It comes as little surprise that life insurance sales have slowed during 2011, according to LIMRA’s U.S. Individual Life Insurance Sales report.  The downturn in individual life insurance sales is related in part to the exodus of carriers from the no-lapse UL market, says Ashley Durham, senior analyst, product research at LIMRA. “Part of the slowdown in growth is a reflection of a few companies moving away from lifetime death benefit guarantee universal life (UL) products,” she said in a press release.

Universal Life carriers are exiting the lifetime death benefit guarantee UL (“no lapse UL”) market in spite of the product’s popularity. Sun Life, for instance, exited the market in 2010. Where no-lapse universal life represented 97% of its life business in 2007, today it makes up only 32% of its business. Many carriers that are staying in the no-lapse market are raising their rates, increasing the likelihood of no-lapse’s continued decline.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of universal life in Advisor’s Journal, see Can Term Life Coupled with a Mutual Fund Investment Replace a Variable Universal Life Policy? (CC 10-77).

For an in-depth description of variable universal life policies, see AUS Main Library: Section 25 B—Variable Universal Life (VUL).

The United States recession has forced service providers to look across the ocean for new clientele. We see markets emerging abroad selling premiums once only offered to the Western World. With less money invested in U.S. business, a recession still underfoot, massive layoffs across the nation and continued outsourcing; citizens of the U.S. just don’t have the money to invest in these premiums.

Life insurance is an optional premium, and with any optional purchase it needs to attract to those who can afford the non essential.  According to a study by LIMRA in 2010,“[T]he percentage of U.S. households with life insurance coverage is at its lowest in 50 years. Only 44% of households have an individualized life insurance policy.”^[1] In the business of life insurance, markets with excess income are attractive. Increased population creates more clients, equates to more business, and increases profit. Ipso facto new market growth.

A quick glance at Bloomberg and one can track the new business model. U.S. stocks have fallen significantly. “[T]he 9.4 percent [drop] since July 22 dragged the S&P 500’s valuation to 13.4 times reported earnings, the cheapest level since April 2009”. ^[2] As for the Asian market, “the yuan strengthened beyond 6.4 per dollar for the first time in 17 years”.^[3]

When it comes to life insurance premiums, the wealth managers production relies on his/her ability to find new clients and place new business. The trend for business to move overseas is underway within the life insurance policy market.^[4] India is one of the newer markets selling life insurance. As of June 30, 2011 there are presently 24 life insurers registered to sell policies in India.^[5] Within the U.S. there has been a decline of agents. ”[I]n 2010, there were 184,873 “affiliated agents”, down from more than 246,000 two decades ago”.^[6]

In India, insurers provide somewhat of a hybrid to their policy holders. Current trends provide sales of a combination coverage called unit linked insurance policies, ulips. An almost mirror image to the variable universal life insurance policy, existing in the U.S. Both allow for flexible terms, however differ in that the ulips allow for the combination of risk cover and investment.^[7]

There is also the magic word consumers love to hear, a guarantee. Lest the insured have an issue with the insurers policies, the Indian Insurance Regulatory and Development Authority (IRDA), provides an ombudsman to mediate grievances.^[8] (Different from the standards in the United States). Strict guidelines are followed to appoint each ombudsman, and in office an ombudsman will be forced to leave if found partaking in any misconduct pursuant to the rules set forth by IRDA.

So, what say for the U.S. life insurance market? Will the U.S. begin offering services similar to those in the new foreign markets? Will the recession affect the U.S. life insurance market so much that it becomes obsolete? One thing is for certain, insurers fortify their continued dominance in the U.S. market with confidence, “…uncertain economic conditions continue to play to [our] greatest strengths.”^[9]

Contribution by: Morrissa Handy, J.D. Candidate, Thomas Jefferson School of Law

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

^[2] Rita Nazareth, BLOOMBERG, U.S. Stocks Fall as S&P 500 Posts Worst Slump Since March 2009, http://www.bloomberg.com/news/2011-08-04/u-s-stock-index-futures-decline-s-p-500-may-fall-for-eighth-day-in-nine.html (posted Aug. 04, 2011, 11:39 a.m. PT).

^[3] Fion Li, BLOOMBERG,China’s Yuan Strengthens Beyond 6.40 Per Dollar for First Time Since 1993, http://www.bloomberg.com/news/2011-08-11/china-s-yuan-strengthens-beyond-6-40-per-dollar-for-first-time-since-1993.html (posted August 11, 2011, 2:17 a.m. PT).

^[4] HSBC,Ins., http://www.hsbc.co.in/1/2/personal/insurance (accessed Aug. 10, 2011, 4:59 p.m. PST).

