Income Protection Insurance is designed to protect your earnings against the risk of sickness or injury.
If you were unable to work and needed to claim the plan would payout a monthly benefit either until you returned to work or you reach the end of the policy term.
Should a long term claim arise it could continue paying out right up until your retirement which is why many insurers provide you with the option of index-linking your policy.
By opting to index link your Income Protection you can ensure you have the same buying power in future years as it has today.
Opting to index link your level of cover will see it increase each year in line with the Retail Price Index and keep up with the pace of inflation.
For example, if you have £100 today and a carton of milk costs £1 each you could buy 100 cartons, however, in 10 years time the price of milk rises to £2 per carton then you would only be able to afford 50 cartons with your £100.
When you choose the level of monthly income you would like your insurance policy to cover, you do so based on both your current earnings and how much you spend per month.
However, the prices of goods and services tend to go up over time due to inflation. This means your monthly spending will likely rise along with the price of goods and services.
What this means for your Income Protection policy is that if your monthly benefit is fixed at your current financial needs, it is going to depreciate over time in real terms.
In the future, the amount that could have easily afforded your lifestyle may not even cover your food shopping for the month.
But, with an index linked Income Protection policy, your insurance benefit will keep up with inflation for as long as you have your policy. This means that no matter how far into the future you decide to claim on your Income Protection, your insurance benefit would be just as valuable as it was when your policy started.
Income Protection Insurance can protect your earnings against the risk of sickness or injury over many years if not decades.
Given the long-term nature of Income Protection, it often makes sense to index your policy to protect your monthly benefit from the risk of erosion by inflation.
Independent Protection Expert at Drewberry
When you take out an Income Protection Insurance policy, you will need to specify the monthly benefit you would like the plan to payout should you need to claim, which is usually up to 65% of your gross earnings.
When applying for your policy, you will be given an option to index link your Income Protection benefit. Depending on which insurer you choose to take out your policy with, index linking your benefit may initially increase the cost of your policy.
The way that indexation works is that your insurer will link your insurance benefit to the Retail Price Index (RPI).
Once your index linked Income Protection policy has started, your insurance provider will review your policy and changes in the Retail Price Index on a regular basis and adjust your cover so that no purchasing power is lost.
These reviews will typically take place every year, however some insurers may review and make changes to your benefit every few years or so.
There’s no need to worry about your benefit being reduced if the RPI sees a decrease. Most insurers will not make any changes to your benefit if there is a decrease in the RPI. They will only change your benefit if the RPI shows an increase of more than 1% and typically cap their benefit increases at 10% per review.
It’s not just your benefit that will increase with the RPI: insurers will increase your premiums as well. They will either increase your premiums at the same rate as your benefit amount, or they may increase your premiums by a multiple of your benefit increase.
You will be notified in advance about any changes that will be made to your policy and insurers will allow you to reject an increase if you want. However, most insurers will limit the amount of times that you can reject a benefit increase.
Most insurers outline in their terms that if you reject an increase in benefit 3 consecutive times, then they will stop offering to increase your benefit in future and your policy will no longer be linked to the RPI.
Beware that some insurers will only allow you to reject an increase once before revoking your policy’s link to the Retail Price Index.
Benefit limits will still apply if your policy is index linked. Your benefit will not be increased if it exceeds the maximum percentage of your gross salary that you are entitled to or your insurer’s maximum available benefit.
As an example, suppose that you took out an index linked Income Protection policy in 1987 with an agreed monthly benefit of £900. According to the terms of this policy, your policy provider reviewed your insurance benefit every 5 years and adjusted it to match the RPI’s percentage increase.
The table below illustrates how your Income Protection benefit would have changed in line with RPI percentage changes and what it would be worth now.
Example of Index Linked Benefit
Inflation Rate Change
It should be noted that when you include the option to link your monthly benefit to the Retail Price Index, you also agree to link the premiums you pay to this index also. This means that when your benefit increases, so will your premiums. However, your premiums won’t always be increased by the same amount as your benefit.
Not all insurers increase the monthly premiums by the same amount that inflation has risen, even though the monthly benefit will only have risen by RPI inflation. Some insurers will increase the premiums by more than inflation or take into account your increased age when calculating your new premiums.
One common approach that some insurers take to adjusting premiums is to increase premiums by 1.5 or 2 times the percentage increase of your Income Protection benefit. This means that if your benefit is increased by 10% your premiums would be increased by 15% or 20%.
This is something to look out for when you take out your policy because it can make a big difference to the cost of your Income Protection in the long run. Ideally, you should look for a provider that will match your premiums’ increase rate with your benefit’s.
Purchasing an index linked Income Protection policy is vital if you intend to keep your insurance on a long-term basis. Thankfully, there are many insurers that allow you to index link your income protection even if your policy has already started.
What matters the most, in which case, is making sure that you find the right Income Protection policy that stays affordable while also keeping your monthly earnings sufficiently protected.
We started Drewberry because we were tired of being treated like a number and not getting the service we all deserve when it comes to things as important as protecting our health and our finances. Below are just a few reasons why it makes sense to let us help.
Taking our Income Protection can be a bit of a minefield particularly if you want to include indexation.
If you need some help please do not hesitate to pop us a call on 02084327333 or email email@example.com
Independent Protection Expert at Drewberry
I had the pleasure of dealing with Jake Mills in organising my insurance. Jake was fantastic to deal with — his patience and understanding really helped.