is claimed.
By index-linking your policy, your life insurance maintains its real cash value, thus providing your loved ones with the financial comfort you intended for them to have.
So, the real benefit here is your peace of mind.
The Cons of Index-Linking Your Life Insurance
The annual increase in premiums is the first con that people think of when considering taking out this type of life insurance. They are worried that at a certain point, the payments might get to be too much for them. However, most providers offer the option of cancelling the indexation if the costs become too high, which means that your premiums and benefits will be frozen at the time of the cancellation.
Another con is that index-linked life insurance is only related to CPI but not to the price changes happening in the housing market. Housing costs rise separately from other goods, which means that the prices may rise even faster than in other sectors.
However, even though we cannot predict what the prices of housing will be in, say, thirty years’ time, a payout from an index-linked life insurance policy will definitely provide more financial freedom to your beneficiaries than just a regular amount, set right now – even if the amount might seem high at the moment.
How to Take Out an Index-Linked Life Insurance Policy
The process of taking out an index-linked life insurance policy is the same as for any other type of life insurance. Request it from your advisor and you will be good to go.
You can read more about other types of life insurance in our other posts.