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September 01, 2010 at 08:00 PM
If you’re on the board of a charity, you probably wrestle with creative ways to raise money. You’re not alone; traditional fundraising methods are failing charities, colleges, and other nonprofits in this economy. Is it any wonder that a charitable fundraising director would sit up and take notice when presented with an idea that allows his or her donors to raise money without opening their wallets? Who wouldn’t be willing to help out their favorite charity if it didn’t cost them anything?
But it’s not that easy (nothing ever is). Which is why you should enter cautiously into the world of leveraged charitable insurance planning.
How Leveraged Charitable Insurance Strategies Work
Most charities encourage donors to name the charity as beneficiary of their life insurance policy–as long as the charity doesn’t have to pay the premiums. Indeed, look at any university website and you’re likely to see something similar to this message from Smith College:
“Do you own paid-up life insurance that is no longer needed for its original purpose? Are your children self-supporting? Have you sold your business? Consider your insurance policy an asset that is easy to give away to charity! You would be allowed a charitable income tax deduction for the cash surrender value of the policy.”
Of course, while colleges encourage such bequests and deferred gifts, they would prefer money they can put to work immediately. This is where enterprising marketers are looking to fulfill an immediate and pressing need–and make a profit to boot.
The leveraged charitable insurance strategy makes sense at first glance. The charity appears to get cash it can use today, as well as a potential future endowment.
Life settlements approach. A charity borrows money from a lender introduced by the marketer. It then buys policies on its wealthy, older donors. The charity plans to sell the policies in a couple of years to life settlement investors, pay back the loan, and keep a small profit–anywhere from 2% to 10% of the policy face amounts. These types of programs have been structured by well-known firms like UBS to offer noncorrelated investments to institutional investors.
Buy-and-hold approach. In another version of this strategy, the charity buys and holds life insurance on the lives of its wealthy older donors. It borrows enough money to pay the premiums and uses donations to service the loans until the death benefit payoff. After retiring the loan principal, the charity anticipates keeping 5% to 7% of the death proceeds.
The IRA approach. In this case, the donor arranges for his or her IRA to lend money to a favorite charity. The charity sets aside enough of the loan proceeds to pay life insurance premiums and interest payments. The balance of the loan is free to be used for the charity’s programs.
Regardless of the strategy employed, the marketers look to a charity’s donors or a university’s alumni list as a source for insurance sales. Unfortunately, the charity usually ends up with a very small percentage of the profits.
What The Government Says
Several years ago, this profit imbalance caught the attention of Congress, which observed that the real purpose of many leveraged fundraising programs was to generate profits for the noncharitable promoters and third-party investors. As Sen. Charles Grassley put it, “A penny of benefit to charities doesn’t excuse a pound of profit to the corporations.”
The Pension Protection Act of 2006 (PPA) mandated a study of the involvement of charities and other tax-exempt organizations with programs that shared their insurable interest in their donors with outside investment groups. In April 2010, the Treasury Department found that investor-initiated charitable arrangements were inconsistent with the policies underlying the federal income tax benefits for charities and life insurance. This does not mean that charities cannot take out loans to maintain the life insurance policies they own on donors. Or that a donor cannot offer to guarantee the loan or provide the needed collateral. It does mean that unrelated business income tax, transfer for value, and other tax issues have to be examined carefully by the charities’ tax and legal advisors.
Is Leveraged Philanthropy Really a Great Deal for Charities?
It is too soon to tell, as this concept is relatively new and the PPA has caused many charities to shy away from such deals. These leveraged fundraising programs are also based on the assumption that insurance companies are mispricing their products. If policies are mispriced, the insured donors will die sooner than expected by the insurance companies’ actuaries. Only time will tell if that’s the case, but, as a whole, life insurance companies correctly price their products more often than they misprice them.
Charities face a real risk that the numbers won’t work in their favor. If they buy and hold life insurance policies, is their “dead pool” large enough to provide predictable cash flow?
Is It Good for the Insured Donor?
