What Is Index Linking?

Index linking in life insurance (also known as inflation-linked life insurance) is a feature that helps your policy payout increase over time to keep up with inflation. This ensures that the money paid to your loved ones after your death doesn’t lose value due to rising living costs.

How Is It Calculated?

When you choose an index-linked life insurance policy, your sum assured (the payout amount) and your monthly premiums can increase yearly. The life insurance amount you would receive and the payments you make are linked to the inflation rate. There are usually two types of increases:

1. Inflation-Linked (RPI or CPI)

• Your cover increases with the Retail Price Index (RPI) or Consumer Price Index (CPI).
• This matches the average rise in the cost of goods and services.

2. Fixed Percentage Increase

• Your cover increases by a set amount each year, often 3%, 5%, or another fixed rate.
• Premiums increase slightly more than the cover amount (to account for the higher risk).

Example: Imagine you take out a life insurance policy with £100,000 cover and choose a 5% indexation option:

• Year 1: Cover is £100,000
• Year 2: Cover increases to £105,000
• Year 3: Cover rises to £110,250
• And so on…

But remember: your monthly premiums will also go up each year. You must check with your insurance provider about how they apply it. Each insurance company can take a different approach to how and when an increase is applied.

What Is an Indexed-Linked Policy?

An index-linked policy is an insurance or financial product where the benefits and/orpremiums increase yearlyin line with inflation or a fixed percentage. This type of policy is designed to protect the value of your cover over time as the cost of living rises.

How Does Index Linking a Policy Work?

Index linking works by automatically increasing the value of your insurance policy each year to keep up with inflationor rising living costs. This helps ensure your policy’s payout or income stays relevant and valuable.

When Can Index Linking Be Used?

Index linking is often available on:

• Life insurance
• Income protection insurance
• Critical illness cover
• Pensions and annuities

Benefits of Index Linking 

Here are the key benefits of choosing an index-linked life insurance policy:

1. Protects Your Policy from Inflation

Inflation causes the value of money to fall over time. What £100,000 can buy today may not be the same in 10 or 20 years. With index linking:

• Your sum assured (payout) increases each year.
• Your loved ones receive a payout that maintains its buying power, helping them manage future expenses like housing, education, or funeral costs.

2. Provides Long-Term Financial Security

Index linking is especially useful if you take out a long-term life insurance policy. It ensures that:

• Your family or beneficiaries are financially protected for years to come.
• Rising costs won’t reduce the impact or usefulness of the payout.

3. Ideal for Covering Growing Expenses

Many people use life insurance to cover:

• Mortgages
• Children’s education
• General living costs

These expenses often increase over time. Index linking helps your policy grow to keep up with those needs.

4. Automatic Adjustments – No Need to Review Annually

With an index-linked policy:

• Your cover adjusts automatically each year.
• There’s no need to increase the payout or reapply for a new policy manually.

5. Peace of Mind for You and Your Family

Knowing that your policy is designed to grow with the economy gives you:

• Confidence that your loved ones won’t be left short.
• A more innovative way to future-proof your financial planning.

Risks of Index Linking 

While index linking can be a valuable feature that helps your insurance policy keep up with inflation, it’s not always the right choice for everyone. There are some critical risks and drawbacks to be aware of, especially regarding life insurance, income protection, or critical illness cover.

1. Rising Premiums

The biggest risk of index linking is that your premiums (monthly or annual payments) will increase each year, often more than the inflation rate. For example:

• If your cover increases by 5% annually, your premium might rise by 6–8%.
• Over 10–20 years, this can become significantly more expensive, especially if you’re on a fixed income or tight budget.

Why this matters: Some people find they can no longer afford the policy and cancel it later on.

2. Overpaying for Cover You Might Not Need

If you only need insurance for a specific, fixed amount, like to cover a mortgage or funeral, index linking may not be necessary. Your payout might grow, but you could pay more than you need to. Example: You take out £100,000 of life cover to match your mortgage. If your cover grows to £130,000, you’re paying higher premiums for extra protection you don’t need.

3. Inflation May Be Low — But Premiums Still Rise

Even during years when inflation is very low, some insurers may:

• Still raise your premiums based on a minimum percentage, or
• Stick to a fixed increase (e.g. 5%) regardless of actual inflation.

This means you’re paying more even though the value added to your policy is small.

4. Complexity and Uncertainty

Index-linked policies can be more complicated to understand, especially:

• How much will your premium increase each year
• Whether there’s a cap or limit on increases
• What inflation index is being used (RPI vs CPI)

This can lead to confusion, especially if you’re not reviewing your policy regularly.

5. Potential for Future Policy Cancellation

As premiums rise over time, some policyholders may:

• Cancel the policy later because it’s become unaffordable
• Lose out on years of payments without receiving any benefit

This is especially risky if you cancel late in life when new insurance would be much more expensive or unavailable due to age or health.

Life Insurance vs. Index-linked Cover

Here is a quick view of some of the key features and differences between level life insurance and index-linked life insurance.

