Income Protection - can the benefits be index-linked?
You can choose to have your income protection benefits index-linked when you take out your cover.
There are typically 3 indexation choices:
- No indexation
- Compound Indexation in line with the Retail Prices Index
- Compound indexation at a fixed percentage, usually either 3% or 5%
If you choose indexation, your premium and benefits will be indexed on each policy anniversary.
If you have selected indexation, and in the event you make a claim on your policy, the benefits in payment to you will continue to be indexed, thus providing you with protection from inflation.
Your income protection provider will write to you about a month before the indexation takes place to inform you what the new premium and benefit will be.
You will have the option, each year, of refusing the indexation and of keeping your premiums and benefits at the current level. However, if you do this, (depending on the exact policy conditions) you may be permanently removing indexation from your policy, which would mean that in the event of a claim, your benefits in payment would not increase and would remain level.
Indexation should always be taken, as the “purchasing power” of a non-increasing income benefit would be rapidly eroded by inflation.
Beware - some income protection plans have benefits indexed on a simple basis:
Not all income protection plans have benefits increasing on a compound basis. Some plans have benefits that increase only on a simple basis.
SIMPLE INDEXATION EXAMPLE:
For example, lets say that a plan with a benefit of £1,500 a month has 5% indexation, but only on a simple basis.
During the claim, on each policy anniversary, the monthly payments will increase by £75 being 5% of £1,500.
So after 10 years, the amount being paid on a plan with simple indexation would be £2,250 a month.
COMPOUND INDEXATION EXAMPLE:
However, lets look at same plan, but with compound indexation instead of simple indexation.
With the same benefit of £1,500 a month, and the same 5% indexation, on the first anniversary, the increase would be the same £75 being 5% of £1,500.
However, on the second anniversary, the increase in monthly benefit would be £78.75, being 5% of the £1,500 and the previous year’s increase of £75. The next year would have indexation of £82.69 being 5% of £1,500 plus 5% of £75 plus 5% of £78.75 and so on, each year....
So after 10 years, you would be being paid £2,443 a month or nearly £200 a month more than if your plan had simple indexation and this difference in payable benefits increases the longer a claim lasts.
Beware of plans with benefits reverting to the original level for subsequent claims:
Some income protection plans will provide indexation during a claim, either on a simple or compound basis, but after the claim has ended, any further claim will start again at the original insured amount.
For example, say you have such a plan with a monthly benefit of £1,000 and you make a claim. Lets say that, some time later, when you have recovered your health and the claim ends, the benefits in payment have, through indexation, been increased to £1,300 a month.
If you were to make a subsequent claim, the policy would start again at the original £1,000 a month, not the £1,300 a month that was being paid when your previous claim ended.
