Recommend stepped premiums over level premiums

A level premium is one that does not change from year to year (except for modest increases relating to inflation).

A stepped premium, on the other hand, does vary from year to year. Typically, stepped premiums increase as the client ages, for the simple reason that illness and death become more likely the older a person becomes.

Most life insurers allow clients to choose whether to use a level or stepped premium for a given policy.

An annual level premium tends to be higher than a stepped premium in the early years of a policy, during which time the insured event is less likely to happen. As the likelihood of the insured event increases, so the stepped premiums increase. Eventually, the stepped premiums will come to exceed the level premium that would be payable for the same level of cover. If the policy is held for long enough, in general the total amount of premium under a stepped premium will eventually exceed the total premium paid under the level premium.

In most cases where an adviser is recommending life insurance, the adviser is also recommending whether the client use a stepped or level premium. As a result, the adviser needs to be clear as to why one or the other type of premium has been recommended. This is especially the case where a level premium is recommended, because the advantages of the stepped premium tend to outweigh those of the level premium in most cases.

There are various reasons for this. These reasons include what is known as the ‘time value of money.’ This concept tells us that $1 saved today tends to be worth more to a client than that same $1 saved in 20 years’ time. This is the case even when inflation is adjusted for, as the use to which a client could immediately put the extra $1 needs also to be factored in. For example, if the money saved today by using a stepped premium was used to make extra repayments on a home loan, or to finance additional super contributions, then the increase in value of those investments needs also to be factored in to the discussion.

Most client’s insurance needs reduce over time. For example, a younger parent with dependent children will typically need more death cover than an older parent whose children have themselves reached adulthood. Thus, for many clients, at the time when the level premium starts to become cheaper than the stepped premium, the need for insurance might be falling anyway. This reduced need allows the client to either take a lower insured amount or simply to stop purchasing a particular type of insurance altogether.

Most life insurance policies have stepped premiums.

Minimising the premium relative to the sum insured is a good reason for recommending a stepped premium rather than a level premium.

What does ASIC say about stepped versus level premiums?

ASIC discusses this question at paragraphs 216 and 217 of Report 413 Review of retail life insurance advice. It says;

216 Most life insurance products sold under advice recommended stepped premium policies. In some cases, SOAs modelled the effect of stepped and level premiums over time and we found examples where this was done well, in ways that were concrete and realistic for the client.

217 In other cases, we found limited consideration of the merits of different premium options or any engaged discussion with the client about how long they intended to hold the cover, and therefore the stepped premiums increases on the premium (and the client’s cash flow) across that timeframe.

The Dover Group