Opting for index-linking may not be the right move

How much life assurance cover does someone with a young family need to buy?

Old rules of thumb of anything from five to 15 times' annual salary vary so widely they are of little help. And then there's the problem of not knowing exactly how much a lump sum of, say, €350,000 will be worth in 20 years' time.

This second problem can be solved by selecting the indexation option. This means that the value of the cover should keep pace with the cost of living and have roughly the same purchasing power as when you first bought the policy.

But there's a catch. Insurers will write to customers to ask them if they want to increase the value of their cover, usually on an annual basis, in exchange for a higher premium.

Some insurers take this opportunity to perform a sleight of hand: although most increase the value of the potential benefits by 5 per cent per annum, some bump up the corresponding premiums by as much as 8 per cent.

This means that people on the hunt for cheap policies who want to inflation-proof their cover may not always be getting the best value policy by selecting the one with the lowest initial premiums, according to John Geraghty, managing director of LABrokers.ie.

Of the companies that sell their products through brokers, Caledonian Life, New Ireland and Friends First all play it even by increasing their premiums at a rate of 5 per cent. But Eagle Star increases its premiums at a rate of 7.5 per cent and Hibernian and Irish Life increase theirs by 8 per cent. Canada Life does not disclose its rate of increase.

The table opposite shows that Eagle Star quotes the lowest premium for a non-smoking male aged 45 looking for €350,000 cover over 20 years with the option to increase his cover by 5 per cent per annum.

But over the full 20-year term, Caledonian Life's lower premium increases means it overtakes both Eagle Star and Hibernian in terms of value. Caledonian Life emerges as €2,889 cheaper than Friends First and €3,786 cheaper than Eagle Star. With its 5 per cent premium increase rate, New Ireland also overtakes Hibernian and Irish Life in terms of cost.

The figures, which exclude Ark Life, Quinn Life and Tesco, which do not do business through brokers, also highlights the savings that can be made by shopping around. Caledonian Life is a massive €16,993 or 30 per cent cheaper than the most expensive insurer, Irish Life.

Indexation only makes sense for level term life assurance policies, not "decreasing term" mortgage protection policies, where the benefits will be assigned to clearing the outstanding loan and there will be no need to keep pace with inflation.

But even on level term life assurance policies, consumers may be better off avoiding the indexation option, says Mr Geraghty.

"When you select the indexation option, you pay a higher premium than someone who says they don't want it, whether you use the option or not," he says.

Mr Geraghty says people working in the industry are now effectively index-linking their own policies themselves by buying more cover than they need.

"They might only need cover for about €200,000 in today's money, but they will buy cover for €260,000 instead. I think if it's good enough for the industry, it's good enough for the consumer."