Life assurance companies use various methods to price your life risk policy premiums, and it is important to understand which pricing pattern your policy will follow so you can make a call on whether or not the policy will still be affordable later on.
The simplest product, and the one that offers you the greatest certainty of what you will pay, has a fixed level of cover for a fixed premium, Peter Dempsey, the deputy chief executive of the Association for Savings & Investment SA (Asisa), says. These level-premium policies are typically offered for a fixed term or for life.
The level of cover is effectively reduced each year by the rate of inflation. This cover is appropriate if you take it out to pay off debt that reduces each year, or to provide for dependants, such as children, who get closer to becoming independent each year.
Therefore, when you are younger, you will typically pay more for a level-premium policy than the cost of the risk you pose to the assurer. But once you are older, the cost to you will be lower than the cost of the risk you pose.
Alternatively, to make a life policy more affordable for you when you are young, it can be priced for your age, Dempsey says. Such a policy will, however, have premium increases.
A life policy priced for your age may in your younger years escalate at a low level, but the premium increases may become quite steep as you get older.
At some point, the premiums on an age-rated policy will overtake those on a level-premium policy.
Hybrid pricing patterns
To make premiums cheaper for you, but without the disadvantages that come with age-rated policies, life assurers have devised various hybrids of age-rated policies. The “Jargon buster” section of Asisa’s website (www.asisa.co.za) explains how these hybrid policies work.
* Compulsory increases. A policy may initially be priced somewhere between a level-premium and an age-rated policy, but the premium will increase by a predetermined amount each year.
The initial premium is higher than that of an age-rated policy, because some of the premium that will be required when you are older is paid in your younger years, while some of the premium increases that would typically be required on an age-rated policy are built into the compulsory increases.
You may be able to choose the level of the compulsory increase, Dempsey says, and the steeper the premium increase, the cheaper the initial premium will be.
On its website, Asisa illustrates how the different policies may initially be priced – see the table (link below).
* Variable age-rated increases. The premium increases rise as you get older, but the increases are not as steep as those you would experience if you took out a policy with an age-rated premium. Higher increases are applied in the earlier years of the policy and lower ones in the later years, compared with those on an age-rated policy.
Stepped increases
Another way in which life assurers can reduce the initial premium is to offer a premium that is reviewed or increased after a certain number of years. This is known as a stepped increase, and is where you are offered a premium guarantee for a set number of years.
You need to understand the terms under which the premium will increase at the end of the guarantee period, Dempsey says.
Assurers typically use one of the following stepped increases:
* Fixed stepped increases. The premium increases by a fixed percentage after a certain number of years. An example is a 20-percent increase after every 10 years.
* Age-rated stepped increases. The premium level is fixed for a period such as 10 or 15 years, and at the end of the term you can renew the policy without requiring a health check, so you are guaranteed that you will not be denied cover. However, at the end of the term, the premium is recalculated based on your age at that time. This can result in a steep increase in your premiums, especially if you are older.
There are some policies, Asisa says, that have both compulsory increases each year and stepped increases. Asisa notes that these policies are the most aggressive ones: they are very cheap initially, but they become very expensive in the long run.
Increases in cover
Most life companies also offer you the opportunity to increase the amount for which you are covered, so that your cover keeps pace with inflation. If you increase your cover, your premium will typically increase too.
* Fixed cover increases for a fixed premium increase. The amount for which your life is covered may increase by a set amount each year.
If you have an age-rated premium, a variable age-rated premium or a premium to which a compulsory increase is applied, your premiums will rise by more than your cover increases.
Asisa cites the following typical examples: a 10-percent premium increase each year may secure a seven-percent increase in cover; a five-percent premium increase, a 3.5-percent increase in cover; or cover grows at CPI, with premiums rising at CPI plus three percentage points.
* Fixed cover increase with a premium increase to be determined. Some policies offer a fixed annual increase in cover, but the premium increase is determined by the cost of cover at the time the increase is applied, and the cost of the cover takes into account your age. So the increase in cover will become more expensive each year as you get older.
* Growth in cover reduces. Some life assurers allow you to increase your cover each year, with the premium based on your age. To mitigate the rise in premiums, the growth in cover reduces each year.