“One thing we need to do is to better train our agents,” said Stephan Leimberg. “They need to know more about recent court cases and IRS rulings. And they need to know that form is not substance–that you’ve got to have both.”
On that note, Leimberg, who is CEO of Bryn Mawr, Pa.-based Leimberg Information Services, closed the opening general session of LIMRA International’s Advanced Sales Forum, held here last week. Joined by Thomas Commito, a director of sales concepts at Lincoln Financial Distributors, Hartford, Conn., Leimberg devoted the 90-minute presentation to reviewing key developments in life insurance, estate and income tax planning.
Prominent among those cited by the speakers was Mayo vs. Hartford Life Insurance, which involved Wal-Mart’s creation of a trust in 1993 to hold corporate-owned life insurance policies on the lives of its rank-and-file employees, naming Wal-Mart as the beneficiary. Because the employees never provided consent, the U.S. 5th Circuit Court of Appeals ruled that Wal-Mark lacked an insurable interest in the employees.
The case is in part significant, the speakers noted, because of the question of jurisdiction: A U.S. District court ruled that Texas law (rather than Georgia’s) governed the dispute; and in Texas, Wal-Mart was not permitted to receive COLI proceeds.
“Which state law governs insurable interest disputes is increasingly an important issue,” said Leimberg. “Jurisdiction will be a key focus not in COLI cases, but also in those involving charitable owned- and stranger-owned life insurance.”
Leimberg added that, unless another state has a more significant relationship to the transaction, state law where the insured is domiciled will govern.
Commito noted the Mayo case was also noteworthy because the court ruled that death benefit proceeds be distributed to the estate of a deceased employee, rather than void the contract and return premiums paid-the traditional remedy in instances involving an absence of insurable interest.
The speakers said the insurance industry is still grappling with one outgrowth of much-publicized violations of state insurable interest laws: The employee notice and consent provisions of the Pension Reform Act of 2006. Still to be determined, observed Leimberg, is whether the provisions apply in cases involving 1035 exchanges, sole proprietorships, family attribution rules and irrevocable life insurance trusts used to fund cross-purchase buy-sell agreements.
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.