When you take out life, TPD, trauma or income protection insurance, one of the first choices you face is how your premiums are structured. Most people choose whichever is cheapest today, and for many that is a stepped premium. That can be the right choice. But for someone planning to hold cover for 15 or 20 years, it can also be the more expensive one by a wide margin.
The difference between stepped and level premiums is simple in principle. In practice, the right choice depends on how long you will keep the cover, whether you expect to reduce it over time, your cash flow now, and how premiums can change even when they are described as level.
This guide explains how each structure works, when level premiums become cheaper, the catches that are easy to miss, and how to decide which suits you.
Stepped vs level premiums at a glance
| Stepped premiums | Level premiums | |
|---|---|---|
| How the premium is set | Recalculated each year based on your current age | Based on your age when the policy starts |
| Cost in the early years | Lower | Higher |
| Cost as you age | Rises each year, steeply from middle age | Does not rise because of age, though it can still increase for other reasons |
| Total cost over a long period | Usually higher | Usually lower if held long enough |
| Effect of reducing or cancelling cover early | Little cost, as you have only paid for cover used | The higher early premiums are effectively lost |
| Typically suits | Short-term needs, tight cash flow, cover expected to reduce | Long-term needs, stable cash flow, cover expected to stay similar |
How stepped premiums work
With a stepped premium, the insurer recalculates your premium at each policy anniversary based on your age at that time. Because the risk of death, disability and serious illness rises with age, so does the premium.
In your 20s and 30s, the annual increases are usually modest. From your 40s onwards, they become much steeper. By your 50s and 60s, a stepped premium can be several times what it was when the policy started, for the same amount of cover.
Stepped premiums are the default for most insurance held inside super and for many retail policies, because they make cover affordable when people first need it.
How level premiums work
With a level premium, your premium is based on your age when the policy starts. It does not increase each year because you are getting older. You pay more than a stepped premium in the early years, and less in the later years.
In effect, you are paying in advance for cover in your later years, when stepped premiums would be much higher.
Many level premium policies only stay level until a set age, often 65, after which the premium switches to a stepped basis. Check the policy terms to see when that happens.
Level does not mean fixed
This is the most common misunderstanding. A level premium does not increase because of your age, but it can still increase for other reasons:
- Indexation. Most policies increase your sum insured each year in line with inflation, and the premium rises in proportion. You can usually decline indexation, but your cover will then lose value in real terms.
- Insurer repricing. Insurers can increase premium rates for everyone holding a particular product, including level premium policyholders. The insurer cannot single you out because of a claim or a change in your health, but it can reprice the whole group.
- Policy fees and stamp duty. These may change over time.
- Increases in cover. If you increase your sum insured, the extra cover is usually priced at your age at the time of the increase.
Over the past decade, some insurers have repriced level premium products significantly, particularly for income protection. That does not make level premiums a bad choice, but it does mean the long-term saving is an estimate, not a guarantee.
When do level premiums become cheaper?
There are two crossover points worth knowing:
- The annual crossover, when the stepped premium for the year becomes higher than the level premium. This often happens within the first several years.
- The cumulative crossover, when the total you have paid under stepped premiums overtakes the total under level premiums. This is the point at which level premiums have actually saved you money. It usually comes later, often somewhere around the 10 to 15 year mark, but it varies widely depending on your age, the type of cover and the insurer.
A hypothetical illustration
Suppose a policy has a first-year stepped premium of $1,000, rising 8% a year with age, and a level premium of $1,600 a year. These are simplified, hypothetical figures, not quotes from any insurer, and they ignore indexation and repricing.
| Years held | Total paid: stepped | Total paid: level |
|---|---|---|
| 5 years | $5,870 | $8,000 |
| 10 years | $14,490 | $16,000 |
| 15 years | $27,150 | $24,000 |
| 20 years | $45,760 | $32,000 |
| 30 years | $113,280 | $48,000 |
In this example, the stepped premium overtakes the level premium in the seventh year, and the total cost of stepped premiums overtakes the total cost of level premiums in about the thirteenth year. If the policy is held for 30 years, stepped premiums cost more than twice as much in total. If it is cancelled after five years, level premiums cost about 36% more.
The lesson is that the choice depends heavily on how long you will actually keep the cover.
The catch: most people change their cover
Level premiums only deliver their full benefit if you keep similar cover for many years. In practice, many people reduce or cancel cover well before the cumulative crossover point, because:
- the mortgage is paid down and less life cover is needed,
- children become financially independent,
- super and investments grow to the point where they are effectively self-insured,
- premiums become unaffordable during a period of reduced income, or
- they change jobs, switch funds or move cover.
If you reduce cover on a level premium policy, the higher premiums you have already paid for that portion are not refunded. Our guides on tailoring your cover as you get older and deciding when you are self-insured explain how cover needs typically change.
Switching between stepped and level
Most insurers allow you to switch from level to stepped premiums. Switching from stepped to level is usually possible too, but the level premium is generally based on your age at the time you switch, so you lose the benefit of having locked in a younger age.
Replacing a policy entirely to change premium structures is a different matter. A new policy usually requires new underwriting, and any health changes since you took out the original cover could lead to exclusions, loadings or a refusal. Our guide to exclusions and medical loadings explains how that works, and our guide to your duty to take reasonable care covers your disclosure obligations when applying. Never cancel existing cover until replacement cover is confirmed.
