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Stepped Premiums


A stepped premium is the most common form of premium paid by those with income protection insurance policies.

With a stepped premium, your premiums will increase each year as you get older. The reason for this is that as you age, you are statistically more likely to succumb to some form of accident or injury, hence you pose more of a risk to the income protection company as you get older.

This increased risk with age can clearly be shown by the below graph, which shows the disability rates by age group and sex for Australians in 2009.

 

 Disability Rates Australia 2009

Above: Disability rates by age group and sex - 2009. Source: Australian Bureau of Statistics


How are Stepped Premiums determined?

An easy way to view stepped premiums is through the following equation:    

Stepped Premiums = Sum Insured X Age Risk Factor

As shown in the graph below, the cost of stepped premiums gradually increase with age, reflecting the risk posed by the insured as they grow older. This increase in stepped premium cost with age closely mirrors the increase in disability probability with age as shown in the graph above.

Stepped Premiums


Stepped premiums will generally be less expensive than level premiums in the short-term, but as they increase in cost as you age, they will end up being more expensive in the long-term.

Generally, the point at which stepped premiums become more expensive than level premiums is generally between the 7th to 10th year.

Stepped premiums are therefore more suitable for those who take out a short-term income protection policy.

Example – Stepped Vs Level Premiums

Mary, who is 31 years old and earns $60,000 per year, is considering taking out an income protection insurance policy to cover her up to the age of 65.

She is a non-smoker and works in a white collar occupation. She is applying for a policy with a waiting period of 30 days.

Mary is trying to weigh up whether she should pay level or stepped premiums given her situation.

If Mary were to choose a stepped premium policy, the monthly premium rate that she would have to pay corresponding to her age would be:

Age Next Birthday Monthly Premium Rate
32 $53
35 $57
38 $65
41 $76
44 $92
47 114


If Mary were to choose a level premium policy, she would be required to pay a monthly premium rate of $68 per month up until the age of 65, a consistent rate based upon her age at the date that the policy went in force.

Who are best suited to Stepped Premiums?

Stepped premiums are best for those who:

  • Require cover for the short-term. In income protection terms, the short term is generally considered as 7 years or less.

  • Are rapidly paying off their financial obligations and may not need the same level of cover in the future, or may have expected fluctuations in future personal income and may need the flexibility a stepped policy offers.

  • Are currently on a tight budget and cant’ afford level premiums

Benefits Comparison – Stepped Vs Level Premiums

In comparison to level premiums, stepped premiums offer the following advantages and disadvantages:

Advantages:

  • Premiums less expensive in the short-term – stepped premiums will generally be less expensive than level premiums in the short term.

Disadvantages:

  • More expensive in the long-term – as stepped premiums increase as you age, in the long-term they will eventually be more expensive than level premiums.

If you would like to compare quotes between stepped or level premiums, please call 1300 135 205 to speak with one of our friendly advisors.