Level or increasing cover: how payouts keep pace with inflation

Income protection is designed to replace some of your income if you cannot work because of illness or injury, and it pays a regular income rather than a lump sum¹. Most policies cover around 50% to 70% of your income, and the amount you get when you claim is limited to between 50% and 75% of your earnings before you were unable to work².

When you take a policy out, one of the choices is whether the cover stays level or increases. Level cover keeps the amount of cover and the monthly payment the same for the length of the policy³. Increasing cover raises the amount of cover in line with inflation, and the premium increases each year⁴. The trade-off is straightforward: a level payout buys less as the years pass, while increasing cover costs more from the start and more each year.

This page sets out what each option pays, how inflation erodes a level payout over a long claim, the premium structures available, how much of your income a policy can replace, what shapes the cost, and where payouts are reduced or stop.

Level and increasing cover: what each one pays

Level cover is the simpler of the two. The amount of cover you choose, and the amount you pay each month, stays the same for the length of the policy³. If you claim, the monthly benefit is the figure you agreed at the start, and it does not move. Level cover is usually more expensive than decreasing cover, because the payout remains the same size rather than shrinking with a mortgage balance⁵.

Increasing cover works differently. The amount of cover you get rises in line with inflation, and unlike level cover, the cost increases each year⁴. One insurer describes it as the monthly payment amount and the cover amount both increasing over time, with the amount you pay increasing by a slightly higher rate than the cover amount³. Another says the amount of monthly cover rises in line with inflation and premiums rise each year⁴.

Some policies offer the choice directly. One income protection plan offers level cover or increasing cover as two options⁴, and a rental protection plan lists level cover or increasing cover⁶. On some life and lifestyle protection policies, inflation protection is optional: if you choose it, the cover amount increases each year to adapt to the cost of living, and monthly payments also increase over time⁷.

The pattern across the market is consistent. Increasing cover starts at a similar price to level cover in some products, and then diverges as the annual increases apply⁹. The choice is not about which is better in the abstract; it is about whether you expect a long claim and whether you can absorb a premium that rises every year.

How inflation erodes a level payout over a long claim

The case for increasing cover rests on what inflation does to a fixed sum. Where payouts are fixed, the effect of inflation will erode the value of the payout over time¹⁰. That statement comes from guidance on over 50s life insurance, but the arithmetic applies to any fixed payout, including a level income protection benefit.

The same principle appears across protection and retirement products. A level annuity is vulnerable to inflation, which might make your annuity income worth less over time¹¹. Level term life insurance pays a sum that does not increase with inflation¹². By contrast, increasing term policies offer payouts that rise by either a fixed percentage or by an inflation-linked index, such as the Retail Price Index or the Consumer Price Index, and they are typically more expensive⁵.

For income protection specifically, the risk is concentrated in long claims. Income protection claims are typically paid until the person returns to work, retires or the policy ends¹³, and some policies pay out until you can go back to work or reach retirement¹⁴. A claim that runs for several years on a level benefit means the same monthly figure arriving while the cost of everything else rises. Cheaper short-term policies may only pay for one or two years, which limits the exposure but also limits the protection¹⁵.

There is a counterweight to consider. An inflation-linked income starts at a much lower rate than a level one in the annuity market¹¹, and increasing cover carries a higher premium from the outset. The question is not whether inflation erodes a level payout, because it does, but whether the extra premium is worth paying for a claim that may never happen or may be short.

Premium options: level, age-costed, reviewable or guaranteed

Premiums on income protection policies can stay fixed, which means any money paid will probably also stay fixed, or they can increase by a fixed amount each year, or by a variable amount linked to, for example, the Retail Price Index or National Average Earnings Index¹. That is the core menu, and it sits alongside the question of whether the premium is guaranteed or reviewable.

One insurer sets out three premium options: level guaranteed, age-costed guaranteed, and age-costed reviewable¹⁶. Its level guaranteed premiums stay the same for the life of the policy and are available where the chosen waiting period is four weeks or longer¹⁷. Its age-costed reviewable premiums increase with age but are reviewed after three years¹⁶.

Reviewable premiums are the ones to watch. Some reviewable policies start with low premiums that rise at each review, and if you do not accept the increase, your cover will fall¹⁸. In the life insurance market, reviewable premiums may cost less initially, but the insurer will review them on a regular basis and may change them¹⁹. One flexible life plan warns that if you chose the maximum basis option, your premium is likely to increase significantly at each review, and you then either pay the increased premium or use the fund value²⁰.

Guaranteed premiums are the alternative. Family income benefit insurance offers guaranteed premiums, fixed for the whole term, or reviewable premiums, lower initially but potentially increased on regular review¹⁹. Whole of life cover can have guaranteed or reviewable premiums²¹. On one life insurance plan, premiums are guaranteed unless increasing cover is chosen, or there is a choice of guaranteed or reviewable if critical illness cover is added²².

How much of your income a policy can replace

Income protection policies do not replace all your pre-disability income. They usually provide a proportion of your income, minus state benefits and any income from similar policies²³. The amount you get when you make a claim will be limited to between 50% and 75% of your earnings before you were unable to work¹, and income protection typically pays out a regular income rather than a lump sum, usually covering around 50% to 70% of your income².

