What is indexation on life insurance?

Indexation on life insurance is an option that increases your cover each year to keep pace with inflation. It is usually added to a level term policy, and it turns that policy into what insurers call increasing term cover. The cover amount goes up, and in most cases the premium you pay goes up with it¹.

It exists because a payout fixed at the start of a long policy buys less by the end of it. If prices double over the term, a payout set at today's prices is worth roughly half what it was. Indexation is the mechanism insurers use to stop that happening, by reviewing the sum insured annually and lifting it in line with a cost of living index³.

The trade-off is straightforward. Your protection keeps its value, and you pay more each year for it. Whether that suits you depends on what the cover is for, how long it needs to last, and whether you would rather keep the premium level and accept that the payout will be worth less in real terms by the time it is claimed.

Indexation keeps your cover in line with inflation

The core idea is simple: the amount you are insured for is reviewed each year and increased, so the payout keeps its buying power. Insurers describe it as an option to increase the amount of cover on an annual basis to combat inflation, with the premium also increasing each year¹. On a whole of life policy the same principle applies to the sum assured, which increases with inflation over time, and the premiums rise too⁷.

There is more than one way to do it. Providers can adjust the policy payout, which is what index-linking means, or they can apply fixed periodic rises instead⁸. Increasing term insurance can go up either by a fixed amount each year or in line with inflation⁹. The fixed percentage route is more predictable; the inflation-linked route tracks the real cost of living more closely.

Indexation is not confined to life cover. Family income benefit policies can have the monthly benefit set to increase with inflation, which usually means higher premiums from the outset¹⁰. Whole of life policies offer an increasing cover option that helps keep pace with inflation and maintain the level of financial protection intended¹¹. The common thread is that the benefit is designed to hold its value over a long period.

It is worth being clear about what indexation is not. It is not investment growth, and it does not build a cash value. It is an adjustment to the sum insured, and it applies to protection policies where the payout is meant to meet a future need. Where the need itself shrinks over time, such as a repayment mortgage balance, indexation works against the shape of the debt rather than with it.

RPI or CPI: the measures policies link to

Indexation has to be measured against something, and in the UK there are two main candidates. Insurers link increases to a cost of living index such as the Retail Prices Index (RPI) or the Consumer Prices Index (CPI)⁵. Some policies use RPI, some use CPI, and some let you choose a fixed percentage increase instead¹².

The two measures are not interchangeable, and the choice matters over a long term. RPI has historically run higher than CPI, so a policy linked to RPI tends to produce larger increases in cover, and larger increases in premium, than one linked to CPI. Which one your policy uses is set out in its terms, and it is one of the details worth checking on a quote rather than assuming.

The wider UK system has been shifting from RPI towards CPI for years. From April 2011, payments from state benefits, public sector pensions and the State Second Pension were indexed to CPI increases rather than RPI increases¹³. NS&I moved its Index-linked Savings Certificates from RPI to CPI: before 1 May 2019 it used the Retail Prices Index, and from the next anniversary falling on or after that date it calculated index-linking using CPI instead¹⁵. The Pension Protection Fund uses CPI to calculate members' compensation¹⁸.

That drift matters if you are comparing an older policy with a newer one, or reading a policy document written years ago. A policy that says it tracks "the index" may mean different things depending on when it was written and which insurer issued it. The policy terms, not the sales illustration, are the definitive statement of which measure applies.

How indexation changes your cover and your premiums

Both sides of the policy move. The cover amount rises, and the premium rises with it. Insurers describe indexation as giving you the option to increase the amount of cover on an annual basis, with the premium also increasing each year¹. On increasing term cover, the premium may increase to reflect the new sum assured, depending on the plan and its terms².

The size of the premium increase varies by insurer and by product, and the formulas are not all the same. One insurer's whole of life plan changes the premium and the cover amount each year in line with RPI, rounded up to the nearest 0.25%, and never increases by more than 10% a year¹⁹. Another applies RPI multiplied by 1.5, subject to a maximum increase of 15% a year on reviewable premiums⁶. A third increases the premium by 1.5 times the increase applied to the benefit amount²⁰. A budget income protection policy uses the same 1.5 multiplier for inflation-linked cover²¹.

That multiplier is the detail most people miss. Where a policy increases the premium by 1.5 times the rise in the cover, the premium rises half again as fast as the cover does. Over a long term, that compounds. The cover grows at the rate of inflation; the premium grows faster.

