What is Indexation in Insurance?

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What is Indexation in insurance?

Indexation (or inflation adjustment benefit) gives you the option to increase the amount of cover you have on an annual basis, to help combat the effects of inflation. The premium will also increase each year, to reflect the increase in policy pay out benefit. Each provider increases the sum assured and premium in slightly different ways. 

Important Facts About Life Insurance Indexation

Alternatively known as inflation adjustment, indexation is a word that many use in reference to a basic concept within the realm of insurance. The following paragraphs will explain exactly that it means and how you can use it to your advantage.

What is Consumer Price Index (CPI)?

In essence, indexation has to do with a benefit payout that rises in amount alongside the stated cost of living. 

As such, if the cost of living sees an increase of, say, 5% for a particular year, indexed life insurance benefits will rise at that same rate. 

This means that the beneficiary of insurance coverage will not experience a loss in value simply because there has been a rise in the cost of living. 

This type of protection against inflation works to raise a policyholder’s coverage amount by 5% annually, or by the rate indicated by the Consumer Price Index (CPI), whichever one is the greater amount.

Four times a year, Statistics New Zealand release their Consumer Price Index (CPI, which records the change over time in the price of a basket of goods and services.

The CPI is a collection of statistical measures that gauge New Zealand’s cost of living. These assess the average cost paid for a range of common services and consumer goods, such as:

  • alcohol,
  • clothing,
  • food,
  • healthcare,
  • transportation,
  • education, and
  • insurance.

When there is an increase in the average cost of within these categories, the CPI will show an increase as well. Any policy of insurance that is indexed to the CPI will also see a boost in its benefit payout amount, and it will be the same rate at which the CPI increased.

This begs the question of whether all policies of insurance are indexed in this way. The basic answer is that they are not. However, consumers have the option to determine whether their own life insurance coverage is indexed, simply by opting for the “inflation adjustment” differentiator when purchasing a policy.

Choosing this type of inflation protection when buying a policy is a smart method of protecting your finances well into the future and ensuring that the cost of living does not reduce the overall value of your coverage.

It should be noted that inflation protection is possible at both level and stepped premium varieties.

Are all policies CPI indexed?

Level Premiums
A level premium policy remains constant year on year.

Though, if coverage increases are triggered by inflation protection, the cost of the additional coverage will be tacked onto the required premium amounts. Policy shoppers should bear in mind that in the case of level premiums, the extra inflation protection-based costs will be determined based on the insured’s age at the moment the increase occurs, not their age at the time the policy was first obtained.

Stepped Premiums
In the case of stepped premiums, or those for which the amount due rises every year with the age of the policyholder, the calculation is somewhat different. Premium costs under such policies will rise according to indexation if they include inflation protection in addition to the increase that is already built-in by virtue of the policy type.

The fact is, though, that many are more than willing to shoulder the extra expense in order to achieve the peace of mind that comes with this type of coverage.