Demystifying premium patterns in life policies
A premium pattern on a life product is illustrated by the graph of the increases in premium over the potential life of the product from inception. Creative use of premium patterns is one of the subtle ways that brokers or call centres will ‘persuade’ someone to switch their life policy to another provider. Even if your advisor has gone to pains to demonstrate the difference in premium patterns, that sort of detail is easily forgotten over time, and the prospect of saving several hundred rand a month can be very compelling.
Why does it matter?
There are basically 3 different premium patterns: level, age rated and stepped. The first two are the most common so I am going to stick to those two right now.
Level: In its purest form, if you have a benefit – say R1m cover, with 0% increase – the premium you pay today you will pay at the end of the policy, and the benefit will also stay the same – a straight horizontal line on the graph. You can choose to increase the benefit, but the premium will increase usually by at least 2% more than the benefit, (with one provider giving the 1 for 1 option). Why does it increase more than the benefit? Because the actuaries ‘reunderwrite’ it every year as you get older, costing it at your older age.
Age-rated: These premiums always start below the premium for the same benefit on a level premium. Every year you get an increase for age, without an increase in benefit. If you choose to increase the benefit, then that increase is added to the age-rated premium (which varies in its growth by provider, there are some very aggressive premium patterns out there). This can translate into an increase as high as 25% per annum, compounded. Below is a graph of a real example. The ‘cross over’ of premium is around 7-8 years (38 yr old male, Brightrock policy).
So what is the problem?
In later years the compounded increases of an age-rated premium get out of control and become unaffordable.
Advisors are often stuck with their head between a rock and a hard place. It is usually in the client’s best interest to have a level premium product, but that opens them up to the risk of someone coming in with a cheaper premium – because they use the age-rated method – and the client is lost, and pissed at you for ‘ripping them off’. There is also that ‘opportunity cost’ of the 7 years when the client could have been paying for a lower premium. One way to optimise this is to keep ‘churning’ the policy every 2-3 years to keep the premiums down. If your advisor is ‘independent’ they will be able to do this, ‘tied’ agents might not have this flexibility. Over the last 10 years this strategy has certainly worked – as long as the client is fit and healthy. As soon as there are potential medical problems, then loading and exclusion makes these churns impossible. It might be possible to change the premium pattern, but it is going to be at the new ‘higher level’ and might still require underwriting. (You can’t have your cake and eat it). As a result most advisors will quote on an age-rated policy. Under the age of 40-45 you’ll probably get away with it.
Recommendation: Know what premium pattern your policies are using. Most policy documents today will give you a table to illustrate this. Graph it if it helps. Add a baseline – your salary increasing at inflation say. If the premium is going to chew up a huge amount of your salary later, or into retirement (when dread disease cover is really needed for example) then look at switching to a level premium. Need help? Give me a shout.
Author Dawn Ridler