This article reviews equity-indexed life insurance policies and structured notes, instruments that offer investment protection and growth potential.
Even in good times many investors would be interested in assets that protect their principal when the market is down but still offer the opportunity for wealth creation. The volatility of the past few years—the rapid pullback in 2020, significantly bull market in 2021, and slow slide in 2022—has only increased this interest. This article reviews equity-indexed life insurance policies and structured notes, instruments that offer investment protection and growth potential.
Equity-Indexed Universal Life Policies
An equity-indexed universal life (EIUL) policy is a type of cash value life insurance. It has a cash value/investment component as well as a death benefit. Cash value policies are also called permanent policies because, unlike term policies, they don’t expire but instead are intended to be kept until the insured dies.
There are several types of cash value insurance, including variable and whole life, in which 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 S&P 500, the market capitalization-weighted index of the 500 largest publicly traded companies in the US.
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, if the index the policy is tied to drops 20%, the cash value does not go down. EIUL policy cash values also have a ceiling or cap, which means that if the index rises beyond the cap, the policyholder will get only a portion of the upswing (ie, capped at 10%).
Because of their combined upside and downside protection, these products have been extremely popular since the Great Recession, with over $2 billion being invested in new EIUL policies in 2018 alone.1
In addition, they offer the benefit of a tax-free increase in cash value that, if managed properly, can also be accessed tax-free. And in many states, the cash value is statutorily protected from lawsuits.
Like any investment product, EIUL insurance is subject to certain risks. One is that it is not 100% liquid; in fact, these policies generally have a surrender period of 8 to 12 years, during which, if the policy is completely surrendered, a charge is assessed against its cash value. But this charge may be avoided if only some, not all, of the cash value is withdrawn.
Another risk inherent in EIUL and other permanent life policies is the possibility that the insured will not be able to adhere to the premium schedule. A policy’s size and costs are based on the premium schedule created when the policy is implemented (ie, $10,000 per year for 10 years). Any deviation from this schedule can result in a significantly negative impact on policy performance.
Finally, because the policy’s cash value is managed by the insurance carrier, carrier solvency risk is also a factor, which is why using top-rated companies is crucial.
Structured notes are “hybrid” securities that combine the features of different financial products. Issued by some of the largest banks in the world, these notes combine bonds and other investments to offer the features of equity and debt assets. According to published studies, $2 trillion is currently invested in structured notes worldwide.
Structured notes are not direct investments. They are derivatives, as their value is derived from another, linked asset. The return on the note depends upon the issuer repaying the underlying bond and paying a premium based on the linked asset, minus the bank’s fee. They can mature as early as 6 months but typically range between 3 and 5 years.
Structured Note Risks
There are several risks inherent in a structured note investment, including:
Conclusion: Work with an Experienced Advisor
Both EIUL policies and structured notes can be valuable components of a dermatologist’s overall portfolio, especially for investors looking for principal protection without forgoing the potential for asset growth. Because these products are complex and contain inherent risks, working with a knowledgeable professional to evaluate options is always recommended.
David Mandell, JD, MBA, is an attorney and the author of more than a dozen books for doctors, including Wealth Planning for the Modern Physician. He is a partner in the wealth management firm OJM Group (www.ojmgroup.com).
Bob Peelman, CFP, is a partner and director of Wealth Advisors.
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