If you are a regular reader of my blog you will have come to realise that there more to life insurance than just having a policy, dying and getting some money.

I have touched on this subject in other posts; this is another post that explores this much more deeply. Level premiums are a somewhat lesser used but potentially considerable part of your insurance planning.

Why isn’t this discussed?

For a couple of reasons, but mainly it is hard enough squeezing your cover into your budget, without doubling the upfront cost of part of it.

I will get this out front, for the first few years, yes stepped, or rate for age, premiums will be cheaper. If you are implementing level premiums, you do need to understand why you are doing this. You need to be able to combat banks and advisers suggesting you move your cover, 'because they can do it cheaper', and undermining what you have planned.

Cheaper is a matter of perspective; the whole cost of your contract or just the premium you pay today? Understanding with most policies the premium you pay tomorrow will be higher than when you started.

So, what is level premium cover?

Level premium cover is just that, a policy where the premiums over time do not increase, though, nor does the value of your cover. If you buy one of these policies, that provides, say $100,000 of life cover, and you only pay $20 per month for it; it will stay this way for the term of the contract.

This is not to be confused with an older style insurance contract called diminishing term. With diminishing term, the premiums stay level but the cover reduces over time. A few of my clients have versions of this particular policy from their historical advice, so it is still around.

This type of contract still charges an age related increasing premium every year, like your current annually reviewable policy, but the cover reduces to maintain a stable premium. What I am talking about in this post is genuine fixed cover at a fixed premium for the length of the nominated premium term.

That term maybe 5 years, it may be 10, but the most effective ones are fixed until age 65, 80, or sometimes longer with some providers. The term needs to be reflective of your need for cover.

Let us unpack this a bit more

Let us focus just on just life cover for a moment. For argument sake, let's say you're 40, married, with a couple of kids; you need $500,000 for your mortgage, $50,000 for unexpected costs, $20,000 for funeral and final expenses and a couple of years of income, @ $120,000 per annum. Therefore, you will need about $810,000 of life cover.

For many people reviewing their life insurance, that is where the discussion stops, as both budgets, the discussion on other cover takes over, and life cover premium, relative to the other covers, is cheap.

Let us stop for a second and look at what money is really required when. This is also where the application of indexation, or cost of living, is also considered.

The Mortgage

We will start with the biggest chunk, the mortgage. Ok this is going to take a while to pay off, depending on resources available, between 8 & 30 years. Let us focus on it being there long term as this is where your risk lies.

So you are 40 now, you could be working to 70 to pay the mortgage off, though more likely in the future you will sell and down size some, once the kids are off your hands.

The bulk of the mortgage is going to be paid in the last 20 years rather than the first 10. Taking the bulk of your insurance cover, for the mortgage, over a longer term will save you considerable long-term premiums. Balancing today's premium with total premium spend should be part of your thinking.

Another point on this portion of your planning; indexation or maintaining value of cover relative to cost of living. As this is a fixed value today, it is not going to increase with inflation, indexing this portion of your cover is not required. If you do have it indexed, the cover amount will increase and so will the premium, resulting in an over insured situation and you paying more premium for your cover than you need to.

What this means is we should look at either a yearly renewable or a fixed 5 or 10 year premium for the initial portion of the mortgage we expect you to pay in the first 10 years. Let us keep the math simple and call this $200,000. This will be more than is likely to be paid off but keeps some flexibility, if you do, that you have not paid too much for the associated life cover.

For the remainder, $300,000, setting this on a premium until retirement, age 65, as this is the likely realistic timeframe for your needs. By age 50 the premium on this $300,000, fixed at age 40 on a to age 65 basis, is going to be cheaper than the yearly assessed premium you currently pay. Therefore, you are already saving money. As the plan is not to have a mortgage in retirement, this is realistic in terms of setting premium structure for your cover.

You could further mitigate the risk of having a mortgage in retirement, by setting a portion of the $300,000 cover, on a to age 80 or older premium, maybe $100,000 of this.

The short answer for the mortgage

• $500,000 of cover needed
  • $200,000 of cover with no indexation on a rate for age, 5 or 10 year fixed term. Your cover is able to be continued past this fixed term, though it is will have an age related premium on review.
  • $200,000 of cover with no indexation on a to age 65 basis. Fixed premium cover for 25 years.
  • $100,000 of cover with no indexation on a to age 80 basis, fixed premium for 40 years to mitigate debt in retirement.

Yes, today's cost of for your life cover is likely to be about 40-50% more looking at the first year's premium. The long term, if you survive to age 80, your cost of cover will be about 30-70% cheaper overall. This could equate to several hundred thousand dollars you do not pay the insurance company over the term, rather than a hundred or two this year.

