What is indexation in insurance?


Indexation is a complex-sounding term that is used to describe a relatively simple concept in the world of insurance. Here, we’ll break down exactly how it can benefit you.

Indexation refers to a benefit payment that increases in proportion to the cost of living, also known as inflation.

If the cost of living increases by 5% in a given year, an indexed insurance benefit will also increase by 5% so that you, or the listed beneficiary, don’t lose out on purchasing power when the cost of living increases.

How does indexation work?

Say you need $100,000 to meet your living costs in 2020, but $105,000 to meet the same living costs in 2021. The cost of living would have increased by 5%. If your insurance benefit were indexed, then, it, too, would increase by 5% to reflect this inflation.

But, if your insurance benefit were not indexed, then it would remain static at $100,000. This would mean that, were inflation at 5% every year for ten years, you would need around $163,000 to meet your living costs in 2030, but your insurance benefit would be the same as it was when you took it out — $100,000, so you might fall $63,000 short of your needs.

Inflation Protection automatically increases your Life Insurance cover amount by 5% every year, or by the level of inflation expressed as the Consumer Price Index (CPI) — whichever is greater. For example, in the first quarter of 2020, inflation was 2.2% in Australia, while in the quarter leading to December 2019, inflation was 1.9%.

CPI and how to calculate CPI increase

The “index” that indexation references is usually the CPI, which is a group of statistics that measure the cost of living in Australia.

In order to calculate CPI increase, we need to work out the average price that Australians pay for a typical variety of goods and services, known as CPI items, and how this price has increased — from quarter to quarter or year to year.

CPI items include:

  • food
  • alcohol
  • clothing
  • housing
  • health
  • transport
  • insurance, and
  • education

When the average price of these CPI items increases, the CPI increases to reflect that.

Insurance policies that are indexed to the CPI will increase, in terms of their benefit payout, at the same rate.

Do typical life insurance rates include indexation?

The short answer is no. Most of the time, typical life insurance rates don’t include indexation.

But there’s good news! You have the power to choose whether your AAMI Life insurance policy is indexed by selecting ‘Inflation Protection’ when you take out your policy.

Adding Inflation Protection to your insurance policy can be a great way to help future-proof yourself and your benefit amount against the rising cost of living.

What is available with AAMI Comprehensive Life Cover?

A lump sum benefit is payable in the event of the death of a life insured, or their diagnosis with a terminal illness. All Australian residents aged 18 to 65 are eligible to apply. A benefit amount of up to $1,500,000 is available per life insured, subject to meeting underwriting criteria. The maximum benefit amount that can result after inflation protection is $2,500,000.

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Insurance is issued by AAI Limited ABN 48 005 297 807 AFSL 230859 (AAI) trading as AAMI. Read the relevant Product Disclosure Statement before buying this insurance. This advice has been prepared without taking into account your particular objectives, financial situations or needs, so you should consider whether it is appropriate for you before acting on it.