CreativityA Blessing And A Curse

Over the years people in our business have used great creativity in expanding the uses of life insurance. Fertile minds have found new ways to use our products to such a degree that sales have far exceeded any level envisioned by the practitioners of yesteryear. That is the blessing of creativity. But new frontiers also are fraught with danger that can, at times, become a curse.

One of the great misconceptions that persists in our business is that government meddling has caused us to be essentially reactive in our approach to legislation affecting our products. In fact, exactly the opposite is true. We are the creative and innovative element in our marketplace and government is the reactive force. We create, government reacts.

There are many examples to illustrate this point: Top heavy pension plans, single premium tax shelters and misleading sales illustrations have all evoked government reaction. Perhaps it would be instructive to examine a current case in point.

More than 50 years ago a person whose name has been lost to history came up with an idea for expanding the use of our product which has since been dubbed “split-dollar insurance.” Split-dollar in its original form was essentially just a way to pay a premium. It simply combined the premium-paying ability of one party with the insurance needs of another party. Use of this technique in most cases enabled an employer with premium-paying ability to help a valued employee secure life insurance on a favorable basis. It was truly a win-win situation, for there were direct and indirect benefits that flowed to both parties in the transaction.

As the practice became more widespread and the applications more creative, government began to take notice. In 1964 the government ruled that there was a taxable event taking place in split-dollar arrangements in that an economic benefit was being transferred from the party with the premium-paying ability to the other party. Government reacted with Revenue Ruling 64-328, which for the first time taxed a portion of premium to the insured.

But this was not the end of split-dollar, rather it was the beginning of a host of creative variations. Some of the creations did not fly and succumbed to government reaction. But many succeeded and became very useful in designing a variety of executive compensation arrangements as well as cooperative ventures with charities.

But, over time, some plans overreached and in one way or another the economic benefit being realized was not being adequately recognized or taxed. The result has been the inevitable reaction by government or you might say, the curse of the excess creativity. The new ruling will not kill split-dollar, but it will inhibit some of the more adventuresome plans and no doubt add fuel to the concept of government meddling in our business.

I bring this up because I believe another form of creativity that is gaining in popularity may spark a reaction from government that could be very destructive to our future. When a business enjoys favorable treatment under the tax code, it seems to me that a certain amount of stewardship is required in order to preserve or protect such provisions.

The real estate industry learned this lesson the hard way in the 1980s. Many projects came into being and were financed not because they made sense economically, but because they worked as tax shelters. Congress became fed up with the abuses and ended the tax-sheltering aspects of the ventures, resulting in the collapse of thousands of projects.

The creativity being employed with the use of “life settlements,” an offshoot of viatical arrangements, is, I believe, a cause for worry. I do not question the proposition that there may be circumstances whereby a policyholder can sell an unneeded policy for a sum greater than its surrender value. It is precisely because it can be done that I believe it is an example of poor stewardship and will likely provoke a government reaction at some point.

One of the prerequisites for obtaining a life insurance policy in the first place and also a tenet of tax law favoring life insurance is that the insured be worth more alive than dead. A life settlement turns that upside down and once the policy is sold, the insured may now be worth more dead than alive. That is a bad social policy as well as tax policy.

The trafficking in life insurance policies has, for a long time, been opposed by Congress. The transfer for value rule, which taxed the gain on policies sold or transferred for value, was promulgated for the specific purpose of discouraging the practice. Tax policy relating to our products is defensible because it is not a contract for profit in the usual sense, but rather it provides socially desirable indemnity for a known and calculable risk. When the contract is reduced to nothing more than an opportunity for gain by investors speculating on the death of other persons, we lose the high ground in our defenses.

Compounding my worry is the likelihood for creativity in fostering abuses in policies covering healthy individuals and providing added incentive to applying for policies by fraudulent means.

When government reacts, it cannot always limit the effects of its action to just the offensive products, but rather a wide net is cast, harming the innocent as well. Creativity is a great blessing and good stewardship prevents it from becoming a curse.


Reproduced from National Underwriter Life & Health/Financial Services Edition, October 24, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.