With stock market volatility likely to remain high until the COVID-19 crisis ends, many investors have become more risk averse. At the same time, bank account, certificate of deposit and treasury yields are near all-time lows. In this environment, many orthopedists may be looking for investment options that provide 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 Basics
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 on 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 Standard & Poor’s 500 index, a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.
Through 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 extremely popular since the Great Recession, with over $2 billion being invested into new EIUL policies in 2018 alone.
EIUL Policy Benefits, Risks
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.
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. 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 that the policyholder 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.
As described in our book Wealth Planning for the Modern Physician: Residency to Retirement, there are a number of crucial success factors in properly utilizing permanent life policies, including EIUL policies. Here, we focus on three of them: 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 policy owner’s retirement, it is important that the purchaser have a relatively long (15 years plus) time horizon. Of course, if the policy is designed for estate planning, this time horizon may be 30 plus 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,” which means they are relatively high in the early years and relatively low in later years. If an orthopedic surgeon 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, taxes are another important reason to keep the policies in place for longer time periods. This especially true for orthopedic surgeons 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 individual retirement account, the simple math dictates that the longer one can enjoy tax-free growth and access, the better.
Proper Design of Policy Up-Front
Proper design of any life insurance policy involves good communication between the policy purchaser and the 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, they 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, Maintenance
In this regard, permanent life insurance is like any other asset class in which one might invest — regular reviews of asset performance are mandatory. Just like an orthopedic surgeon reviews their investment performance with an investment advisor quarterly or annually, they should also 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 policy owner 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 the Right Advisor
An EIUL policy can be a valuable component of an orthopedist’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 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.
For more information:
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 firstname.lastname@example.org or 877-656-4362.
Disclosures: Bhatia and Mandell report no relevant financial disclosures.