You will be able to explain how stepped and level premiums handle the rising cost of risk over time.
Jun Hao is 34, an engineer with a wife, Mei, and a two-year-old daughter, Elise. Every year his insurer sends a renewal notice for his hospital plan, and every few years the number on it goes up. His whole life policy, bought at 26, has charged S$2,400 a year since the day he signed. Over lunch he asked a colleague why one premium climbs while the other never moves. Neither knew.
The answer is the same for every policy you will meet in this course. The cost of cover rises as you age, and each policy chooses how to pass that rising cost on to you.
Think back to lesson 1.1, Every premium pays for risk, costs and sometimes savings. The risk part of a premium is the insurer's estimate of what it will pay out on people like you this year. At 30, few people in a large pool die or fall seriously ill in any one year, so the risk part is small. At 50 the share is higher, and by 70 it's much higher. Insurers build their prices from tables of how often claims happen at each age, and those tables only slope one way.
Suppose a policy charged you exactly the cost of your risk each year. Your premium would rise every birthday: slowly in your thirties, faster in your fifties and steeply after 60, which is the honest price of cover. What differs between products is how it is billed.
A stepped premium is one that is recalculated as you age, usually at set age bands such as every five years. You pay close to the true cost of your risk at each stage. It starts low and climbs.
Jun Hao's hospital plan and its rider work this way. So do many other riders, and many one-year renewable covers such as some group and personal accident plans. His renewal notice is the plan moving him into a new band, and the insurer can also revise the premium table for everyone in the plan, which is a separate kind of increase.
Stepped pricing is fair in a narrow sense: you never pay for risk you don't yet carry. The catch is timing. The premiums are lowest when your income is still growing and highest when you may have stopped working. A stepped premium that feels small at 34 can be a real cash bill at 70, and nothing on today's renewal notice warns you. Lesson 4.4, Premiums at 30, 50 and 70: can you keep paying, works through what that does to a retirement budget.
A level premium stays the same for the whole premium term. The insurer works out the total cost of your cover over the term, adds its costs, and spreads the result evenly.
That means you pay more than your risk costs in the early years and less than it costs in the later years. The early surplus is held as a reserve, and that reserve carries the policy through the expensive years. In effect you are prepaying, in your thirties, for cover your older self will use.
Jun Hao's whole life policy is level, and so are most term policies with a fixed term, such as cover to age 65. Two consequences follow, and both show up later in this course.
First, a level-premium policy dropped after a few years has used your early surplus on costs and reserve, which is part of why early surrender values are low. Lesson 7.2, Why replacing a policy usually costs you, puts a number on that.
Second, a level premium is not automatically cheaper or dearer than a stepped one. Over a long life the totals can be close. What changes is when you pay. Level premiums move cost forward into your working years. Stepped premiums push it out to later life.
The policy documents usually say which kind a premium is, although not always in those words. Look for these signs:
a premium table by age, or a note that premiums "are not guaranteed and may be revised", which points to stepped pricing or reviewable rates one fixed premium shown for every year of the premium term, which points to level pricing a premium term shorter than the cover term, for example premiums for 20 years and cover for life, which is level pricing compressed into fewer years riders listed with their own premium, which often follow different rules from the main policy
Watch for one trap. "Guaranteed level premium" and "level premium" are not the same thing. Some level premiums can still be revised for a whole class of policyholders if the insurer's claims experience worsens, and only the contract tells you which kind you have.
Jun Hao drew a rough picture on a sheet of paper. One line for his whole life premium, flat at S$2,400 until it stops. One line for his hospital plan and rider, low today and climbing in steps. His group cover from work had no line at all, because he pays nothing for it and it ends when he leaves.
The flat line was easy to budget. The stepped line was the one he had never thought about. It was small enough today that he had never looked at the premium table, and he did not know what it would be at 60 or 75.
That's the habit this lesson asks you to build. For each premium, ask whether it will stay where it is, and if not, what it will be when you are old. Exact figures can wait: a label against each policy is enough to start, and module 4 fills in the numbers for your hospital cover.
For each policy you hold, write whether the premium is level or stepped and what happens to it as you age.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).