Premium Structure: Getting it Right from the Start

The structure of the insurance premium chosen will dictate its initial cost, as well as the total cost over the lifetime of the policy.  

Not all premium structures are available from all Insurers. Retail Insurers will generally offer level or stepped premium structures, with some offering a hybrid option (due to recent legislative changes, some Life Offices may now not offer level premium on certain cover types). Group Insurers may only offer unit-based premiums; or if fixed cover is available, it will most likely be offered under a pseudo ‘stepped’ premium structure. 

It’s important to get the premium structure right from the start to maximise total savings over the life of the policy. 

Stepped Premiums  

Stepped premiums increase as the life insured ages to reflect the higher likelihood of a claim (i.e. as risk increases, so does price). It is the most common premium structure used, as it’s the least expensive option over the shorter to medium term. However, as the life insured ages, the annual cost can increase significantly (especially for a policy holder in their 50s which is when cover may be of most importance) and the total cost over the lifetime of the policy can be much higher compared to level premiums.   

Level Premiums 

Level premiums are designed (all things being equal) to remain consistent from policy commencement up until the life insured reaches a predetermined age (e.g. level to age 65), at which time the premium (if cover hasn’t expired) converts to a stepped structure.  

In practise, there may be increases to level premiums over time. This may be a result of indexation of the sum insured or increases to premiums due to changing assumptions and expenses of the insurer (i.e. re-pricing, which has occurred recently across the entire industry particularly with Income Protection contracts).   

Level premiums are usually more expensive at policy commencement. This is because the increased risk of claim, as the insured person ages, has been factored in, with premiums being averaged over a period of time.  

Hybrid Premiums 

Some retail insurers will offer the option of a hybrid premium structure that allows the client to use stepped premiums for a portion of cover, together with level premiums for the remainder of cover.   

This allows the premium structure to be aligned to short-term or long-term needs within a single policy 

Premium Expense 

When do total level premiums become less expensive than total stepped premiums? 

The point (timeframe) at which accumulated level premiums are lower than accumulated stepped premiums depends on the actual premium payable. This ‘break-even’ point will be affected by:

  • Type of policy
  • Age of the life insured 
  • Age that level premiums will cease
  • Indexation of the sum insured
  • Any loadings
  • Any additional options that have been added to the policy

Unit-based premiums 

With unitised cover, premiums remain fixed, but cover decreases as the life insured ages. This will vary with each group Insurer, however, cover will generally start to decrease for the life insured aged in their 30s. This can mean there is often very little cover in place by the time the life insured reaches their 50s. 

Conclusion 

The decision to use a stepped or level premium structure should be based on a number of factors, including the purpose of cover and importantly, the life insured’s personal circumstances.  

There are advantages and disadvantages to each premium structure, however, if the policy is expected to be required for the longer term (offsetting future earnings capacity, medical and recovery costs etc), the total aggregate cost of level premiums will eventually be lower than total stepped premiums. In cases where there is a shorter to medium term need (often offsetting your debt obligations), it may be more suitable to implement stepped premiums.

About the Author
James Grindrod - Financial Advisor
James Grindrod , Melbourne
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