Personally with my own policy, which I fixed on a similar 'to age 80' policy when I was in my early 30's. This will save me about 90%, or about $230,000, in future premiums, premiums I don't have to pay just on this part of my life cover. This will allow me to afford things like trauma and income protection, well into my 50's, which is where I am really going to need this cover. The average trauma claim is currently about age 47-48, depending on which insurers stats you're looking at, and claim rates by age are pretty consistent all the way through from there.

Ok, the next bit, future income

Insuring future income for life is an interesting thing. Most advisers would say you need to insure a good portion of this until retirement, my issue is this sucks up your premium $ on a lower risk part of your cover when you could focus that on higher risk areas like, trauma, medical insurance or income protection. If there's budget left over then maybe we talk more future income on life cover.

My experience, when we have the discussion about future incomes, has been, most households make the decision to cover a year or two but not much longer. The reality is while having the extra income continue, once the mortgage is paid and other expenses are covered, the survivor is likely to be able to work and able to earn enough to maintain their current lifestyle. Though after losing their life partner, many people do make radical changes, so insuring the reality can be difficult and easy to over insure.

So how does level premium apply here?

Unless you have a long-term view, it usually does not, but indexation does. Because this is a value of future buying power, buying power needs to be maintained, so this part is indexed. If you have 5 or 10-year timeframes, then using indexed versions of these premium structures may be appropriate. Again, links back to your timeframe.

Lifestyle expenses

The next largest is lifestyle expenses, what to do here? This again is about future buying power, so indexation should be applied. How this is structured will depend on your timeframe, if it is for something way out in the future then a to age 65 or to age 80 indexed cover might be appropriate. If it is something a bit closer then indexed rate for age might be the best approach. In the scheme of things, this is often not a large part of the premium, so it may not matter too much.

Final expenses

This one is an interesting one; it is the one you really want it to be out there, way out there in your future. It is also the one you want the most stable premium, as you are going to be paying for this cover in your retirement. It has to remain affordable.

This is where the to age 80 and higher age premium options do come into their own. To deviate from my previous stance, this cover needs to take into account indexation from the outset. This is to ensure it remains affordable into your future. Indexation increases on fixed term cover are calculated based on the age they are taken, to have every year from now until you pass away add to your premium is going to make it unaffordable When you really need it.

So how do we get around that?

Stay with me here, its a bit of a journey. If you look at 3% inflation, yes higher than we currently have, but an optimistic average of what has happened in the past for the future, for a policy taken now to maintain it's value in 50 years time you'll need three times today's money in future money. On the other hand, $20,000 today will need to be $60,000 in 50 year’s time. I am using 50 to give some breathing space if indexation does average higher. 40 years is a long time, and I have no idea what the inflation rate will be, so being cautious is prudent. Given we could save 70-90% of the future cost on this part, sacrificing 3-5% of those savings to be sure, isn't a big deal.

This may be counter intuitive, but taking $60,000 today for your future final expenses on a to age 80 policy, is going to be cheaper for you over the term of the contract than taking $20,000 and letting indexation add to the cover and the premium.

Scratching you head yet? I did too the first few times I worked through this early in my career. There is some heavy math involved and getting to the real information does take a bit of digging, but it can be done.

The easy answer is call me, and have me work it all out for you.

Last but certainly not least; you do need to pick your provider for this. Some, with the way they structure policies, will make it more expensive. Others will allow you to group your cover and access large sum discounts.

Moreover, sometimes using multiple companies may be required.

What I'm saying here is all of these benefits with their structures can be made cheaper if you structure it with the right company, by utilising how the insurance company system works, again where your adviser comes in.

So, what is the solution to our example?

Working through the points above

• $200,000 level benefit fixed for 10 years
• $200,000 level benefit fixed to age 65
• $100,000 level benefit fixed to age 80
• $240,000 indexed benefit fixed for 10 years
• $50,000 indexed benefit rate for age
• $60,000 level benefit fixed to age 80

Alternatively, to consolidate the age 80 bits.

• $200,000 level benefit fixed for 10 years
• $200,000 level benefit fixed to age 65
• $160,000 level benefit fixed to age 80
• $240,000 indexed benefit fixed for 10 years
• $50,000 indexed benefit rate for age

With $850,000 of total cover, accounting for $40,000 for the future indexation on final expenses.

Which with some providers will be 5 policies, others just 1.

If you read through all of this, it's now time to call me or email me to come and review your premium structure, it could save you a small mortgage on an investment property or a pay for a new boat or a million other things you want in life. The sooner you start, the more you will save.