Feature	Level Life Insurance	Index-Linked Life Insurance
Payout Amount	Fixed for the term	Increases annually with inflation
Premiums	Fixed	Rise each year
Inflation protection	No	Yes
Best for	Covering fixed debts or short-term needs	Long-term protection and rising living costs
Cost over time	Consistent and predictable	Becomes more expensive over time
Ease of budgeting	Easy to plan for	It can be harder to budget due to rising costs

Benefits of Level Life Insurance 

• Fixed premiums make it easy to budget long-term.
• Simpler to understand and manage.
• Often more affordable in the short to medium term.
• Perfect for covering fixed liabilities like a repayment mortgage.

Benefits of Index-Linked Life Insurance

• Protects the value of your payout from inflation.
• Helps ensure your family’s financial support keeps up with the rising cost of living.
• Suitable for long-term financialprotection (e.g. 20+ years).
• Ideal for covering expenses that increase over time, such as childcare, education, or general living costs

Alternatives to Index-Linked Cover

When selecting life insurance, one key decision is whether to opt for index-linked cover or explore other alternatives. While index-linked cover offers the benefit of adjusting your payout and premiums in line with inflation, it may not always be the best option for everyone. Here are some of the best alternatives to index-linked life insurance, including their pros, cons, and when they might be more suitable for you.

1. Level Term Life Insurance

Level term life insurance is a popular and straightforward option. It offers a fixed payout amount and fixed premiums for the duration of the policy. Unlike index-linked cover, the payout remains the same throughout the policy’s life. Key Features:

• Fixed payout for the term of the policy.
• Predictable monthly premiums.
• Ideal for covering specific, fixed costs such as a mortgage or funeral.

Pros:

• Easy to budget – premiums remain constant.
• Lower premiums compared to index-linked policies.
• Simpler to understand and manage.

Cons:

• The payout may lose value over time due to inflation.
• Not ideal if you must protect your family against long-term cost increases.

2. Decreasing Term Life Insurance

Decreasing life insurance is typically used to cover a debt that decreases over time, like a mortgage. The amount of cover gradually reduces each year as your debt decreases, meaning the payout amount is lower towards the end of the policy term. Key Features:

• Sum assured decreases over time.
• Premiums are typically lower than level term insurance.
• Best suited for covering a mortgage or a loan that decreases in value.

Pros:

• Affordable premiums.
• Ideal for covering and reducing debts.
• No need to worry about inflation, as it covers debts that decrease in value.

Cons:

• No inflation protection, so the cover may not be sufficient for long-term needs.
• The payout reduces over time, which may not be enough to cover future expenses.

3. Whole of Life Insurance

Whole of life insurance provides lifetime cover, ensuring that your beneficiaries will receive a payout when you pass away, no matter when that happens. Unlike term insurance, this type of cover doesn’t expire. Key Features:

• Lifetime coverage with guaranteed payout.
• Premiums can be fixed or reviewed throughout the life of the policy.
• Ideal for providing an inheritance or covering long-term costs like inheritance tax.

Pros:

• Guaranteed payout at any age.
• No worry about outliving the policy.
• Useful for long-term planning, such as leaving an inheritance.

Cons:

• Premiums are typically higher than term policies.
• Does not automatically include inflation protection unless specifically added.

4. Critical Illness Cover with Inflation Protection

Critical illness cover pays a lump sum if you are diagnosed with a serious illness like cancer, stroke, or heart attack. Some critical illness policies include inflation protection, allowing the payout to rise with inflation. Key Features:

• Covers major illnesses that may prevent you from working.
• Inflation protection can be added to the policy.
• Can be combined with life insurance or taken as a standalone policy.

5. Flexible Life Insurance

Flexible life insurance policies allow you to adjust your coverage and premiums over time, making them ideal for those whose needs may change. You can increase or decrease your level of coverage based on major life events like marriage, homeownership, or starting a family.

Key Features:

• Flexibility to change the coverage as your life evolves.
• Fixed premiums, but the option to increase the cover.
• Ideal for growing families or changing financial responsibilities.

Frequently Asked Questions

Can I switch from index-linked cover to level term insurance later?

Yes, but if you do, you cannot put the index-linked option back on at a later date. You can also remove the index link at any time, but you will not have the option to put it back on.

Do all insurers offer index-linking?

All mainstream protection insurers offer index linking on their policies. We recommend that customers strongly consider applying this at the start of the policy because you can always remove it but never add it on.

What happens if I decline the annual increase?

If you decline the annual increase, insurers take different approaches. Some will allow you to decline once every three years, while others may remove the option forevermore.

How The Insurance Surgery Can Help

We understand that choosing life insurance can feel overwhelming. That’s why we take the time to explain your options and find the best policy for you. As an award-winning specialist broker, we compare whole and term life insurance options to find the best cover at the most competitive price. When the time comes for your family to make a claim, we’ll guide them through the process with care and expertise. Ready to find the right life insurance policy? Get in touch with our team today.