Do level premiums still make sense?

14 August 2020

Level premiums are typically selected as a means of helping clients avoid sharp premium increases as they age. For those that can afford the higher premium initially, this can be appealing as it helps provide budgeting certainty and, over the long-term, it may mean a lower overall premium. But is choosing level premiums based on this rationale still in the best interests of your client? While it will be for some, it may not be for all.

It’s a commonly held belief amongst many advisers we’ve spoken to, that level premiums reach the ‘crossover point’ at around the seven-year mark. After this time, the client can expect to reap the benefits of paying a lower premium than they otherwise would.  

However, while a seven-year crossover point was a once a realistic assumption, it’s an assumption that no longer holds true. In fact, today’s client must typically hold their policy, and therefore pay a higher premium than they otherwise would, between 15-20 years on average before the crossover point is reached.

So why has this changed?

One of the key reasons is that interest rates are at historical lows.

For level premiums to work, insurers have to ‘save’ the extra premium a customer pays in the initial years of their policy, in order to pay for claims in the later years of the policy (when customers are older and more likely to claim). To do this, insurers typically invest the extra premium in fixed interest assets (e.g. bonds). However, due to low interest rates, the return on the invested premium has also been lower and a result, insurers are needing to increase the premiums charged in early years. 

This has meant that over the past 10 years, insurers have had to push through significant increases to both new and in force business. These increases have pushed out the crossover point significantly and unfortunately; this trend is unlikely to be reversed anytime soon.

Realising the benefits

For the average client to realise the benefit of level premiums, they must therefore hold their policy unchanged for many years beyond the 15-20 year crossover point.

Hence, not only do we need to carefully consider the likelihood of someone keeping their policy unchanged for this period of time, we also need to consider the opportunity cost of the extra money a client is putting into their policy (especially when funded through super).

As an example, it may make more sense for your client to invest the extra money in shares, which would likely generate greater returns, including funds to pay for future stepped premiums.

Putting aside expectations around crossover points and when a level premium policy can start to make sense, the other benefit put forward for level premiums is that they won’t increase as we age and hence, the client can have greater certainty around how much their policy is going to ‘cost’ each year.

But while it’s true that the premium will not increase as a result of the client’s age, it’s not true that level premiums will never increase. The choice to apply the indexation option will obviously result in annual increases, but perhaps more importantly, the base premium rate can (and does) change.

As evidenced by the ongoing round of rate increases, insurers are now regularly increasing their level premium pricing as they adjust their future interest rate and other assumptions.

Education and careful consideration is key

From a client’s point of view, increases to their level premiums can be quite shocking. While those who have chosen stepped premiums naturally expect their premiums to change, those who have chosen level generally don’t, and significant and/or regular changes can undermine a client’s satisfaction and trust in their adviser and insurer, not to mention the affordability of their policy.

Educating clients about what level premiums really mean is therefore critical. However, so too is carefully considering the likelihood of level premium increases in the future, and what impact increases may have on affordability, customer satisfaction and the client’s eventual crossover point.

Every client is unique, with different circumstances, goals and values and level premiums may still be the right option. However, with the low interest environment unlikely to change in the short to medium term, and ongoing changes to current level premium pricing almost a given, it’s important that we ask whether level premiums really do still make sense.

If you have any questions or you’re interested in learning more, why not join our 30-min Level Premium webinar at 11am on Thursday 10 September? You can register here

By Charl du Plooy, Head of Sales, NEOS Life