Some state insurance regulators are looking into the idea of allowing tax-free exchanges of corporate-owned life insurance policies (COLI).

The Life Insurance and Annuities Committee at the National Association of Insurance Commissioners, Kansas City, Mo., plans to discuss the possibility Wednesday during a conference call.

The NAIC staff began studying the issue because of reports that uncertainty about how to roll assets from one COLI policy into another have trapped some employer-policyholders, Eric Nordman, NAIC regulatory services director, writes in a memo to members of the Life Committee.

In some cases, employers are stuck with COLI policies that have “obsolete terms, poor inside build-up of policy cash values, deficient service and/or troublesome credit exposure to carriers in deteriorating financial condition,” Nordman says.

In the 1990s, states developed COLI laws that typically require employers to notify the employees that they will be insured.

In 2006, Congress adopted a COLI that includes federal COLI notice requirements.

In 2009, the Internal Revenue Service (IRS) said in a notice that an employer can complete a tax-free Section 1035 COLI policy exchange without meeting all of the notice requirements listed in the 2006 federal law.

The insurable interest requirements and notice requirements are important in a COLI exchange because a COLI policy may insure former employees as well as current employees, and the employer may have difficulty re-establishing insurable interest on all lives covered by a COLI policy, Nordman says.

The Life Committee could consider remedies such as drafting amendments to the NAIC’s Guidelines on Corporate Owned Life Insurance model or starting the process of developing a new model law, Nordman says.

Representatives from three insurance industry groups – Michael Lovendusky of the American Council of Life Insurers (ACLI), Washington; Tom Korb of the Association for Advanced Life Underwriting (AALU), Reston, Va.; and Gary Sanders of the National Association of Insurance and Financial Advisors (NAIFA), Falls Church, Va. – have joined to write a comment letter opposing the idea of

trying to revise state insurable laws.

Group representatives note that the IRS has spelled out policies in IRS Revenue Ruling 2011-9 that could lead to tax problems for employers that try to exchange COLI policies.

The groups “believe that the solutions proposed to be undertaken by the NAIC and the states would not be effective” and “oppose opening state insurable interest laws for less than compelling reasons,” the group representatives write.

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