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Keeping A Wary Eye On The Storm Clouds

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Life insurance companies face perils on multiple fronts, some of their own making, said speakers at a meeting here, and if advisors and their firms dont take the threats seriously, the tax advantages upon which the industry has long prospered might soon vanish.

These words of warning were a recurring theme at the Limra International 2004 Advanced Sales Forum held here last month, as advanced market professionals got an earful on the more sobering challenges that lay ahead.

Stephan Leimberg, CEO of Leimberg Information Services, Inc., Bryn Mawr, Pa., highlighted the potentially deleterious effects of IRS and Treasury Dept. regulations proposed earlier this year. The regulationsReg. 126967-03, Rev. Rul. 2004-20, Rev. Rul 2004-21 and Rev. Proc. 2004-16collectively aim to eliminate abusive transactions involving individual and group insurance, retirement plans, and Section 83 transfers.

Leimberg expressed particular concern over Reg. 126967-03, which would measure the worth of distributions from a life insurance policy for income tax purposes according to a single standard: fair market value. The rule would thus eliminate other variables for determining worth, such cash value, cash surrender value and reserve.

Leimberg views the proposed single standard as overly restrictive. But, he notes, the insurance community effectively invited government intervention by not blowing the whistle on firms that engage in “blatant and significant abuses” of tax laws. Without a self-policing entity (Leimberg suggests an NASD-like governing body) more such adverse rules can be expected, he says.

“This [government regulation] is a rolling stone thats coming down the hill,” says Leimberg. “And, like a snowball, its just going to get bigger as its reach extends from 412(i) plans and pension rescue to other transactions bearing on gift taxes, estate taxes and generation-skipping plans.”

“Were to blame for the current situation,” he adds. “We dont know how to shun or censor our own members. If we dont find a way to shut down abusers, much as the securities industry has done with the NASD, then our community will continue to get pummeled.”

William ODonnell, president of William T. ODonnell Associates, Chicago, Ill., concurs about the challenge, but questions whether a self-regulating industry organization is the answer. Pointing out that similar initiatives had been undertaken in the past, he observes that “the more rigid the rules, the harder the industry will buck you.”

During a general session on drawing the line between aggressive strategies and abusive techniques, ODonnell says the solution is for advisors to “exercise personal leadership” in upholding the spirit of the tax laws and in navigating ethical dilemmas.

Leadership will be required of the insurance community, too, if it is to stave off government assaults on the tax-free status of death benefit distributions, long an industry pillar. The threat, conference panelists warned, comes from two fronts: the advent of investor-owned life insurance (mockingly termed stranger-owned life insurance or SOLI) and insurance firms growing abandonment of the middle market.

The first, typically marketed as charitable-owned or foundation-owned life insurance (CHOLI or FOLI), allows third-party investors in states with liberalized insurable interest lawscurrently Texas, Virginia, Tennessee and North Carolinato buy an interest in a trust that provides a small payment to a charity or education organization when the insured dies. Most of the death benefit goes to the investors.

If extended nationwide, investor-owned life insurance could prompt Congress and the states to revoke the tax-free benefit, says Leimberg. The rationale? Politicians would view life insurance no longer as a product chiefly for the benefit of widows and orphans, but as a commodity to be traded among investors in secondary markets, much like stocks and bonds.

“CHOLIs and FOLIs are a danger not only to the insurance agents, whose sales will drop precipitously, but also to the public,” says Leimberg. “With the tax benefit gone, individuals may have to buy twice as much life insurance to net as much [in death benefits] for their families.”

C. Robert Brown, president of UCL Financial Group, Memphis, Tenn., and president-elect of the National Association of Insurance and Financial Advisors, agrees, noting that CHOLI promoters are “acting not out of concern for the public, but only so investors can benefit.” He adds that NAIFAs state associations are working hard to thwart the liberalization of insurable interest laws in other jurisdictions.

NAIFA is also partnering with the Million Dollar Round Table and GAMA International in a project dubbed Task Force for our Future. The organizations are exploring ways to reverse trendsnotably the consolidation of insurance distribution channels and the increasing tendency of advisors to cater primarily to the affluentthat have left the middle market underserved.

“If the only people benefiting from life insurance are at the top of the demographic pyramid, then how in the world can we justify keeping the tax-free treatment for the masses when all were doing is insuring the [upper] classes,” says Brown.

And not always doing the best job of it. Charles Ratner, national director of insurance counseling for Ernst & Young, New York, N.Y., pointed out during one general session that advanced sales professionals sometimes get a bit too creative in devising strategies for high net worth clients, the result being less than optimal performance of their plans.

Ratner specifically focused on the merits of “the simple plan,” a tried-and-true technique for minimizing gift taxes paid on premium contributions to an irrevocable life insurance trust (ILIT).

Alternative strategies, including equity split-dollar and premium financing arrangements, may yield lower gift taxes. But because these plans are more complicated, he observes, more things have to go right (such as the fluctuating interest rate charged by a third-party lender who is funding the premium payments) to achieve the desired result (maximizing liquidity).

“Theres a constant search in this business for ideas that will help agents clinch the sale and make them appear more creative than the next person, without going over a cliff,” says Ratner. “The producer who explains the pros and cons of each approach will deliver more value than by saying, this [one technique] is the way to do it.

“Thats a high-risk, all-or-nothing strategy,” he adds. “The advisor needs to let the client choose the level at which he wants to eat well versus sleep well.”

Reproduced from National Underwriter Edition, September 9, 2004. Copyright 2004 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.