Should You Be Concerned About Cost-of-Living Increases On Income Protection Costs?

At a glance:

• Cost-of-living increases, driven by inflation, impact income protection costs.
• Rising expenses necessitate adjustments in income protection coverage to maintain financial security.
• Policies with cost-of-living adjustments help preserve purchasing power and offer long-term financial stability.

 

 

Around 1960, income protection was first introduced to Australia. Despite its importance often being overlooked, income protection has had a solid premise for nearly 60 years. However, rising claims costs are making insurers unhappy, while increasing premiums make customers unhappy.

 

In most Australian households, losing a regular income would cause significant financial (and psychological) strain, making it important to cover this risk. Demand for income protection and claims rates can be subject to economic ups and downs. The economic cycle – like the cost of living – influences income protection demand, as does the claims rate. This poses a threat to growth and profitability.

 

When you consider income protection insurance, it’s paramount to recognise that the financial landscape can shift with the changing tides of inflation. The cost of living, as measured by the Consumer Price Index (CPI), has been on an upward trajectory, as exemplified by a substantial increase of 5.1% in the 12 months leading up to March 2022 – the highest annual rise since the introduction of the GST in 2000.

 

These upward movements carry significant weight, and understanding their ramifications is crucial for Australian residents seeking to secure their financial future. This topic holds profound relevance for residents Down Under. As the cost of living in Australia continues its ascent, so too does the potential impact on income protection costs.

 

 

 

Explaining Cost-of-Living Increases

 

Cost-of-living increases, simply put, refer to the rising expenses associated with everyday life. These increments are a direct result of inflation, which measures the increase in prices of goods and services over time.

 

In the Australian context, the Consumer Price Index (CPI) serves as the yardstick for evaluating the cost of living against the price of a basket of goods. When the average price of these goods and services experiences fluctuations, the CPI adjusts accordingly, shedding light on the financial challenges faced by individuals and households.

 

The impact of these changes in the cost of living extends to various facets of personal finances. Housing, utilities, petrol, and groceries, often deemed essential expenditures, are particularly susceptible to inflationary pressures. As prices rise, individuals and families may find themselves grappling with higher expenses that, if left unmanaged, could disrupt their financial equilibrium.

 

 

Relation between Increasing Cost-of-Living and Income Protection Costs

 

Now, let’s address the crucial question:

 

“Should you be concerned about cost-of-living increases in income protection costs?” The answer lies in the intricate relationship between these two facets of financial security.

 

As the cost of living steadily climbs, it casts a significant shadow over income protection insurance premiums. The link between these two elements is undeniable and, more importantly, practical. Here’s why:

 

Impact on Premiums

 

Cost-of-living increases have a direct bearing on the premiums you pay for income protection insurance. This is primarily because, as the cost of living escalates, so too does the amount of money required to maintain your standard of living. In essence, it necessitates an upward adjustment in the amount of income protection coverage you have in place.

 

Consider this scenario

 

As essential expenses like housing, utilities, groceries, and transportation become more expensive due to inflation, your financial safety net must expand to accommodate these rising costs. Income protection insurance is designed to step in when you are unable to work, providing you with a portion of your income to cover these very expenses.

 

Therefore, the need for an adequate level of coverage becomes paramount to ensure that your financial well-being remains intact in the face of unforeseen circumstances.

 

Insurance premiums and rising claim costs

 

Insurers sometimes raise maximum monthly benefits or sums insured at 3% – 5% above the consumer price index. It’s been a decade since wages grew at those levels, resulting in an increment in the cost of living.

 

Then, what happens when benefit indexing exceeds wage growth and cost of living while underemployment persists? Income Protection claims and economic conditions are known to have a negative correlation. Low claims rates follow good economic conditions (people are very motivated when the sun shines), whereas high claims follow bad economic conditions (people are less motivated to return to work promptly). Stress caused by a poor economy contributes to mental health problems and then leads to higher claims frequency & length.

 

 

How income protection has changed with the cost of living?

 

We’ll delve into how income protection insurance has adapted in response to the changing landscape of the cost of living, drawing from the information provided in the previous sections.

 

Adjustment Mechanisms

 

Income protection policies often include mechanisms to address the impact of cost-of-living increases. One such mechanism is the inclusion of an inflation adjustment feature, which automatically increases your sum insured annually.

 

This adjustment is typically tied to the Consumer Price Index (CPI) or a fixed percentage, ensuring that your coverage keeps pace with rising living costs. While this feature can provide peace of mind, it’s important to note that it may result in an annual increase in premiums as well.

