Life Insurance Premium Types
A fact of insurance is the payment of premiums. Current term life insurance premiums offered in Australia work on a similar basis in to your home and contents or car insurance, that is, to put it simply, you pay your insurance premium and your covered, you stop paying and your coverage ceases with no cash value (unless a claim has been made). What is little known however is that is a choice of insurance premium types available to policy holders whether it be taking out a new policy or reviewing existing policy that is already in place.
There are 3 main insurance premium types offered by insurers in Australia; Stepped, Hybrid and Level. Premiums in a general sense are based on age, smoking status, occupation, gender and in some cases state of residence (if state stamp duties apply) and the same premium will apply to all those insured that have the same variables unless a premium loading has been applied to an individual policy holders premium.
Each insurance premium types has both advantages and disadvantages that need to be considered when taking out a policy that will be discussed below.
Stepped Insurance Premium
Arguably the most commonly paid premium types, the stepped premium is yearly reviewable premium that is recalculated annually on policy anniversary. The stepped style premium when compared against the other two options starts at a lower base, however will increase incrementally each year as the life insured’s age increases. Unfortunately the premium recalculation is generally always up, however the increase in premium is based on two factors an increase in age and an increase in the sum insured. Insurers by default will normally increase a policy by an inflationary factor automatically (unless opted out of) to protect the benefit against inflation. It is not uncommon for lump sum policies to be indexed by approx. 5% and income policies by approx. 3% annually.
It is these two factors that generate the increased stepped premium and the step in premium will gradually get bigger each year as you get older and the risk to the provider for the next 12 months increases. To list some advantages and disadvantages of a stepped premium;
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Level Insurance Premium
The second of the insurance premium types, the level premium works in a totally different manner. Instead of starting from a lower base and increase annually, the level premium starts from a higher base however remains fixed at the age that the life insured starts the policy. If you take out a policy at age 40, your level premium will be based on a 40 year old until either your 65th or 70th birthday (depending on type of cover and insurer) alternatively if you take a level premium at age 50, your premium rates will always be based on that of a 50 year old. This can offer longer term premium stability for clients looking for a longer term insurance solution. With longer term pricing advantages however comes a higher level of inflexibility. Generally, policies cannot be changed without resetting the premium so these policies suit longer term insurance needs where it is unlikely that major alternations to cover are not required.
Level policies do have the option for the client to have annual sum insured indexation however most (but not all) companies apply future indexation at stepped premium rates with a handful offering clients indexation based on initial age premium rates.
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Hybrid Insurance Premium
The third, less common of the insurance premium types, the hybrid premium is not offered by all insurers and can be referred by different names, however the hybrid premium option offers somewhat of a halfway mark. Generally the hybrid option will step up in the first years of the policy fixing at a future date. It is priced initially around half way between the stepped premium and the level premium. A hybrid premium can offer clients the advantages of both the stepped and level premium. The hybrid premium still can have flexibility issues if a client wants to make alterations.
How do these premiums work?
Take the example below. The following quotes are for a 40 year old male, non-smoker, Plumber, living in NSW;
The stepped premium looks attractive initially being the lowest option initially however the stepped premium continues to increase to a point where compared to the level or hybrid premium, is priced significantly higher. It is likely that at some point this premium would become unaffordable and the policy holder would lose their cover at a time when it could be needed most. A 20 year cumulative premium comparison is shown below;
The stepped premium in this case over 20 years would have cost the policy holder an extra $28,235.28 for no additional level of cover or benefits.
In all cases and with all insurers, premiums across the board are reviewed from time to time and insurers reserve the right to alter premiums for all policies holders at any time, however any change affects all policies holders on the same structure.
Insurance premium types, mostly overlooked by clients, forms an important part of insuring appropriately both for the longer term and the short term and is essential in ensuring that clients current and future needs are met and importantly when cover is needed most, is still affordable and available. No one option is appropriate for all clients and the best option can depend on multiple factors however if a client is considering a hybrid or level premium, it can be advantageous opting for the structure sooner than later as each year the level premium start point increases as you get older.
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