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[GUEST ARTICLE] Insurance Premium Structure: Getting it right from the start
Based on the questions received during a recent webinar, Financial Adviser Stephen Price (Integer Financial Group) shares some advice.
We all understand the necessity and importance of insurance, but most don’t know where to start looking when it comes to finding cover that is a right fit. Researching insurers can be tedious, confusing and potentially incredibly costly if you get it wrong. As frustrating as it may be spending money on something you hope to never use, if an event occurred where you had to make a claim then you would be relieved knowing that you have the protection required to see you through. It’s critical that we get this right.
For those who either have cover already or are looking to take out protection for the first time, taking the time to understand two words and how they effect your insurance policy over the long run can save you a fortune. Those two words are: Premium Structure.
For most people it is well known that there are two broad categories of premium structures when it comes to purchasing insurances. They are stepped premiums and level premiums. Understanding how they work is critical to ensure that you don’t pay too much. However, there is a third category of premium that isn’t often understood or talked about, but the savvy consumer that understands it can benefit from massive savings over the life of their policy. This is the True Level premium. To understand how each of these are distinct from one another let’s consider an example.
John Smith is a 35-year-old doctor who, having recently married, has determined that it is important to protect his most important money generating asset – himself. He makes a good salary of $240,000 per year and has worked out that he can go 30 days without income. If the worst were to occur and he couldn’t work then he would want to ensure that he was protected until retirement at age 65. Given that you can insure up to 75 per cent of your income, John is wanting to apply for a $15,000 a month benefit with a 30 day waiting period until the age of 65. On a stepped premium basis John’s premium could be $-3,000 per year. This seems reasonable to John and he understands that as you get older, the likelihood of claiming similarly increases and as such so too will the premium he pays. That seems fair.
Now, if John had a good sense of foresight, he would understand that level premiums might be a smarter alternative. It was explained to him that while stepped premiums increase each year in line with his age and corresponding risk of claiming, a level premium will lock in a premium at his age now and will not increase. This seems like the obvious of the two alternatives, however when you consider that the starting price of a level premium is often twice as expensive as a stepped alternative then most will allow emotion to overcome logic and choose to pay the stepped. A level premium in this scenario could be $4,550 per year. It’s hard to make a decision that is going to cost you now and you will only realise its benefit years from now once the stepped premiums surpass their level counterparts.
What often isn’t understood is the role that inflation plays in the cost of cover. To ensure that the purchasing power of your benefit is not diminished over time, insurers will almost always increase your cover each year by the consumer price index (CPI). What often isn’t talked about is that, naturally, this additional cover has a corresponding additional cost. And here lies the value of the true level premium. As your insurance is required each year to keep up with CPI, on a standard level premium you will have to pay proportionately more and more as your age increases each year. On a true level premium, these CPI changes are charged at the age you took out the policy. In John’s case, if he were to take a policy with a true level premium then he can rest easy knowing that these CPI increases will be charged at 35-year-old rates as he gets older. From one year to the next this might only have marginal impact on costs. However, if you were to consider the cumulative effect this has then John could potentially have saved $232,600 until the age of 65 on a true level premium compared to a stepped. Now that’s a retirement gift you’ll thank yourself for.
This is one consideration among many when it comes to protecting your wealth and asset position. Getting this one variable wrong can have significant impact on you and your family’s financial position over time. This is where the value of advice really makes itself apparent. A good adviser will have a solid understanding of your financial profile and what you are trying to achieve. Their role is to work closely with you to develop a strategy that is right for you.
For more information contact the team at www.integerfg.com.au
Stephen Price Authorised Representative of Matrix Planning Solutions Limited ABN 45 087 470 200, AFSL & ACL No. 238256. This information is of a general nature only and has been prepared without taking into account your particular financial needs, circumstances or objectives. While every effort has been made to ensure accuracy of the information, it is not guaranteed. You should obtain professional advice before acting on the information contained in this publication. This case study and any graphs or examples included in this case study are for illustrative purposes only and are based on specific assumptions and calculations. Individual circumstances may vary and this will alter the outcome. The case study does not represent any forecast or guarantee on return.