Indexed linked income protection: How does it work?

How does income protection work?

Income protection insurance is designed to provide financial security in the event that you are unable to work due to illness or injury. By paying regular premiums, you are essentially purchasing a safety net that will replace a portion of your lost income during this time of need.

When you take out a policy, you will have the option to choose the level of cover that suits your individual circumstances. This includes the amount of income you would like to protect, the length of time you would like to receive payments for, and any additional benefits you may want to include.

The monthly benefit is typically up to a set percentage of your pre-tax income, often around 50-65%. The benefit will be paid out after a waiting period known as the ‘deferred period’, which can range from 4 weeks to 12 months. Once the deferred period has passed, you will start receiving monthly payments until you are able to return to work or reach the end of the policy term.

What is indexed linked income protection?

Index linked income protection means that your monthly benefit amount will increase each year in line with inflation, so the value of your cover keeps up with the cost of living.

By choosing an index-linked policy, individuals can have peace of mind knowing that their coverage will not lose its value over time and will continue to provide adequate financial support in the event of illness or injury.

Does my income protection increase with inflation?

This all depends on whether you’ve ‘Index Linked’ your policy, or your policy includes ‘Indexation’. Both these terms mean protecting your policy against inflation, therefore ensuring your Income Protection cover keeps pace with annual price rises.

Should I get Indexed Linked Income Protection? 

When you first take out income protection, you do so, on the basis of your current monthly earnings and outgoings.  However, as the years go by, the cost of goods and services will tend to go up over time due to inflation. This means, of course that say, in five years’ time, your average monthly spend will likely to have risen from what it is today.

In answer to the question: does my income protection increase with inflation? This all depends on whether you’ve ‘Index Linked’ your policy, or your policy includes ‘Indexation’. Both these terms mean protecting your policy against inflation, therefore ensuring your Income Protection cover keeps pace with annual price rises.

How does Index Linking work?

Also known as the inflation proofing option or cost of living, index linking Income Protection works by enabling your benefit entitlement and consequently your monthly premium to be linked to an official index from the Office of National Statistics.

Depending on your policy, this index could be either the:

• Consumer Price Index (CPI)
   
• Average Weekly Earnings (AWE)
   
• Retail Price Index (RPI)

Your Income Protection cover and monthly premium is renewed annually in line with the chosen Index and if necessary increased to be in line. If changes to the Index are 1% or less then both the cover amount and the premium will typically stay the same until the next review. Over this percentage and either your premium, cover or both will increase.

The premium can increase at a different rate to the cover amount because it’s typically indexed in line with the Index multiplied by two, although this does vary. This is because it will take into account the likelihood of you making a claim due to the increase in your age.

Not all insurers offer work with the same index, so it’s important to check which one your policy uses. It’s also worth noting that some policies may have a cap on how much your benefit can increase each year, typically around 10%.

How much does index-linked Income Protection cost?

Indexation can increase the initial premium by a small amount if selected but in the long term means your policy will reflect the changing cost of living. As with all insurance, the cost of the premium initially depends on your personal circumstances and on a variety of factors, including your age, occupation and payment period.

You do have the option each year to decline an increase due to indexation if you feel that either the increase is not beneficial or, in the case of a policy based on the maximum allowable, an increase would mean you would not be able to claim on the full benefit of the policy. As always, you should get advice to ensure any income protection policy applied for is appropriate for your circumstances.

Please note age-costed and reviewable premiums are not index linked. Instead these will increase on the anniversary of the policy, the 1^st of January each year or on your birthday depending on the provider. Age-costed will increase by a pre-determined amount each year and the increases will get bigger each year as you get older and the risk of the policy increases. Reviewable premiums will be based on various factors including market forces and age and the increases are not pre-determined which means there is no guarantee as to how much this changes the policy.