Over time the pricing of goods and services in an economy will generally increase, this is known as inflation. Inflation is important because as it occurs it erodes the specific value of money and thus causes a drop in purchasing power per unit of currency.
For example if the rate of inflation in any one year is 5% it takes 5% more money at the end of the year to buy the same goods as it did at the start of the year. So if 25 Kg of potatoes were to cost $20 on the 1st of January and the rate of inflation was applied to them, by December 31st they would cost $21.
In the United States the general measure of inflation is the Consumer Price Index which tracks a basket of products and measures the average price increases over time to determine a general level of inflation. Inflation for individual items within the basket may be higher or lower than the index rate.
What is inflation protection?
Inflation protection is a clause in an insurance policy that protects the policy holder from the specific effects of inflation. This means that the insurer agrees to continue paying benefits specified under the policy but to increase them in line with general inflation.
From a policy holders perspective this means they can reasonably expect the benefits paid under a given policy to match the actual payments required of them over time.
Why is inflation protection important?
Inflation protection is particularly important to a policy holder when they can reasonably expect some of the risks covered by the policy to result in long-term benefit payment.
For example in the case of health insurance or disability insurance, the risk covered by result in an open-ended or permanent treatment regime. If care were to continue over an extended period of years inflation would gradually erode the benefit and the policy holder would be forced to make up the difference from their own pocket – which in the case of long-term disability or sickness might eventually become impracticable or even impossible for the policy holder.
For this reason though the policy holder may need to pay a higher premium for inflation protection in their insurance contract, they may consider it wise to do so because in the event of a claim they will want to ensure their standard of care is not compromised in the long-term.