Index-Linked Life Insurance Explained

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By Crispin Bateman
Updated on Monday 4 November 2019

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Life insurance lasts a very long time and the world can change a lot while your policy sits in the background doing its thing. If you are not careful, that policy can be left behind and rather than being the tip-top life insurance policy you bought many years ago, it could now be a cobwebbed remnant of a long-forgotten age.

Cobwebbed? OK, that’s a little too far – but have you considered the impact of inflation on your life insurance policy? Maybe it’s time to look at index-linking.

What does index-linked mean in insurance?

Most people have experienced going to buy something and having that thought - ‘back when I was a kid, this cost so much less!’

From Mars bars to mortgages, the price of things just keeps going up – but what effect does this have on a life insurance policy? Well, if you haven’t taken measures to protect it, it can turn something that was previously a substantial mountainous payout into something a lot smaller - little more than a hump.

Index-linking is that protection – it means tying your life insurance policy to inflation and making sure that what you get out in the end is what you really meant to have at the very beginning.

Looking at the numbers – understanding the Consumer Price Index (CPI)

What are the CPI and RPI?

The CPI and RPI mean similar things. Consumer Price Index and Retail Price Index are a measure of how much your everyday purchases have gone up year-by-year. For example, if four pints of milk costs £1.00 one year and then £1.10 a few years later, the CPI and RPI know about it and have kept track of it.

By using an average across all sorts of goods, these indexes can tell us how much real-world inflation has happened over the years.

They measure slightly different things (RPI takes things like gas bills into account) but are ultimately very similar ways to look at the general increase in costs.

How does index-linked life insurance work?

If your life insurance policy is index-linked, it means that your premiums and the sum insured (the amount paid out if an insurance claim is made) are both tied to the CPI (some insurers use the RPI, but as the two are similar, we’ll talk about the CPI from now on).

If the CPI says that the average costs have gone up by 1.4%, then your insurance levels rise to match it. If costs go up by 7% then up ramps the life insurance. If they go down, then…well, they never usually go down and even if they did, you wouldn’t want your life insurance to drop, so insurers ignore that!

This means that if you could have bought a million pints of milk with your life insurance payout when you first got your life insurance policy, your family can still buy a million pints of milk if it is ever needed.

Or, indeed, a house.

Why should I index-link my policy?

It’s really all about big things like houses. Talking about milk helps to understand the principle, but it doesn’t really mean much in the real world.

In 1979, the average price of a London house was £14,013.

In 2019, the same house is worth over £475,000.

If you took out a life insurance policy in 1979, it would have been considered reasonable to do so for £15,000. If left unchecked, the sum assured on that policy today would still be £15,000.

But if the policy were to pay out tomorrow, it wouldn’t be able to buy that London house. In fact, it would barely be able to buy the doors for that London house!

By index-linking your policy, it will rise with inflation. That doesn’t mean a £15,000 policy from 1979 will be worth £475,000 today because house prices have risen well above the CPI rate, but it does mean it’d be worth a lot more. In fact, a £15,000 index-linked term life insurance policy started 40 years ago would pay out £75,262.22 today.

The benefits of an index-linked life insurance policy are simple – your life insurance pays out an amount which is closer to its intended value, rather than simply holding to the same initial figure.

Why are the different types of life insurance not index-linked as standard?

Index-linking has two downsides:

  • It can be complicated to understand, especially when first explaining life insurance

  • It links your premiums as well as your sum assured

Neither of these can be simply ignored. This article serves as an explanation for index-linking and thus helps you understand this finer nuance of life insurance, but the concept is often too complicated to explain in an initial conversation for a life insurance advisor over the phone. It is far better for the customer if they understand the difference between decreasing term life insurance and whole of life insurance during that first call, so advisors tend to leave index-linked insurance alone.

As turning your term life insurance into an index-linked insurance policy can be done later on, there’s not as much need for focussing on the concept in the first few discussions.

Of course, now you understand, you’ll be on the phone to your insurance company asking them to make the change!

The second reason (that it will increase your premiums) is also valid and can be off-putting for some. It’s a slow growth and remember that in real terms, it’s just keeping in line with inflation - but adding a pound or two onto their premium every single year can be see as a negative for many people.

Getting index-linked term life insurance

At Compare UK Quotes, we are keen to offer you the best advice on your personal finances available on the internet today.

We work behind the scenes investigating and researching so that you don’t have to! When it comes to life insurance, we recommend contacting Quick Quote Life. Unlike many insurance brokers, Quick Quote Life are registered advisors, meaning they can discuss all your life insurance options with you and make sure you are getting the product that suits you best, rather than simply selling you the cheapest quote.

They understand all about index-linking and will be able to discuss the pros and cons of every aspect of your life insurance with you before you settle on a final deal. Plus, because they work with a huge range of insurers across the UK, you can be sure that they’ll get you the best package available – not only for your life insurance but when looking at Critical Illness Cover and Income Protection too!

For more details about life insurance, check out our extensive library of articles here on Compare UK Quotes. Whether its starting at the beginning and understanding the four main types of life insurance, or if you want to get some deeper knowledge into how some of the additional life insurance products can help you, we have more fully-researched pieces for you to read.

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