Stepped vs Level Premiums: Understanding the Difference
When considering personal insurance in Australia, whether it be Life, Total and Permanent Disability (TPD), Income Protection, Trauma or Key Person Insurance, choosing the right premium structure is critical to long-term financial planning. Two common premium structures are stepped and level premiums, each offering distinct advantages and disadvantages depending on your financial goals, life stage and insurance needs.
What are Stepped and Level Premiums?
Stepped Premiums:
Definition: Stepped premiums increase over time, typically on an annual basis. These premiums are recalculated each year, primarily based on your age and the likelihood of making a claim as you grow older.
How they work: In the early years, stepped premiums are relatively low. However, they increase significantly as you age, which means your costs can rise considerably, especially past the age of 50 or 60.
Level Premiums:
Definition: Level premiums on the other hand, remain relatively constant over time. These premiums are based on your age when you first take out the policy, so while the initial cost may be higher than stepped premiums, they tend to be more predictable in the long run.
How they work: Because the premium cost is fixed based on your entry age, level premiums provide cost certainty and can potentially save you money if you keep your policy for a long period.
Stepped Premiums for Life Insurance:
Advantages: Initially, the premiums are lower, making life insurance more affordable when you are younger. This is ideal if you need high levels of cover for a temporary period, such as when supporting a young family or paying off a mortgage.
Disadvantages: The annual increase in premiums can become burdensome as you get older, especially when you might need the cover the most.
Level Premiums for Life Insurance:
Advantages: By locking in a premium based on your age at the time of application, you get the benefit of cost stability. If you intend to hold your life insurance policy for many years, level premiums can prove to be more cost-effective over the long term.
Disadvantages: The initial premiums are higher than stepped premiums, which might be prohibitive for younger individuals or those with a tight budget.
TPD Insurance (Total and Permanent Disability Insurance)
Stepped Premiums for TPD Insurance:
Advantages: As with life insurance, stepped premiums start lower, which can make this type of protection affordable when you're younger and less likely to make a claim.
Disadvantages: The likelihood of a TPD claim increases as you age, leading to a steeper rise in premiums over time. This can result in higher costs just when you’re more likely to need the cover.
Level Premiums for TPD Insurance:
Advantages: Level premiums can offer a more affordable long-term solution for TPD insurance, providing financial predictability during your working life and into retirement.
Disadvantages: As with life insurance, level premiums are more expensive at the outset.
Stepped Premiums for Income Protection:
Advantages: Since income protection premiums can rise dramatically over time, starting with stepped premiums may make sense for those who expect to hold the cover for only a short period.
Disadvantages: However, stepped premiums become expensive quite quickly as you age, potentially leading to financial strain during later working years.
Level Premiums for Income Protection:
Advantages: Given the likelihood that you’ll need income protection for an extended period—especially if your profession exposes you to injury or illness—level premiums provide cost certainty and could result in long-term savings.
Disadvantages: You’ll need to be prepared for a higher initial cost.
Stepped Premiums for Trauma Insurance:
Advantages: Stepped premiums are initially more affordable, allowing you to secure cover for critical illness during your younger years when claims are less likely.
Disadvantages: The premium increases as you age, and the likelihood of claiming for serious conditions like cancer or heart disease rises, making it more expensive over time.
Level Premiums for Trauma Insurance:
Advantages: With level premiums, you lock in your cost early, which can result in considerable savings if you intend to hold the policy for many years.
Disadvantages: The higher initial premium can be difficult for some to afford, especially early in life.
Stepped Premiums for Key Person Insurance:
Advantages: Ideal for businesses that need short-term cover, as the initial premiums are lower, reducing upfront business expenses.
Disadvantages: If the cover is required for an extended period, stepped premiums will increase significantly, leading to higher costs for the business.
Level Premiums for Key Person Insurance:
Advantages: Level premiums can be more cost-effective for businesses that intend to keep the key person cover in place for many years, providing budget certainty and long-term affordability.
Disadvantages: The initial premiums are higher, which can impact cash flow in the early stages.
Final Thoughts
When deciding between stepped and level premiums for any form of insurance, whether it be life, TPD, income protection, trauma, or key person insurance, it’s important to consider your long-term goals, budget and coverage needs. Both premium structures have their merits, and the right choice will depend on whether you're seeking immediate affordability or long-term savings. A financial advisor can help tailor your insurance strategy to your specific situation, ensuring you have the right protection at the right cost.