Equity-indexed life insurance: An investment with protection
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With stock market volatility likely until the COVID-19 crisis ends, investors have become more risk averse. Bank account, certificate of deposit and treasury yields are near all-time lows.
In this environment, orthopedists may investment options that have some upside potential with downside protection. In the July 2020 issue of Orthopedics Today, we discussed one such option – structured notes. We now cover another option that, if implemented properly, can achieve this result: an equity-indexed universal life insurance policy.
Equity-indexed universal life policy
An equity-indexed universal life (EIUL) policy is a type of cash value life insurance policy. It has a cash value/investment portion, and a death benefit. Cash value policies are also called “permanent” policies because they do not have a term after which they expire (ie, “term” policies) and are intended to be kept in place until the insured dies.
Some types of cash value life insurance are variable and whole life, where the cash values grow based on various methods. With an EIUL policy, the cash values are used to implement a collar strategy.
In a collar strategy, the insurance carrier sells call options and buys protective put options on positions they own. In return, policy performance is tied to an index, such as the Standard & Poor’s 500 index, a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.
With the collar strategy, the carrier is able to guarantee the policyholder a floor, or minimum return (ie, 0%) that protects them from losses. With an EIUL policy, if the index the policy is tied to goes down 20%, the cash value will not go down. EIUL policy cash values also have a ceiling, or cap, on the upside (ie, 10%), which means that if the index goes up beyond the cap, the policyholder will get a portion of the total upswing (ie, capped at 10%).
Because of their upside potential, combined with downside protection, EIUL products have been popular, with more than $2 billion being invested into new EIUL policies in 2018 alone.
EIUL policy benefits, risks
In addition to downside protection/upside potential, EIUL policies have the benefit of the cash value growing tax free and, if managed properly, accessed tax free. In many states, the cash value is protected from lawsuits by statute.
Like any investment product, EIUL insurance has various risks. One such risk is that EIUL policies are not 100% liquid. In fact, policies generally have a surrender period of 8 to 12 years during which, if one surrenders the policy completely, a surrender charge is assessed against the cash value, which can be avoided if one withdraws some, but not all, of the cash value.
Another inherent risk with EIUL and other permanent life policies is the possibility the policyholder will be able to adhere to the premium schedule. A policy’s size and costs are based on the premium schedule outlined when the policy is implemented. Deviation from the premium schedule by the policyholder can result in a significant negative impact to policy performance.
Because an EIUL policy’s cash values are managed by the insurance carrier, carrier solvency risk is also important to acknowledge. This is why using top-rated companies with track records of 100 years or more is crucial.
Among the of crucial success factors in properly utilizing permanent life policies, including EIUL policies, we focus on three herein: investing for a long-term time horizon, utilizing the proper policy design upfront and regularly reviewing policy performance.
EIUL policy long-term success
If an EIUL policy is designed to accumulate significant cash values for the policyowner’s retirement, the purchaser should have a relatively long 15 years or more time horizon. If the policy is designed for estate planning, this time horizon may be 30 years or more, depending on the age of the insured.
One reason a long time horizon is important relates to expenses within the policy. In most EIUL policies, expenses are “front-loaded,” which means they are relatively high in the early years and relatively low in later years. If orthopedic surgeons can treat an EIUL policy as a long-term investment and hold it well beyond the surrender period, they have effectively amortized the upfront costs over time and will not be penalized if they surrender the policy going forward.
Beyond the upfront expenses, taxes are an important reason to keep the policies in place for longer time periods. This is especially true for orthopedic surgeons using such policies for retirement income because the tax benefits afforded by a policy (tax-free growth within the policy and tax-free access through basis withdrawals and policy loans) only gain more value as policy growth compounds over time. Like a Roth individual retirement account, the simple math dictates the longer one can enjoy tax-free growth and access, the better.
Proper design of policy up front
Proper design of a life insurance policy involves good communication between the policy purchaser and insurance agent. The agent should understand whether the client is purchasing the policy for death benefit proceeds to protect the family or part of a retirement income strategy. Once the agent understands the objective for the policy, the agent can design it properly.
For example, with a goal of cash value accumulation for retirement, the agent should design the policy to minimize death benefits for any level of premium, within tax rules, as lower death benefits mean lower cost of insurance charges. Also, the policy can be planned, within tax rules, to reduce death benefits over time and should be designed to do so from the outset.
Permanent life insurance is like any other asset. It requires regular reviews of asset performance. During regular review is when the insurance agent and policyholder make decisions on options within the policy.
Because these products are complex and have inherent risks, working with a knowledgeable professional advisor to assess options is suggested.
- References:
- Wealth Protection Planning for Orthopaedic Surgeons and the newly published Wealth Planning for the Modern Physician: Residency to Retirement are available free in print or by ebook download by texting OT20 to 47177 or at www.ojmbookstore.com. Enter code OT20 at checkout.
- www.investmentnews.com/indexed-universal-life-insurance-sales-continue-hot-streak-78621
- For more information:
- Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon at Northwestern Medicine in Warrenville, Illinois. He can be reached at email: sanjeevbhatia1@gmail.com.
- David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group www.ojmgroup.com. You should seek professional tax and legal advice before implementing any strategy discussed herein. He can be reached at mandell@ojmgroup.com or 877-656-4362.
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- Wealth Protection Planning for Orthopaedic Surgeons and the newly published Wealth Planning for the Modern Physician: Residency to Retirement are available free in print or by ebook download by texting OT20 to 47177 or at www.ojmbookstore.com. Enter code OT20 at checkout.
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