Individual insurers quote their own ceilings. One says income protection can replace up to 60% of your monthly earnings if you are unable to work due to illness or injury²⁴. Another covers up to 60% of your gross annual income up to £60,000 a year, then 50% of your gross annual income over £60,000 a year²⁵. A third offers up to 70% of your pre-tax income²⁶.

You cannot insure yourself for an amount higher than your earnings when you take the policy out¹. You can have more than one income protection policy, but the total amount you can claim is usually capped at a percentage of your pre-disability income across all policies, to prevent over-insurance²⁷.

The interaction with state support matters here. State benefits you might be able to claim, such as Statutory Sick Pay, Universal Credit or Employment Support Allowance, will also be considered¹. One worked example shows how this lands: with a £2,500 monthly salary, 75% insured, £325 of Universal Credit and £1,250 of employer payments, the income protection policy pays out £300 a month, because that then totals £1,875, which is 75% of the normal monthly salary¹.

Deferred period and benefit term: what shapes the cost

The deferred period is the amount of time you have to have been off work before the policy will start paying you benefit, agreed when you took out the policy²³. You choose a set deferred period, usually of four, 13, 26 or 52 weeks, bearing in mind that longer periods usually mean lower premiums¹. Most policies include a waiting period, known as a deferral period, which can range from a few weeks to several months after you stop working², and it can generally range from one to 12 months after you were taken ill, with longer waiting periods often reducing the cost²⁸.

The effect on price is direct. Longer waiting periods reduce your premium, while shorter periods increase it²⁹. The benefit term matters just as much. Income protection claims are typically paid until the person returns to work, retires or the policy ends¹³, and some policies pay out until you can go back to work or reach retirement¹⁴. Cheaper short-term policies may only pay for one or two years¹⁵. Most policies also end at a certain age, like your selected retirement age, with an upper age limit of 65¹.

The cost factors listed by one insurer are age, job risk, health and lifestyle, amount of cover, deferred (waiting) period, and benefit term²⁹. Prices can vary depending on your job, health and the level of cover, and cheaper policies may offer a lower level of protection, so it is worth checking what is included².

Level or increasing: which suits your circumstances

The choice turns on how long a claim might last and how the rest of your finances are arranged. A level payout suits a claim you expect to be short, or a household where other income will keep pace with rising costs. An increasing payout suits a claim that could run for years, because the benefit moves with inflation rather than standing still.

There is a wider point about how the state treats inflation, which shows what indexation is worth. The basic State Pension increases every year by whichever is the highest of earnings growth in wages in Great Britain, Consumer Prices Index price growth in the UK, or 2.5 per cent³⁰. Pension age benefits are increased under the rules of the triple lock, based on the highest of wages, September's Consumer Prices Index or 2.5%³¹. Protected payments increase in line with inflation, as measured by the Consumer Price Index³². These are examples of inflation-proofing in public and pension policy, and they show the principle that a fixed sum loses ground over time.

Against that, increasing cover costs more from the start and more each year, and the premium increase can be slightly higher than the rise in cover³. If your income is stretched, a level policy with a longer deferred period may buy more cover for the same money, at the cost of a benefit that does not grow. If your budget can absorb annual increases, increasing cover keeps the payout in touch with the cost of living.

Circumstance, not preference, tends to decide it: the length of claim you are protecting against, whether you have savings to bridge a longer deferred period, and whether the premium is guaranteed or reviewable. A reviewable premium that rises at each review, with cover falling if you do not accept the increase, behaves differently from a guaranteed one¹⁸.

Where payouts are reduced or stop

Income protection will not usually pay out if you lose your job, are made redundant or choose to stop working, because it is not unemployment cover¹⁵. It will not normally pay out if you are unemployed when you become unable to work, though if it does, it will be based on your ability to perform certain activities of daily living¹. You will not receive benefits for accidents or illnesses caused by drug or alcohol abuse, criminal acts, intentional self-harm, wars, or pregnancy unless your policy includes it¹.

The definition of incapacity in your policy decides whether a claim succeeds. The most common definitions mean you would not be able to work in your current occupation, work in any occupation you are trained for or have experience in, work in any occupation at all, or do various daily activities such as dressing, washing, eating, climbing stairs, shopping or cooking¹.

Payments stop when you recover and go back to work, when you start a new job that pays less or go back to the old one part time, when the policy term ends, or on death¹. A partial return is handled proportionately: if you are earning 60% of what you were making, 40% of your income protection benefit would be payable until your earnings reach the level they were at before¹. One policy pays a reduced amount proportionate to your reduced salary until you reach the end of your claim period¹⁶. Some policies pay a rehabilitation benefit if you can only go back to work in a reduced role with a reduced income, usually payable for up to six months after you return to work¹.

If you stop paying premiums, you lose your cover¹. If you stop paying your premiums your cover will stop, your policy will end, and you will receive no benefit²⁷. You cannot cash in or surrender an income protection policy, and it does not normally pay out on death¹. During a claim, where the insurer is paying money to you, the monthly premium does not have to be paid¹. A second claim for the same condition, or one directly related to it, within six months of an earlier claim ending is called a linked claim and does not involve an additional deferred period¹.

Your policy may only be valid while you are resident in the UK, EU or Western Europe, the USA or other developed countries¹. If a dispute arises, the Financial Ombudsman Service looks at the deferred period that applies to your policy when considering a complaint²³. Free, impartial help is available from MoneyHelper and from Citizens Advice, and debt advice charities can help if a claim leaves you short³³.