Level vs Stepped Premiums: Do Level Premiums Actually Pay Off?

Sometime ago I got a quote from a tradie for some work - around five times what everyone else had quoted. I asked a friend why, and they said: "that's an 'I don't want to do this job' quote."

That sprang to mind recently when a client asked about a level premium policy. So in my role supporting Keep's clients, I pulled 20 years of premium projections from seven insurers to find out whether level premiums actually deliver what they promise.

The short answer: it depends heavily on which cover you're buying, and for death cover at age 45 the case is weak.

Premium structures

What Level and Stepped Premiums Actually Mean

A stepped premium is recalculated every year based on your age at that renewal. Because the chance of a claim rises as you get older, so does the premium. It starts cheap and climbs, gently at first and steeply from your fifties onward.

A level premium is calculated once, at your age when the policy starts, and holds that rate until a set age - usually 65, sometimes 70 - at which point it converts to stepped. You pay substantially more in the early years and substantially less in the later ones.

Useful way to think about it: a level premium is a stepped premium plus a forced savings component. In the early years the extra is effectively saved. In the later years, once the stepped premium overtakes level, those savings are drawn down to cover the gap. The whole question is whether that's a good trade - and it is a question about what life insurance costs over time, not just today.

Methodology

What We Modelled

We pulled 20-year premium projections for death cover from a starting age of 45, comparing the stepped and level structures offered by the same insurer on the same product. Age 45 is a useful test case because most level premiums convert to stepped at 65 - so a 20-year projection covers the entire level period, start to finish.

Seven insurers were quoted. Four - MetLife, NEOS, OnePath and Zurich - returned level premium projections for death cover and are shown below. TAL, AIA and Encompass did not, which is part of the story in itself: several insurers have narrowed or withdrawn their level premium offerings in recent years.

Core finding

Are Level Premiums Cheaper Over the Long Term?

Eventually - but for death cover starting at 45, it takes almost the entire term to get there.

Three Things Stand Out

The year one gap is large. The level premium at 45 costs five to six and a half times the first-year stepped premium. That's the money going out the door up front.

It takes 12 to 13 years for the annual stepped premium to overtake level. Only from that point does level start giving anything back.

It takes 18 to 20 years - 19 on average - for total costs to break even. That's one year short of the point at which the level premium converts to stepped anyway.

Cover type comparison

Does This Hold for TPD, Trauma and Income Protection?

No - and this is the most important qualification in the post. Death cover is the least favourable case for level premiums. Run the same comparison at the same starting age across the other cover types and the picture changes materially.

Level premiums are available on income protection - five of the seven insurers quoted offered them - and the upfront gap there is the smallest of any cover type, at roughly one and a half to two and a half times the stepped premium rather than five to six. TPD and trauma sit in between, with breakeven arriving four to six years earlier than death cover.

So "is level worth it?" isn't one question. It is a different question for each cover in your income protection and TPD arrangements, and it is entirely reasonable to answer it differently for each.

Trade-offs

What You Give Up to Get There

Even a marginal cost outcome might be worth it for budgeting certainty. But that certainty comes with conditions.

• Leaving early is expensive. The extra premium paid in the early years is not refundable. On the death cover figures above, the amount pre-paid peaks at between 5.7 and 6.6 times a single year's premium, at around year 11 or 12 - which is roughly the point at which level finally starts looking like the cheaper option. Cancel before then and you have paid for cover you will never receive. If you're looking at Level Premiums, make sure you expect to hold the policy for long enough to not lose the savings.
• Switching gets harder, not just costlier. That forfeiture makes clients materially less likely to move insurer - assuming moving is even available, which it may not be if their health has changed since underwriting. This optionality (being able to switch) has real value - it is worth giving up for more regular premiums?
• Fewer product options. Some features may not be available on level premiums. Premium pause is a common example. If any of the options impacted are important, or could become important, you will need to weigh up the pro's and con's.
• There is a price shock waiting at 65. In the projections above, the year 20 stepped premium lands at 3.4 to 4.6 times the level premium the client had been paying. That arrives at a point when many people are reducing cover or income, not increasing either.

