Index Linked Income Protection Cover

Income insurance can protect your earnings against the risk of sickness or injury for the long-term. If you were to suffer an illness or injury that prevented you from working the plan would payout a monthly benefit either until you returned to work or the policy term ends.

Given the long-term nature of income protection it makes sense to protect the monthly benefit you could receive against the risk of inflation. It is possible to have your chosen benefit amount indexed to the Retail Price Index (RPI) so that it increases year-on-year with this measure of inflation.

Why index link your benefit?

When you choose the level of monthly income you would like to cover you do so based on both your current income and the prices you pay for goods and services today. For example, you may decide to take out enough cover to protect your mortgage repayments, utility bills and monthly expenditure on groceries.

When you do this you are working out how much income cover you would need based on the current level of your expenditure. However, the prices of goods and services tend to go up over time, which is called inflation. Thus, if the monthly benefit you take out is fixed at todays prices then you would get less in real terms for your money at any point in the future should a claim need to be made.

For example, if you have £100 today and tomatoes are £1 each you could buy 100 tomatoes, however, in 10 years time the price of tomatoes rises to £2 each then you would only be able to afford 50 tomatoes with your £100. In this example, by having your policy index linked you are enabling the benefit paid by the policy to effectively increase to £200, thus allowing you to continue to buy 100 tomatoes rather than the 50 with no index linking.

How does index linking work?

When you take out an income 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. If this amount of benefit was fixed over time then you would be able to buy less with the payout in the future because of inflation, i.e. the prices of goods and services have risen.

When gaining a quote for income cover it is possible to select an option so that your chosen level of monthly benefit rises in-line with inflation each year, as measured by increases in the Retail Price Index (RPI). This means that the benefit level you choose will increase over time to reflect changes in the prices of goods and services so that you are effectively able to purchase the same amount of these goods and services with the payout from the policy, at any point in the future.

Indexation example

As an example, suppose that you chose a benefit level of £1,000 per month and RPI inflation over the year was 2.5%, at the start of the next policy year your level of cover will have risen from £1,000 to £1,025 per month. If the inflation level remained at 2.5% for the next 10 years then your level of cover will have risen to nearly £1,250 per month, an increase of around £3,000 over the year.

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 the benefit you would receive and the premiums you pay will both increase in-line with inflation each year, thus leaving your purchasing power even over time.

It is very important to note that not all insurers increase the monthly premiums each year just by the amount that inflation has risen, even though the monthly benefit with only have risen by RPI inflation. Some insurers actually increase the premiums by more than inflation or even take into account your increased age when re-calculating. With indexed income protection it is important to select the right insurer to avoid unexpected premium increases.

Next Steps

If you would like to run through your index linked income protection policy options with one of our expert advisers then please feel free to contact us. Alternatively, if you would like the most competitive quote from a panel of leading UK insurers then please submit your details in the quote box provided above.