^[5] Ins. Reg. & Dev. Auth., Life Insurers, http://www.irda.gov.in/ADMINCMS/cms/frmGeneral_NoYearList.aspx?DF=RL&mid=3.1.1 (updated 20, June 2011).

^[6] USATODAY, Households With Life Insurance Hits Lowest Level in 50 Years, http://www.usatoday.com/money/perfi/insurance/2010-12-03-1Alifeinsurance03_ST_N.htm (updated Dec. 03, 2010, 2:21 p.m.).

^[7] Id. at, Frequently Asked Questions, http://www.irda.gov.in/ADMINCMS/cms/frmGeneral_Layout.aspx?page=PageNo261&flag=1&mid=FAQs (accessed Aug.11, 2011, 8:51 a.m. PST).

^[8] Id. at Functions of Ombudsmen, http://www.irda.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?page=PageNo233&mid=7.1 (date 11, Aug. 2003).

^[9] Aurthur Postal, Natl. Underwriter, U.S. Rating Downgrade: Insurers Emphasize Continued Strength, http://www.lifeandhealthinsurancenews.com/News/2011/8/Pages/US-Rating-Downgrade-Insurers-Emphasize-Continued-Strength.aspx?k=life+insurance (published Aug. 9, 2011).

Split Dollar Plans—Who’s Paying for that Life Insurance?

Why is This Topic Important to Wealth Managers? This blogticle discusses the general properties as well as taxation of the traditional split dollar plan. It is intended to provide both a review of concepts and refresher of a planning opportunity.

Split dollar insurance is an arrangement generally between an employer and an employee under which the policy benefits are split, and the costs (premiums) may be split. Split dollar plans can also be set up between corporations and shareholders (“shareholder split dollar”) or between parents and their children (“private split dollar”).

Under the traditional plan, the employer pays part of the annual premium equal to the current year’s increase in the cash surrender value of the policy and the employee pays the balance, if any, of the premium. From this basic concept, hybrid plans have evolved; for example, “employer pay all” plans under which the employer pays the entire premium, and level contribution plans under which the employee pays a level amount each year.

If the employee dies while the split dollar plan is in effect, the employer receives from the proceeds an amount equal to the cash value of the policy or at least its premium payments (under a basic plan), and the employee’s beneficiary receives the balance of the proceeds.

It is no secret to wealth managers that split-dollar life insurance arrangements can be a key feature incorporated into executive compensation packages. Beginning in 2001, transitional guidance on the valuation of split-dollar life insurance arrangements was provided in the form of notices and proposed regulations in anticipation of final regulations which were adopted in 2003.

How are the current regulations applied regarding this arrangement?

Under the final regulations issued September 17, 2003, the tax treatment turns on who owns the split-dollar policy.  If the executive owns the policy, the employer’s premium payments are treated as loans to the executive.  Consequently, unless the executive is required to pay the employer interest on the loan at or above the applicable Federal rate (AFR), the executive will be taxed on the difference between the AFR interest and the actual interest.  Verify that the rate of interest being charged is at least AFR.

If the employer is the owner of the split-dollar policy, the employer’s premium payments are treated as providing taxable economic benefits to the executive.   The economic benefits include the executive’s interest in the policy’s accessible cash value and current life insurance protection.

The final split-dollar regulations apply to any split-dollar life insurance arrangement “entered into” after September 17, 2003.  The term “entered into” is defined in 1.61-22(j)(1)(ii) of the regulations.  Under section 1.61-22(j)(2) of the regulations, an arrangement entered into on or before September 17, 2003 that is materially modified after September 17, 2003 is treated as a new arrangement entered into on the date of the modification, and is subject to the final regulations.

Section 1.61-22(j)(2)(ii) of the regulations provides a non-exclusive list of changes that are NOT considered material modifications.

See Tax Facts Q 3793 What is reverse split dollar and how is it taxed? for a discussion of reverse split dollar plans.

Tomorrow’s blogticle will discuss issues surrounding year-end planning preparation.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

Aviva Life and Annuity Co. sued six of its agents earlier this year, claiming the agents were involved in a fraudulent sale of life insurance to 119 church members. The agents recently responded, charging that Aviva was not only complicit in the charity-owned life insurance (CHOLI) scheme, but actively “directed, ordered, approved, and in all other respects, ratified the acts and performance of” the agents.

Aviva filed the lawsuit against the agents in March of this year in the United States District Court Central District of California. According to the lawsuit, the six agents arranged for church parishioners to purchase life insurance that would be held in 119 individual life insurance trusts.