Cost drivers

What Determines the Cost of a Level Premium

Level premiums are priced on the same underwriting factors as stepped - age, sum insured, gender, smoking status, occupation, health history and any loadings or exclusions. Two things matter more for level than for stepped:

• Your age when the policy starts sets the rate for the entire level period. Starting at 35 rather than 45 doesn't just lower the premium, it lengthens the runway over which the structure can pay off. This is why the case for level is stronger at younger ages.
• The conversion age. A policy that holds level to 70 gives you five more years of benefit than one converting at 65.

Indexation matters too. If you index your sum insured, the level premium is no longer flat - it rises with the cover amount. The figures in this post assume no indexation.

Switching

Can You Switch Between Stepped and Level Later?

Often, yes - many insurers allow a change of premium structure on an existing policy without new underwriting. The catch is that the level premium is calculated at your age at the time of the change, not your original age. Waiting five years to switch to level means paying a 50-year-old's level rate, not a 45-year-old's.

Going the other way - level back to stepped - is usually simpler, but the extra you have already paid is gone. It does not convert into a reduced future premium.

Switching to a different insurer is a separate matter entirely and requires fresh underwriting. If your health has changed since you first applied, that option may be limited or unavailable.

Practical alternatives

If Rising Stepped Premiums Are the Problem

Level is one answer to premium creep, but it isn't the only one, and it is the least reversible. Worth considering first:

1. 01

   Review the sum insured

   Cover set against a mortgage 12 years ago is often larger than the remaining need. Reducing cover reduces premium immediately and permanently.

2. 02

   Check what's bundled

   Riders and optional benefits added at application are frequently still being paid for long after they stopped being relevant.

3. 03

   Compare across insurers

   Stepped rates at the same age vary considerably between insurers, as the year one column above shows - $463 to $583 for the same cover.

4. 04

   Consider structure and ownership

   How cover is held can affect the cost and the tax treatment of premiums.

5. 05

   Look out for cashback opportunities

   Transfer to a broker that offers premium cashbacks. Just by transferring the policy, with no changes to the cover, terms or premiums, you could save over 10% of each and every premium

Level still has a genuine place: where cover starts at a younger age, where the need is fixed and long-dated, where budget certainty outranks total cost, or where your health means switching later is unlikely to be available at any price and so the flexibility being given up has little practical value. Those situations are real. They are also narrower than the way level premiums are often presented.

Final thoughts

Final Thoughts

Level premiums are sold on a simple promise: pay more now, pay less later, know where you stand. For death cover starting at 45, the "pay less later" part arrives so close to the end of the level period that most clients will never see it, and leaving before then is costly. For TPD, trauma and income protection the case is meaningfully stronger, and worth running the numbers on rather than assuming either way.

The better question isn't "stepped or level?" It's "what am I paying for the certainty, and how long do I have to stay in order for it to make financial sense?"

One closing thought on the insurer side of this. The extra premium collected early on a level policy is meant to fund cover in later years - so when a policy lapses before those years arrive, the insurer keeps money set aside for a claim it will now never pay. Level policies do lapse less often than stepped ones, partly because of the forfeiture described above, but the amount at stake per lapse is large. Combine that with a year one price five to six times the stepped alternative, and for death cover at least it's hard to read as anything other than the tradie scenario: a price set for a job the insurer would rather not do.

If you want the background on how retail life cover works in Australia, we've covered that separately.

Assumptions

Assumptions and Caveats

The following specific factors could change the result for you:

• Starting age drives almost everything. This modelling starts at 45. At younger starting ages the year one gap is smaller and the level period longer, both of which move breakeven earlier.
• These are quoted standard rates. A pre-existing condition, a loading or a non-standard occupation will change your pricing, and may change it differently for each structure.
• First-year and ongoing discounts are not modelled. Several insurers apply a first-year discount that reduces the year one premium but not later years. Because insurers discount level and stepped differently, a discount applied to one structure and not the other can move the breakeven year by more than a year in either direction.
• No indexation is applied. The sum insured is held flat throughout.
• Projections are not guarantees. Insurers can and do reprice level premium books. Projected future premiums are estimates, not contractual commitments.
• The effective interest assumption is illustrative. The 3% and 5% figures show the sensitivity of the breakeven point. They are not a forecast, and are effectirvely after tax and fees.
• Insurer coverage varies by cover type. Seven insurers were quoted, but not all returned a complete stepped and level pair for every cover. Counts are shown in the comparison table.

If your situation is complex, or the sums insured are large, speak to a licensed financial adviser before making a change.