|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
 |
Journal of Financial Planning - March 2003 Follow-ups to several previous columns are covered, ranging from lawsuit-infected VEBAs to life settlements and preserving cost basis in an unneeded universal life policy. ERISA Jurisdiction May Not Applyby Peter Katt, CFP, LIC My November 2002 column dealt with planning devices that abuse life insurance and are little more than tax-avoidance schemes with clients paying a high price for falling victim to them. Regarding the planning that abused voluntary employees' beneficiary associations, or VEBAs (Neonatology v. Commissioner), I lamented that the developers, marketers and sellers of these schemes were successful in hiding behind ERISA (Employee Retirement Income Security Act) jurisdiction in lawsuits filed in New Jersey. I noted that when ERISA jurisdiction applies, punitive damages aren't allowed and that this creates a moral hazard because it removes the risk of serious financial punishment. But along comes a New Jersey case, Finderne v. Barrett, where judges in Somerset and Union counties agreed with the defendants' position that claimed ERISA preemption, but the New Jersey appellate court reversed the trial courts. The appellate court ruled that plaintiffs' claims are not preempted, basically because the plan was set up for entrepreneurial purposes by defendants and was not a bona fide multiple employer benefit plan. I spoke with an attorney representing some of the Neonatology v. Commissioner physicians and understand that this ruling may be directly applicable to their claims. I recommend that you follow the Finderne v. Barrett case because plaintiffs have named as defendants advisors who had no direct role in selling the plan, but who rendered positive opinions about it. This and several other cases are attempting to substantially raise the bar for advisors who may recommend and give positive comments about various schemes but aren't selling them. You need to pay attention to this activity and respond accordingly to protect yourselves. Life Settlements My July 2002 column was about life settlements, which is the selling of unneeded life insurance policies. Such sales only apply to insureds over 65, whose health since purchasing the policy has deteriorated more than just having gotten older. It is this deterioration in health that creates the mortality arbitrage necessary for life settlement firms to purchase a client's policy. (Life settlements should not be confused with viatical sales, which refer to the purchase of policies from terminally ill insureds regardless of their age). I since have had more experience with life settlements and can expand a bit on my July 2002 column. First, be aware that there are two types of life settlement firms. One type purchases policies for their own investment purposes. Another group purchases policies and repackages them to sell to investors. (Firms buying policies for their own account may securitize them by selling investment units to investors, but investors aren't buying a particular policy or a portion of a particular policy). It is reasonable to believe that firms buying policies for their own accounts will be more prudent in pricing them. Conversely, firms that are essentially playing a middleman role have the potential incentive to be less prudent in pricing policies so they can expand their inventories of policies to package and sell to investors. These firms assure me that investors cannot identify insureds, but I am not convinced that a motivated investor couldn't obtain this information with some investigation. Unless specifically instructed by clients, I am staying clear of the life settlement firms that resell policies because Joseph Belth's (editor and publisher of Insurance Forum) constant warning about mayhem to insureds isn't completely farfetched. So far, even though there is the potential for higher purchase amounts, my clients have not been interested in obtaining quotes from firms that resell policies. I have been somewhat surprised at the number of quality life settlement firms (all buying policies for their own accounts). I had been familiar with Coventry First (www.coventryfirst.com), a firm that has been very forthright and helpful. In addition to them I have found Peachtree Life Settlement (www.lump-sum.com), Living Benefits Financial Services (www.livingbenefitsllc.com), Life Equity (www.lifeequity.net) and Stone Street Financial (www.stonestreet-financial.com) to be professional to deal with. If you are a fee-only planner, don't be afraid to directly assist your clients without using an insurance agent who will earn a commission of up to 15 percent of the purchase price. If you submit the case, be sure to make it very clear to these firms to quote without the commission expense. This will substantially increase the amount these firms will offer your clients. Health Insurance or Finance If you pay close attention to the various political debates about health care, you can't help but be confused because most politicians and commentators don't know the difference between insurance and financing. In my May 2000 column ("Getting 'Real' with Health Care") I offered this definition of insurance from the book Life Insurance: "…human beings are exposed to many serious perils, such as…losses from disability and death…[T]he function of insurance in its various forms is to safeguard against such misfortunes by having the losses of the unfortunate few paid by the contributions of the many who are exposed to the same peril." This definition can be applied to health insurance. Real health insurance has high deductibles with insureds paying routine costs with easy-to-obtain reimbursements for costs in excess of the high deductible. Genuine health insurance uses the market to regulate costs and helps maintain a good relationship between patients and health care providers. But for many years the debate about health care and insurance has really been about financing. Health payment plans that have no or very small deductibles are financing plans, not insurance. Another language problem in this debate is the claim made by some that "x percent of Americans have no health care," when of course what they really mean is some don't have an established health financing plan. There aren't people lying in our streets with dire medical conditions. Most of these souls obtain treatment, although it is inefficient and certainly causes some chaos within the system. Preserving Cost Basis Last year I was retained by a client who had purchased a universal life policy three years earlier. The $35,000 annual premiums were becoming a burden because of declines in his business and his stock portfolio. The policy had an account value of some $85,000, but a surrender value of zero, and it had extraordinarily high surrender charges continuing for another 12 years. After considering his alternatives, he decided to cancel the policy. I noted that his cost basis in the policy of $105,000 was being wasted as it isn't considered a loss for tax purposes. But the cost basis could be preserved and used in a deferred annuity if I could convince the insurance company to grant the policy $1 of surrender value so we could do an IRC Section 1035 exchange with a deferred annuity. My client was prepared to add to this exchange a payment of $100,000. After a good deal of begging, the insurance company relented and granted us $1 of surrender value. With the addition of the $100,000 premium, the deferred annuity had $100,001 in initial value and a cost basis of $205,000. This means that the first $105,000 of annuity earnings will be tax free, whether the client decides to annuitize it and take lifetime payments or keep it until his death. Usually 1035 exchanges are associated with avoiding taxable gain when exchanging annuities, life insurance policies or life insurance for annuities, but in this case there was no taxable income to avoid-only the preservation and use of the client's otherwise lost cost basis. This strategy isn't exactly a planning home run-it's more like moving the runner from first to third. This same strategy of preserving and using cost basis can be planned for. Because of the unlimited marital deduction, the estate tax usually is not due until the second spouse's death. Therefore, when the only life insurance need is for temporary liquidity, we consider using low-load survivorship universal life on one of the spouses instead of term insurance, using a target premium projected to keep the policy in force for the desired time. Universal life will let you manage the policy so it has a small amount of surrender value when it might be terminated. This isn't the case with term insurance, which never has any surrender value and therefore nothing to use to initiate a 1035 exchange. Let's say a husband and wife are both 45 and need $5 million of liquidity for about 20 years, after which they expect the family business to be sold or liquidated. The current target annual premium of $2,800 will produce a cost basis in 20 years of $56,000. With a small amount of surrender value and the addition of around $50,000, the $56,000 liquidity insurance cost basis can be preserved and used by exchanging with a deferred annuity. (Remember, as with all priced-to-the-market permanent life insurance policies with level death benefits, you need to monitor and adjust the target premiums as interest crediting, and perhaps mortality costs, change). This isn't grand planning, but creative little advantages
can add up for your clients. Reprinted with permission by the Financial Planning Association, Journal of Financial Planning, Volume 16, Issue 3, March 2003.
|
|
||||||