The producers are accused of violating Aviva’s “producer guidelines” by participating in the sales. The scheme outlined by Aviva’s complaint is a variation on stranger-originated life insurance (STOLI), where church members were approached about participating in an endowment program under which life insurance death benefits would be split between the church, beneficiaries and a third party.

Members who allowed policies to be purchased on their lives have told Aviva that they either did not pay premiums on their life insurance policies or paid only the initial premium.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of STOLI in Advisor’s Journal, see Court Holds that STOLI Law Is Not Retroactive (CC 11-108) & STOLI Scheme Lands Insurance Agent in Jail (CC 11-92).

The Foreign Account Tax Compliance Act (FATCA) was enacted as a comprehensive measure to combat offshore tax evasion—a noble enough goal. But FATCA’s comprehensiveness is also a sore point for many in the financial services industry, especially insurance carriers and producers. In comments to regulators, one foreign life insurance trade organization, the Association of International Life Offices (AILO), recently called FATCA’s requirements “onerous and disproportionate to the risk involved.”

Passed as part of H.R. 2847, the Hiring Incentives to Restore Employment Act (HIRE Act) on March 18, 2010, FATCA combats tax evasion by requiring disclosure from foreign institutions about accounts held by individuals, including U.S. citizens, and institutions that may be subject to U.S. tax. Many life insurance and annuity contracts are considered “accounts” under the Act, although FATCA doesn’t generally apply to property, casualty, and term life insurance contracts.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of FATCA in Advisor’s Journal, see IRS Proposed FATCA Guidance Expands Offshore Compliance Initiatives (CC 10-52) & Offshore’s Limited Shelf Life (CC 10-47).

Why is This Topic Important to Wealth Managers? This blogticle discusses one area that is well known to many wealth managers. However, this reexamination of a topic is designed to provide a refresher to wealth managers. Here we discuss the three year bring-back rule.

With certain exceptions, there is a general rule with respect to estates which requires that any property transferred by gift within three years prior to the transferor’s death has to be included in the gross estate of the deceased transferor, at its date-of-death value (even though the transferor may have had no ownership interest or retained rights of any kind when she died). [1] This rule is sometimes referred to as the “three year rule” or the “bring-back rule”.

The 3-year “bring-back” rule is applicable with respect to dispositions of retained interests in property which otherwise would have been includable in the gross estate.[2] All of these sections involve transfers of property as to which the transferor retained some form of continuing interest or right, which, if still retained when the transferor dies, is deemed sufficient to require the inclusion of the property in the gross estate of the transferor:

• §2036 -  Transfers with certain life interests retained
• §2037 -  Transfers with a reversionary interest retained
• §2038 -  Transfers with a right retained to alter, amend or revoke the transferee’s beneficial interest
• §2042 -  Transfers of life insurance policies with an incident of ownership retained

Under I.R.C §2035, if an insured individual transfers an insurance policy to a trust or another individual, even though the insured may no longer retain any incidents of ownership, if he dies within the 3-year period following the transfer, the entire policy proceeds will be includable in the insured’s gross estate, effectively defeating the major objective of the having the death benefits payable outside the estate.

For the most part, this problem can be eliminated by establishing a trust with a new policy (i.e., never owned by the insured). This, of course, may not be a viable alternative when an existing policy is involved. While consideration might be given to cancellation of an existing policy and replacement with a new one, such a course of action should be based more upon the non-tax aspects of a policy change (e.g., premium costs, contractual terms, quality of carrier, etc.) than purely the tax risk of §2035, the 3-year bring back rule.

In situations where a decision is made to establish an irrevocable life insurance trust with a policy to be newly issued, the §2035 problem (the 3-year rule) can usually be avoided by simply having the policy applied for by, and initially issued to, the trust as owner. If this is properly accomplished, the insurance proceeds will not be includable in the insured’s gross estate even if he should have the misfortune of living less than three years thereafter.

The critical factor in assuring the inapplicability of I.R.C. §2035 (the 3-year rule) is that the grantor/insured not have possessed at any time anything that might be deemed an incident of ownership with respect to the policy.

Generally it is the IRS’ position that reapplication by third party owner after decedent initially applied for the insurance within three years of death does not present a three year rule problem. Central to the position is the notion that an application for insurance (as long as money is not submitted with the application) is only an offer to contract. There being no contract between the parties, decedent never held any incidents of ownership.[3]

Tomorrow’s blogticle will continue to discuss issues surrounding wealth management.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

[2] For example, under I.R.C. §§ 2036, 2037, 2038, or 2042.

[3] See Technical Advice Memorandum (TAM) 9323002.

