Since the early 1990s, the UK has seen fairly steady rates of inflation with an average rate of 2.5 per cent since the introduction of inflation targeting and the rate has not gone higher than 3.3 per cent.
Times have changed since the inflation generation of the mid 1960s, when we saw prices increase by 750 per cent over a period of 25 years. At that time, there seemed to be no prospect at all of price stability.
What does all this mean and how does if affect the advice you give on longterm products such as protection and annuities?
Nowadays, with inflation at a steady low rate it does not give us anything to worry about and if we look at the figures from the consumer price index, we would have reason to believe that everything is getting cheaper and that we are all much better off than we might actually be.
The CPI seems to concentrate on material goods and consumables – cheap imports such as clothes and electricals – and less on the cost of fuel, transport, housing, taxes etc.
It does seem a bit at odds with the true cost of living. Take energy prices for example. Electricity costs are increasing at a rate of over 25 per cent a year and gas prices are even worse at 37.1 per cent, so the real rate of inflation for those who are hit hardest by increases in the cost of keeping warm – older people and those on a pension – is nearer 4 per cent. A professor at the University of Kent has calculated that inflation for the average middleclass family is around 10 per cent.
Inflation seems to be low now but it does not truly account for the cost of living. If you had £20 in 1975, based on the retail price index that £20 would be equivalent to around £115 today. RPI is generally used as an accurate measure of the rate of change of our standard of living, although it does not take things such as changes in quality of goods or the decreasing cost of technology into account.
For example, we might pay a fifth of the price for an electrical item today compared with, say 10 years ago, but that item might now have any expiry date built in. What cost five times as much previously might have lasted 10 times as long.
We cannot ignore the cost of property which has been the favourite topic of the nation for a number f years now. According to the Office of the Deputy Prime Minister, house price inflation has been positive in all regions of the UK for the first time since July, with an average over the past three months of 3.1 per cent. Again, when we look at house price inflation in terms of RPI, we need to acknowledge that there are many more one and two-bedroom properties being built now than in previous decades so although the prices are increasing, size and quality are not. To maintain a standard set in past generations will in all likelihood cost more than RPI would indicate.
We also need to take a look at the cumulative effect of inflation over a number of years, especially on long-term purchases such as life cover.
If you buy a life cover policy with a sum assured of £100,000, you want that policy to be worth the equivalent of £100,000 when it pays out – especially if that payout is near the end of the policy term, which could be over 20 years from the day you effect the policy.
If you were to take out £100,000 of cover today, the buying power of that money in 25 years time would be roughly the equivalent of £51,400.
If the aim of the policy is to help your family and dependants maintain their lifestyle, isn’t it important to make sure that the value is not eroded over time?
National average earnings increase faster than inflation – for every 1 per cent increase in earnings, the equivalent effect on inflation is compounded.
Many protection policies are taken out to protect a mortgage on a decreasing basis and the effect of inflation on the debt is the opposite to that of the cost of living. The higher inflation, the more value of the debt is eroded over time.
But there are much wider protection needs, as we can see from the extensive protection gap that exists in the UK today and it is important to recognise the need for future-proofing payouts to keep the protection gap from getting any wider.
For those policies that are not related to a mortgage, life, critical illness and income protection benefits all need to be protected against the effects of inflation over time to make sure that your family gets the greatest value for their benefit and the easiest way of doing this is to link the benefits to RPI. Even if you do advise your clients to index-link their benefits, it is still important to carry out regular reviews.
Our lives move quickly – we change jobs more often than previous generations and we have easier access to cash in the form of credit cards and loans, and medical science and technology is advancing at a rate of knots so it is only sensible to keep a weather eye on our own needs and the changing needs of our customers. It pays to build a relationship with your customers – for you and for them.
We see a similar debate for protection policies as there is over annuities – should people buy level or increasing? If you go for a level benefit and get £20 this week, you will get £20 every week for the rest of the term.
But if you want to have £40 a week in 20 years, can you afford to live on £10 just now? If you want more out of life later on, you might need to do without something today.
With life cover, if you plan to meet your needs should the worst happen today, you should plan still to meet the same needs if the worst happens tomorrow.