Rethinking CPI Indexation on Sum Insured in Retail Life Insurance

Retail life insurance has historically relied on CPI-linked benefit escalation as a default mechanism to preserve adequacy over time. While appropriate in early policy years, customers’ objectives, financial situation and needs often evolve as they age. The result is rising premiums, growing affordability pressure, and ultimately higher lapse rates, often at precisely the point where customers still require some level of protection.

There is an opportunity to consider whether product escalation options can be adapted to better align with changing customer circumstances, ease affordability pressures and support long-term customer outcomes.

The longstanding design of retail life insurance has been to increase sums insured annually by the higher of CPI or 5% until policy expiry. At the start of cover, typically around age 35-40, this approach is broadly aligned with customer circumstances, where income, debt levels, and family responsibilities are still rising. Indexation helps maintain the real value of cover during this phase. 

However, this same design persists unchanged as customers move into later life stages. From around age 50 onwards, many customers experience declining debt, increased asset accumulation outside the family home, and reduced costs associated with dependants. Despite this, insured benefits continue to escalate, increasingly disconnecting cover levels from actual financial need. 

At the same time, premiums accelerate materially due to both age-based increases and indexation , compounding affordability pressures and limiting customers’ ability to redirect cash flow toward retirement or other priorities.

In theory, ongoing advice should rebalance cover as circumstances change. In practice, many customers disengage from advice over time, and the economics of advice do not support frequent reviews solely to reduce insurance cover. The cost of a review can act as a significant barrier, particularly where the outcome is a reduction rather than an expansion of cover. 

As premiums rise and cost of living pressures intensify, customers often face a stark choice, maintain increasingly unaffordable cover or cancel altogether. Critically, many customers are unaware that reducing cover levels is an option, and lapse decisions are frequently made without professional guidance. This results in customers moving from “too much cover” to “no cover,” rather than to a more appropriate level of protection. 

This dynamic stands in contrast to well accepted principles in other areas of financial management. In investment portfolios, rebalancing and lifestage adjustments are considered standard practice. Likewise, most default group insurance arrangements within superannuation similarly reflect lifestage curves, with benefits typically increasing and then tapering over time in line with expected financial dependency, albeit at much lower levels of default cover designed to suit majority of the membership which may not align with each individual customers' personal financial circumstances.

Retail insurance, by contrast, largely offers a binary choice: product indexation on or product indexation off . This lack of nuance contributes to structural inefficiency, excess cost, and poorer customer outcomes. 

Perhaps there should be a middle ground between full indexation and no indexation. Potential design options include:

• indexation switching off automatically from a specified age (e.g. 50), or
• indexation applying only for a defined period post inception (e.g. the first 10 years),
• cover automatically reducing by a set % each year from a chosen year, such as when the customer turns 50/55 to help address age based premium increases and lower needs.

These settings could be determined at inception, informed by the adviser’s original needs analysis, where projected insurance requirements are expected to peak and then decline. 

Such features would:

• Better align cover with expected life stage needs
• Limit unnecessary benefit inflation in later years
• Reduce premium escalation and affordability stress
• Lower the friction associated with needing advice purely to reduce cover

Importantly, customer choice is preserved. Indexation could be reactivated, guaranteed future insurability used, or advice sought where circumstances warrant it. 

While no single feature will deliver a perfect outcome for every customer, this approach can enhance alignment with customers’ evolving needs over time. In doing so, it may help reduce the risk that cover becomes less aligned or lapses entirely. Better alignment supports:

• Greater customer outcomes and trust
• Insurance cover aligned to a typical customer's needs throughout the life cycle
• A clearer articulation of value in a cost of living constrained environment
• Lower friction for benefit adjustments in an advice constrained market
• Lower lapse risk caused by affordability shock
• More sustainable and stable premium within in force books

The end goal is getting closer to adequate protection aligned to lifestage needs, delivered at a cost that preserves customer cash flow and supports long-term financial wellbeing.