Washington

President Bushs new budget calls for curbing sales of an emerging life insurance product, criticized by many in the industry, through which investors buy life insurance on major charitable donors and then pay the premiums in hopes of capitalizing on the tax-free inside buildup.

Under the administrations budget, a 25% excise tax would be imposed on the product, one of the most popular of which is called Life Insurance and Life Annuities Based Certificates, or LILACs. Under these programs, the investors get the benefit of the inside buildup if they agree to give a small part of the benefits to charities, such as colleges or affiliates of colleges.

Under the proposal, the tax would be imposed upon any person who receives death benefits, dividends, withdrawals, loans or surrenders under a life insurance contract, if (i) a charity has ever had a direct or indirect ownership interest in the contract, and (ii) a person other than a charity has ever had a direct or indirect interest in the same contract (including an interest in an entity holding an interest in that contract).

The product has been criticized heavily by Stephan Leimberg, an author and estate planner in Pennsylvania, who says LILACs are part of a group of insurance products called “stranger-owned life insurance” that threaten to make life insurance a commodity and increase the chances that Congress will move to curb inside buildup.

According to Leimberg, the product has been criticized by the three main industry trade groups, the American Council of Life Insurers, the National Association of Insurance and Financial Advisors, and the Association for Advanced Life Underwriting.

All three have been working with states to thwart efforts to change the definition of “insurable interest” that is needed to increase sales of these “stranger-owned” life policies.

Jack Dolan, an ACLI staff official, says the trade group is lukewarm about the administrations approach to curbing the sale of LILACs. “Our position on this provision is that while we agree with the administration that speculative uses of life insurance should be curtailed, we do not believe that life insurance death benefits should ever be subject to income tax.” Dolan adds, “We are planning on working with Treasury on other ways to disincentivize these speculative uses, short of taxing the death benefits.”

Dolan points out that the ACLI and other industry trade groups have been working in the states to oppose efforts to loosen the definition of insurable interest. “We agree there should be some limitation on speculative uses of life insurance, but a tax on death benefits is not the way to go.”

Dolan adds that, “We are naturally concerned if life insurance is used in a manner inconsistent with the basis for tax-free death benefits.”

A NAIFA staff official says, “We are opposed to efforts by some who support investor-owned life insurance to weaken insurable interest laws in states to make it legal.”

Leimberg, who has written extensively on the subject, cautions that the administration initiative is just a proposal and that it must be acted upon by Congress. If passed, it would impose the excise tax only on LILACs sold as of Feb. 8.

And the administration proposal only affects cases where a charity gets a part of the pie, even if only a small part of the pie. “Stranger-owned life insurance is a dangerous and disturbing trend,” Leimberg says. “Left unchecked, this short-sighted, too-good-to-be-true, something-for-nothing ploy could adversely impact on the charities it is promoted to benefit, trigger a sea change in the way life insurance is taxed and priced, and in extreme cases, encourage criminal activity of the worst kind.”


Reproduced from National Underwriter Life & Health/Financial Services Edition, February 11, 2005. Copyright 2005 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.