Life insurance policy loans can generally be taken without income tax consequences, but there are circumstances where a “loan” is immediately taxable. We’ve covered situations where a policy is surrendered with a loan outstanding, resulting in taxable income. This article discusses another case where a policy “loan” will be treated as taxable income.

In Frederick D. Todd II et ux. v. Commissioner (T.C. Memo. 2011-123), the Tax Court considered whether a distribution from a welfare benefit fund to a fund participant was a policy loan or a taxable distribution.

For previous coverage of life insurance policies held by welfare benefit funds in Advisor’s Journal, see Deductions for Life Insurance Premium Payments to Welfare Benefit Plan Denied (CC 10-29).

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For in-depth analysis of welfare benefit funds, see Advisor’s Main Library: B—Welfare Benefit Funds.

Life insurance is a common tool for ensuring estates have adequate liquidity to pay estate expenses and taxes. But recent changes to the estate tax have some people questioning whether the high premiums they’re paying are worth it when their estates are no longer likely to be hit by the estate tax.

With a $5 million exclusion amount and brand-new exclusion portability provisions, far fewer households have to deal with the federal estate tax. But is allowing unneeded life insurance to lapse the best solution?

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of life insurance valuation in Advisor’s Journal, see Relative Policy Value of Life Insurance (CC 11-57).

The Tax Court recently determined that the fair market value (FMV) of a life insurance policy distributed by a terminated 419 welfare benefit plan is reduced by surrender charges. [Lowe v. C.I.R., T.C. Memo. 2011-106 (2011)].

This ruling further cements the Tax Court’s position on surrender charges that was enunciated in Schwab v. Commissioner [Michael P. Schwab et ux. v. C.I.R., 136 T.C. No. 6 (2011)]. Although the IRS continues to challenge taxpayers who apply surrender charges to reduce or eliminate their tax liability when a policy is distributed to them by a welfare benefit plan, this ruling adds another degree of certainty to the FMV calculation.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of Tax Court rulings in Advisor’s Journal, see Tax Court Revives Partnership Self-Employment Tax Debate (CC 11-56).

Why is this Topic Important to Wealth Managers? Life insurance is an important tool in many areas of modern and advanced financial planning.  In many planning scenarios, the rationale of the transaction rests on gift and estate tax consequences. This means for wealth managers that it is crucial for planning purposes to understand how a life policy is valued at the time of transfer.

Generally the gift tax is an excise tax on the transfer, and is not a tax on the subject of the gift itself. [1]

The gift tax applies to a transfer by way of gift whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. [2]

For example, a taxable transfer may be effected by the creation of a trust, the assignment of the benefits of an insurance policy, or the transfer of other asset classes generally. [3]

The Code provides that if a gift is made in property, its value at the date of the gift shall be considered the amount of the gift. The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. [4]

Valuation of certain life insurance and annuity contracts

Generally, the value of a life insurance contract or of a contract for the payment of an annuity issued by a company regularly engaged in the selling of contracts of that character is established through the sale of the particular contract by the company, or through the sale by the company of comparable contracts. [5]

Examples

(1) A donor purchases from a life insurance company for the benefit of another a life insurance contract or a contract for the payment of an annuity. The value of the gift is the cost of the contract.

(2) An annuitant purchased from a life insurance company a single payment annuity contract by the terms of which he was entitled to receive payments of $ 1,200 annually for the duration of his life. Five years subsequent to such purchase, and when of the age of 50 years, he gratuitously assigns the contract. The value of the gift is the amount which the company would charge for an annuity contract providing for the payment of $ 1,200 annually for the life of a person 50 years of age.

(3) A donor owning a life insurance policy on which no further payments are to be made to the company (e.g., a single premium policy or paid-up policy) makes a gift of the contract. The value of the gift is the amount which the company would charge for a single premium contract of the same specified amount on the life of a person of the age of the insured.

(4) A donor purchases from a life insurance company for $ 15,198, a joint and survivor annuity contract which provides for the payment of $ 60 a month to the donor during his lifetime, and then to his sister for such time as she may survive him. The premium which would have been charged by the company for an annuity of $ 60 monthly payable during the life of the donor alone is $ 10,690. The value of the gift is $ 4,508 ($ 15,198 less $ 10,690). [6]

Tomorrow’s blogticle will continue our discussion on topics related to planning with life insurance.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] Id.

[3] Statutory provisions exempt bonds, notes, bills and certificates of indebtedness of the Federal Government or its agencies and the interest thereon from taxation are not applicable to the gift tax. Treas. Regs. § 25.2511-1.

[4] IRC section 2512; Treas. Regs. § 25.2512-1.

[5] Treas. Regs. § 25.2512-6.

[6] Id.