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?

The initial reaction may be “What have I got to lose?” but in fact any life insurance owned by another entity reduces the donor’s capacity for additional insurance. And if the donor provides an IRA as collateral, the donor gives up access to the principal. This could be challenging when it comes time to take required minimum distributions.

How Do You Analyze One Of These Proposals?

Don’t rely on the legal opinions provided by the promoter or be swayed by marketing materials that tout “IRS approval” and “patent pending.” The promoters may offer a long list of supporting regulations and private letter rulings that have only tenuous relevance to the actual program. There are a multitude of issues that must be examined, from private inurement and unrelated business income to insurable interest.

For example:

l Get feedback from other participating charities that are far enough along that they’ve passed the honeymoon period.

l Research the promoters’ backgrounds. Were they previously involved in discredited programs?

l Determine whether the assumptions underlying the plan’s success are reasonable. If the assumptions are off, how would that affect the success of the plan?

l Do a cost-benefit analysis. Factor in the setup, administration, legal, and accounting costs.

l Talk to the advanced marketing departments at the insurance companies whose products will be used in the program. Do they endorse the program or are they unaware of how their products are being used?

l Ascertain the charities’ risk tolerance for complexity, changes in law, or things going wrong.

l Ask for an exit strategy if the key assumptions should change.

If It Seems Too Good To Be True…

Oklahoma State University could have used a good exit strategy when it set up its Gift of a Lifetime program. On the endorsement of its most famous alumnus, T. Boone Pickens, in 2007, Cowboy Athletics Inc. bought 27 Lincoln National Life policies for $10 million each on its oldest, wealthiest alumni. The fundraising program got a lot of press and generated considerable interest among universities around the country. But it didn’t take long for things to fall apart. Having used a temporary loan to pay the initial premiums, Cowboy Athletics failed to obtain permanent financing. It spent more than $33 million in premiums before it tried to cancel the program two years later, claiming it did not receive the policies until 2009. Accusing the marketers of misrepresenting the plan and its costs, Cowboy Athletics sued Lincoln National and its insurance agents for a return of the premiums.

Lincoln turned around and countersued the OSU athletic fund for breach of contract and sued T. Boone Pickens for urging OSU to cancel the policies. Lincoln claims that only after the Cowboy’s temporary premium financing loan expired and additional financing was unavailable did the plan go sour. While the insurance agents promised to secure financing, Lincoln disavows having any responsibility for helping the organization obtain premium loans.

Interestingly, in other cases, Lincoln brought lawsuits when it suspected the parties purchased policies with the intention to sell them to investors on the secondary life insurance market. In OSU’s case, there is no indication that the group intended to sell the policies, but if it had, the market for life settlements has since hit the skids, further reducing their options.

The moral of the story is, if it seems too good to be true, it usually is. Weigh the risks against the benefits. Understand how all parties benefit from a leveraged insurance plan. And get good independent advice.


Tere D’Amato is the vice president of advanced planning at Commonwealth Financial Network(R), member FINRA/SIPC, a registered investment adviser, in Waltham, Massachusetts. She can be reached at tdamato@commonwealth.com.

All guarantees are based upon the claims paying ability of the issuing insurance company. Commonwealth does not offer tax or legal advice.