LIMRA Speakers Flag Key Developments Impacting Life Sales

In the absence of IRS guidance, Leimberg counseled attendees to “paper” all employer-owned insurance contracts, mandating that the employees, the employer, the agent and the insurer each receive a signed copy of notice and consent forms. Otherwise, employers risk exposure to a lawsuit and paying ordinary income tax on death benefit proceeds.

Adverse consequences also await those who engage in insurance fraud by purchasing life insurance with the intent to sell the policy to a third-party investor. Leimberg cited an instance in which New York rescinded a $1 million policy on an insured’s life because a trust created to house the policy was not done at the behest of the insured, but rather for the benefit of investors who had no familial or economic interest in the insured’s life.

“[Insureds and investors] can’t play these games,” said Leimberg. “In determining whether a policy is legitimate, the courts are going to look at solicitation materials and other documents, who started the ball rolling, and the time between the inception and sale of the policy.

“When you create a new risk with the intention of assigning or shifting benefits, either directly or indirectly, to an outside party who couldn’t care less whether you continue to live, then you’ve engaged in [stranger-owned life insurance],” he added. “If you try to circumvent insurable interest laws, you’ll get caught. And if you lie or omit information from an application, then you’ve engaged in insurance fraud, which is punishable by jail time.”

Commito added that the largest buyers of investor-initiated life insurance policies, among them Deutsche Bank, may now be looking to jettison these contracts in the wake of recent credit crunch involving sub-prime loans to home buyers. Like mortgages, he noted, insurance policies often are securitized and sold to hedge funds and banks, many of which may now be facing a liquidity crisis.

Leimberg said policyholders will have to weigh the tax and financial implications of several recent IRS revenue rulings when deciding to transfer or sell an insurance contract. Among these is ILM 200504001, which holds that an insured’s basis in a life insurance contract is reduced by the cost of insurance protection provided through the date of sale.

Separately, in PLR 200606027, the IRS stated the exchange by one irrevocable life insurance trust for two other policies held by a second ILIT and created by the same grantor is not a transfer for value for income tax purposes, and, therefore, no gain or loss is recognized.

Leimberg cautioned, however, against executing transfers that assign less than fair market value to an insurance policy, thus incurring a gift tax, and selling policies to a grantor trust for a valuing equaling their interpolated terminal reserve plus unearned premium. While not creating a taxable event, the sale might prompt a lawsuit from trust beneficiaries on the grounds that they could have received more money through the distribution of death proceeds.