Equity-indexed life insurance policy: Asset class with upside potential, downside protection
For many physician investors, the present bull run in the U.S. stock market – the longest in its history – has led to long-term concerns about how the markets will fare in the next decade or two.
At the same time, bank account, CD and treasury yields are near all-time lows and government policy seems to dictate that interest rates will remain low for the foreseeable future. In this environment, many physicians may be looking to utilize an asset class in their portfolio that provides some upside potential, with downside protection.
This short article covers one 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, as it has a cash value/investment portion, as well as a death benefit. Cash value policies are also called “permanent” policies because they do not have a term after which they will expire (ie, term policies) and are intended to be kept in place until the insured dies.
There are several types of cash value life insurance, including variable and whole life, where the cash values grow based a variety of 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, the policy’s performance is tied to an index, such as the S&P 500, a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.
Through the collar strategy, the carrier guarantees the policyholder a floor, or minimum return (ie, 0%) that protects them from losses. With an EIUL, if the index the policy is tied to decreases 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 (i.e., capped at 10%).
Because of their upside potential, combined with downside protection, EIUL products have been extremely popular since the Great Recession, with more than $2 billion being invested into new EIUL policies in 2018 alone.
Benefits of an EIUL policy
In addition to the downside protection/upside potential, EIUL policies have the benefit of the cash value growing tax free and, if managed properly, accessed tax free. Also, in many states, the cash value is totally protected from lawsuits by statute.
Risks of an EIUL policy
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 8-12 years, during which, if one surrenders the policy completely, a surrender charge is assessed against the cash value. This charge 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 insured will not be able to adhere to the designed premium schedule. A policy’s size and costs are based on the premium schedule charted out when the policy is implemented (ie, $10,000 premiums each year for 10 years). A deviation from this premium schedule by the policyholder can result in a significant negative impact to policy performance.
Finally, 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 100-year plus track records is crucial.
Implementing an EIUL policy
As described in our book Wealth Planning for the Modern Physician, there are several essential success factors in properly utilizing permanent life policies, including EIUL. Here, we will focus on three – investing for a long-term time horizon, utilizing the proper policy design upfront and regularly reviewing policy performance.
Long-term time horizon. If an EIUL policy is designed to accumulate significant cash values for the policyowner’s retirement, it is important that the purchaser have a relatively long (15 years or more) time horizon. Of course, if the policy is designed for estate planning, this time horizon may be 30+ years, depending on the age of the insured.
One reason that a long-time horizon is important relates to expenses within the policy. In most EIUL policies, expenses are “front-loaded,” meaning they are relatively high in the early years and relatively low in later years. If a physician can treat an EIUL policy as a long-term investment and hold the policy 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 in the policy, there is another important reason to keep the policies in place for longer time periods – taxes. This especially true for physicians using such policies for future 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 the policy growth compounds over time. Like a Roth IRA, the simple math dictates that the longer one can enjoy tax-free growth and access, the better.
Proper design of the policy up front. Proper design of any life insurance policy involves good communication between the policy purchaser and his/her insurance agent. Most important is the agent understanding exactly why the client is purchasing the policy. Is it for death benefit proceeds to protect the family, or part of a retirement income strategy? Once the agent understands the objective for the policy, he/she can design it properly from the beginning.
For example, when the goal is cash value accumulation for retirement, the agent should be designing 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.
Regular reviews and maintenance. In this regard, permanent life insurance is like any other asset class in which one might invest – regular reviews of asset performance is mandatory. Just like a physician reviews his or her investment performance with an investment advisor quarterly or annually, so should they review their EIUL policy with their insurance agent.
It is in those reviews where one makes decisions on a myriad of options within the policy. Whether changing investments within the policy, paying more/less premium or changing premium frequency, adjusting the death benefit, adding or removing a beneficiary, or even exchanging the policy for a different type, regular reviews are where the agent and the policyowner bring issues to light and make decisions accordingly. Permanent life insurance is not a “set it and forget it” asset – few valuable assets are.
Bottom line: Work with a professional
An EIUL policy can be a valuable component of a physician’s overall portfolio, especially for those looking for downside protection with upside potential. Because these products are complex and contain inherent risks, working with a knowledgeable professional advisor to evaluate options is always recommended.
Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or by ebook download by texting HEALIO to 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
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David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group. You should seek professional tax and legal advice before implementing any strategy discussed herein. He can be reached at email@example.com or 877-656-4362.