Life insurance: stepped or level?

When taking out life insurance you may be asked to choose between stepped and level premiums. As there are significant differences between the two, it pays to consider both your current and future financial needs before making a decision.

Stepped premiums are similar in nature to a variable mortgage in that your insurance premium will increase each year as you get older but are cheaper in the beginning. Level premiums are more like a fixed mortgage: your insurance premiums won't change as you get older but are more expensive in the beginning.

Some insurers also offer 'blended' premiums, starting with a stepped premium and then changing to 'level' at a fixed date.

Ask these questions to find out which is the better option for you.

Do I want short term or long term cover?

Level premiums are best suited to long term insurance contracts because they will become cheaper in the long run, but you won't reap these benefits unless you remain in the same policy.

Short term insurance needs are best covered by a stepped premium because the cost of cover starts off low if you start at a young age, but the premiums increase significantly over time.

How will my age affect the premium?

Under the stepped premium structure, it is assumed that the older you get the more likely that your health may deteriorate and therefore your premiums will increase significantly, especially past 50 years of age.

Under the level premium structure, if you take out a policy at age 40, the premium will be based on a 40-year-old or if you are 50 it will be based on a 50-year-old. At the age of either 65 or 70 (depending on the type of cover) your 'level' premium will switch to a 'stepped' premium.

What are the indexation rules?

Insurers will normally increase both stepped and level policies by an inflationary factor automatically (unless opted out of) to protect the benefit against inflation. Lump sum policies are commonly indexed by around 5 per cent and income policies by around 3 per cent annually.

Level premiums will also change if the insurer increases policy fees or if there is an increase in the sum insured, but the rise may be considerably less than stepped premiums.

What are the penalties for changing my policy?

Find out if there are penalties involved in replacing the policy (for example, to move it out of superannuation) as most level premiums can't be changed without resetting the premium at your higher age.

Stepped policies offer the most flexible options when it comes to premium alterations.

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