An Indexed Life Insurance policy is a type of life insurance policy that has a face value varying according to a prescribed index of prices, which can be ascertained using indices such as the Consumer Price Index (CPI). While similar to ordinary whole life insurance in many respects, indexed life insurance adjusts the policy’s death benefit based on the movements of the selected index.
Key Features of Indexed Life Insurance
Face Value Variation
The defining feature of an Indexed Life Insurance policy is that its face value adjusts according to changes in an index. For instance, if the Consumer Price Index (CPI) is chosen, the face value of the policy will rise with increases in the CPI, thus potentially providing protection against inflation.
Death Benefit
Despite the variable face value, the core death benefit mechanisms are analogous to those found in traditional whole life insurance. This means that upon the policyholder’s death, beneficiaries will receive a payout equal to the policy’s current face value, adjusted according to the selected index.
Automatic or Elective Indexing
Policyholders typically have the option to choose how the indexing will be applied:
- Automatic Basis: The face value adjusts automatically with the movements of the chosen index.
- Elective Basis: The policy owner can decide when and how much of an adjustment to make, providing some control over the policy’s value adjustments.
Comparison to Other Life Insurance Policies
Whole Life Insurance
Whole life insurance offers a fixed death benefit and a cash value component that grows at a guaranteed rate. In contrast, indexed life insurance provides a variable death benefit tied to an index, potentially offering better inflation protection.
Universal Life Insurance
Universal Life Insurance policies offer flexible premiums and adjustable death benefits. Indexed Universal Life Insurance (IUL) blends the features of Universal Life with an indexed component, often linking the cash value growth to an equity index such as the S&P 500.
Historical Context and Applicability
Indexed life insurance emerged as a response to the need for insurance policies that provide better inflation protection. By linking the policy’s value to an index like the CPI, these policies cater to individuals looking to maintain their purchasing power over time.
Examples
Example 1: CPI-Based Policy
Suppose a policyholder purchases an indexed life insurance policy with an initial face value of $100,000, linked to the CPI. If the CPI increases by 3% over a year, the new face value of the policy will be:
Example 2: Elective Index Application
A policyholder has a policy tied to the employment cost index (ECI). They may choose to adjust the face value at intervals other than those automatically prescribed, potentially aligning more closely with personal financial planning needs.
FAQs
What indices can be used for indexed life insurance?
Is indexed life insurance more expensive than ordinary whole life insurance?
Can I switch the index once the policy is active?
Summary
Indexed Life Insurance policies provide a substantial advantage through their inflation-protected face value, proving to be a valuable tool for individuals seeking long-term financial security. Unlike ordinary whole life insurance, they safeguard the policy’s real value against the erosion of purchasing power caused by inflation.
References:
- Insurance Information Institute, “Understanding Indexed Life Insurance,” [Link]
- Investopedia, “Consumer Price Index (CPI) and Insurance,” [Link]