 

Customised Options

 

Recognising that individuals have varying preferences and needs, income protection providers offer customised options. This means policyholders can choose whether to opt in or opt out of the inflation adjustment feature.

 

This flexibility empowers you to make decisions aligned with your financial goals and circumstances, allowing you to manage the impact of cost-of-living increases on your coverage and premiums.

 

 

The Rising Cost of Income Protection and Claims

 

Alongside the escalating cost, we witness an uptick in claims. In this section, we will explore these developments and their underlying factors.

 

Increasing Risk of Claims: An Aging Population

 

Australia, like many other developed nations, is experiencing demographic changes characterised by an ageing population. With more individuals entering retirement age, the likelihood of claims for income protection insurance rises.

 

As people age, they may encounter health issues or disabilities that make it challenging to continue working. Consequently, insurers must prepare for a higher volume of claims, which can impact the overall cost of providing income protection coverage.

 

The Soaring Cost of Healthcare

 

As medical treatments and services become more advanced, they also become more costly. These escalating healthcare costs have a direct influence on insurance premiums. Income protection policies often include provisions for covering medical expenses related to injuries or illnesses, further fueling the need for higher premiums to sustain these benefits.

 

Increased Competition and Selectivity

 

The insurance industry in Australia has witnessed a surge in competition in recent years. While this competition has led to a more significant number of options for consumers, it has also introduced a degree of selectivity among insurers.

 

As companies vie for market share, they may become more discerning about the risks they are willing to underwrite. This selectivity could mean that individuals with specific health conditions or higher risk profiles may face challenges in obtaining income protection insurance. While competition may drive down premiums for some, it can make coverage less accessible for others.

 

Technological Advancements and Data Analytics

 

Insurers now have access to a wealth of data that allows them to refine their pricing models and underwriting criteria. While this can result in more tailored coverage and pricing, it may also contribute to nuanced increases in premiums based on individual risk profiles.

 

Legislative and Regulatory Changes

 

Changes in legislation and regulations governing the insurance industry can also impact the cost of income protection insurance. Regulatory shifts may introduce new requirements or standards that insurers must adhere to, potentially influencing the pricing of insurance products.

 

 

 

Benefits of Cost-of-Living Adjustments

 

Opting for income protection policies that include cost-of-living adjustments can offer several significant advantages. These adjustments are designed to help policyholders maintain the purchasing power of their benefits over time. Here are some key benefits:

 

Preservation of Purchasing Power

 

In a scenario where inflation erodes the real value of money, these adjustments help preserve your purchasing power. This means that if you need to make a claim in the future, the benefit you receive will be sufficient to cover essential expenses, just as it would have when you initially purchased the policy.

 

Financial Security in the Face of Inflation

 

Inflation is an ever-present economic force. Without adequate protection, your savings and insurance benefits may not be sufficient to meet future financial needs. Cost-of-living adjustments act as a shield against the eroding effects of inflation, providing you with a sense of financial security even as the cost of living continues to rise.

 

Peace of Mind

 

Knowing that your income protection benefits will adjust to keep up with inflation can offer peace of mind. You won’t need to constantly worry about whether your coverage remains adequate. Instead, you can focus on other financial priorities with the confidence that your insurance will adapt to changing economic conditions.

 

Long-Term Financial Planning

 

Cost-of-living adjustments align with the principles of long-term financial planning. When you invest in an income protection policy with these adjustments, you are essentially future-proofing your financial stability. This can be especially important for individuals who plan to rely on their income protection benefits during their retirement years.

 

Reduction of Coverage Gap

 

Without cost-of-living adjustments, there can be a significant coverage gap between the benefit you receive and the actual cost of living. This gap can create financial stress during challenging times. Adjustments bridge this gap, ensuring that your coverage remains in sync with your evolving financial needs.

 

If you’d like to know more, reach out to expert advisors at Aspect. They are committed to providing you and your clients with the best services possible. You are welcome to ask us any questions about our Income Protection policies. Having over 40 years of collective experience, Aspect Underwriting is able to deliver positive outcomes to its clients. Our team takes pride in providing products that meet the needs of our clients, followed by service that enhances their experience.

 

 

As the cost of living in Australia continues its ascent, individuals and families must be vigilant in safeguarding their financial stability. Cost-of-living increases, intricately linked with inflation, have a direct bearing on income protection costs. It is imperative to consider these factors when evaluating your insurance options.

 

Income protection policies with cost-of-living adjustments emerge as a prudent choice, preserving your purchasing power and offering peace of mind in an ever-changing economic landscape.