There is a starting point question too. Applying indexation generally does not change the starting premium, though some insurers may apply a slight increase, especially for income protection². So the first year often looks the same as a level policy, and the difference only shows up as the years pass.

Will my premiums go up if my policy is index-linked?

Yes, in most cases. That is the design, not a side effect. The premium rises each year as the cover rises, and the amount it rises by is set by the policy terms¹. A level term policy with no indexation keeps the same premium for the whole term; an indexed policy does not.

How much it goes up depends on the formula. Where the premium tracks inflation one for one, a year of high inflation produces a matching premium rise. Where it tracks inflation multiplied by 1.5, the premium rises half again as fast as prices⁶. Where there is a cap, such as a maximum 10% or 15% annual increase, a spike in inflation is partly absorbed by the insurer rather than passed on in full¹⁹.

There is one protection worth knowing about. Once a policy is in place, the premiums cannot be increased after a cancer diagnosis²². That applies to existing policyholders who are diagnosed with cancer, and it means the insurer cannot reprice the cover because of a change in health. It does not stop the annual indexation increase, which is a feature of the policy rather than a reassessment of risk.

The practical effect is that an indexed policy costs more in its later years than a level policy would have. Whether that is a problem depends on your circumstances at the time. Premiums are usually fixed at outset on a level policy, so the cost is known from day one; on an indexed policy the later cost is not known in advance, because it depends on inflation.

Can I turn indexation off on my life insurance?

Often, yes, but not always cleanly. Many policies allow you to opt out of increases, and the increase is usually offered rather than imposed. On increasing term cover, the increases could affect the cost of your premiums, but you can choose to accept or decline them⁸. On one insurer's increasing life policy, the person covered is given the option each year to increase the insured amount in line with changes in RPI, without further medical evidence, and the premium increases only if the option is taken²³.

The catch is what happens if you keep saying no. If you opt out multiple times in a row, some providers may remove indexation from your policy⁴. Once it is removed, the cover stops rising altogether, and reinstating it may not be possible on the original terms. That is a meaningful difference from simply skipping a year.

Declining an increase also has a cumulative effect. Each year you decline, the gap between your cover and the cost of living widens, and it does not close again. A policy that started out at an adequate level can fall well behind after a decade of declined increases, which is precisely the outcome indexation was chosen to avoid.

Is indexation worth having on a mortgage life insurance policy?

It depends what the cover is for, and the answer is not the same for every mortgage. A repayment mortgage balance falls over time, so cover that rises each year does not match the debt. An interest-only mortgage is different: the capital stays outstanding until the end, so a payout that keeps pace with prices is closer to the need.

The more common issue is where the cover came from. Life insurance sold alongside a mortgage by a lender has historically been poor value, and the guidance is to shop around and consider buying cover separately²⁴. Buying separately also means you can choose whether indexation is included, rather than having it bundled into a product you did not compare.

If the cover is really there to protect a family's living costs rather than to clear a specific debt, the case for indexation is stronger. Household costs rise over time, and a payout fixed at today's prices will not cover the same standard of living decades later. That is the situation indexation was designed for, and it is why increasing term cover is described as suitable where the cover needs to stay in line with inflation²⁵.

There is a middle path. Because it is common to hold more than one life insurance policy, either for different purposes or as an additional policy to increase cover, some people keep a level policy for the mortgage and add a separate indexed policy for family protection²⁶. That way the mortgage cover matches the debt and the family cover keeps pace with prices.

Where to get help and what protects you

Indexation is a policy feature, so the terms of your own policy are the first place to look. If you bought through an adviser, they can explain what your policy does and whether the increases are being applied as described²⁷. If you bought directly, the insurer's customer service team handles questions about how the cover and premium are being adjusted.

If something has gone wrong, there is a route. Complaints about the sale or administration of a policy go first to the firm, and if you are not satisfied with the response you can take it to the Financial Ombudsman Service, which handles disputes about savings endowments and similar products²⁹. The ombudsman service is free to consumers.

On tax, a payout from a life insurance policy is generally not something you need to report, and a loss on a life insurance policy cannot be set against a gain on another policy or against your other income, with no relief available for that loss. If a policy is written in trust, the payout can be set up in advance to avoid inheritance tax. Both of these are worth checking with the insurer or a tax adviser if the sums are significant.

Free, impartial guidance on protection insurance and how it fits with the rest of your finances is available from MoneyHelper. For debt problems, which can affect whether cover is affordable, the debt advice charities offer free help. Neither sells products, and neither will recommend a particular insurer.