Insurance inside super
Default insurance inside super is almost always stepped, or priced in age-based bands that work in a similar way. Premiums are deducted from your super balance, which can make rising premiums less noticeable, but they still reduce your retirement savings, and the effect compounds over time.
Some retail super products offer level premiums. Holding cover in super can also help cash flow, since premiums come from your balance rather than your take-home pay. Our guide to life insurance inside or outside super compares the two approaches.
Income protection
The stepped versus level choice applies to income protection too. Income protection premiums held outside super are generally tax deductible, which reduces the after-tax cost of both structures.
Income protection premiums are also affected by other choices, such as the waiting period and benefit period, and by your occupation. These can have as much effect on cost as the premium structure. Our guides on waiting periods and benefit periods and occupation classes explain how.
Which is right for you?
Stepped premiums may suit you if:
- you need cover for a limited period, such as until the mortgage is paid off,
- you expect to reduce your cover significantly within 10 years,
- cash flow is tight now and keeping adequate cover matters more than long-term cost, or
- you are older when taking out the policy, so the long-term saving from level premiums is smaller.
Level premiums may suit you if:
- you are younger and expect to need similar cover for 15 years or more,
- you have stable income and can comfortably afford the higher premium now,
- you have long-term needs, such as a young family or business obligations, or
- you want to reduce the risk of premiums becoming unaffordable later in life.
Some people use a combination, holding part of their cover on level premiums for long-term needs and part on stepped premiums for shorter-term needs such as the mortgage.
For younger people, the choice is often between affordable stepped cover now and paying more for long-term savings. Our guide on whether life insurance is worth it for young people covers that trade-off. Professionals with high incomes and long careers, such as doctors, often find level premiums worthwhile because their cover needs tend to stay high for longer.
Other ways to manage premium costs
The premium structure is only one lever. Others include choosing the right amount of cover rather than too much or too little, selecting appropriate waiting periods for income protection, reviewing cover as your circumstances change, and understanding how health and lifestyle factors such as smoking affect premiums. Our guides on finding the right level of cover and how lifestyle choices affect premiums cover these in more detail.
Choosing the cheapest premium today without considering the long-term cost is one of the common life insurance mistakes we see.
Where professional advice adds value
The stepped versus level decision looks simple, but the right answer depends on how long you will need cover, how your needs will change, your cash flow, whether cover is held inside or outside super, and the specific terms of the policies available to you. Comparing the true long-term cost of different options, including indexation and the risk of repricing, is difficult without access to insurer quotes and modelling.
A life insurance adviser can project the cost of each structure over your expected timeframe, compare policies across insurers, and structure cover so it remains affordable as your needs change. An adviser can also review existing cover before you switch structures or replace a policy, to make sure you do not lose valuable terms or face new exclusions.
If you would like help choosing the right premium structure, or reviewing your existing cover, our life insurance advisers in Adelaide can help.
Frequently asked questions
What is the difference between stepped and level premiums?
A stepped premium is recalculated each year based on your current age, so it starts lower and rises as you get older. A level premium is based on your age when the policy starts, so it starts higher but does not increase because of age. Over a long period, level premiums usually cost less in total.
Do level premiums ever increase?
Yes. Level premiums do not increase because of your age, but they can increase because of indexation of your sum insured, insurer repricing that applies to all policyholders, changes in policy fees, or increases in your cover. Level does not mean fixed.
When do level premiums become cheaper than stepped premiums?
The annual stepped premium often overtakes the level premium within the first several years. The total cost of stepped premiums usually overtakes the total cost of level premiums later, often somewhere around 10 to 15 years, depending on your age, the type of cover and the insurer.
Can I switch from stepped to level premiums?
Often, yes, but the level premium is generally based on your age when you switch, not when the policy started. Switching from level to stepped is usually straightforward. Replacing a policy entirely requires new underwriting, so do not cancel existing cover until replacement cover is confirmed.
Is insurance inside super stepped or level?
Default insurance inside super is almost always stepped, or priced in age-based bands that rise as you get older. Some retail super products offer level premiums. Premiums inside super are deducted from your balance, which reduces your retirement savings over time.
Should young people choose stepped or level premiums?
Younger people gain the most from level premiums if they expect to keep similar cover for many years, because they lock in a low starting age. However, if cash flow is tight or cover is likely to be reduced within a decade, stepped premiums may be more practical.
What happens to level premiums at age 65?
Many level premium policies only stay level until a set age, often 65, after which premiums switch to a stepped basis and start rising with age. Check your policy terms to see when this applies.
General advice warning. This article contains general information only and does not take into account your objectives, financial situation or needs. It is not a recommendation to acquire, vary or cancel any insurance product. Premium figures in this article are hypothetical illustrations, not insurer quotes. Premium structures, indexation and repricing terms vary between insurers and products. You should read the relevant product disclosure statement and target market determination, consider whether the information is appropriate for you, and seek personal advice before acting on any of it. Money Path Pty Ltd is a Corporate Authorised Representative (No. 001306822) of Australia National Investment Group, AFSL 522028.
