Abstract:
The estate tax is the only wealth tax levied by the Federal government. It was enacted in 1916, and its scope was expanded to encompass gifts as well. It evolved over the years into the current Unified Transfer Tax which consists of the estate, gift, and generation skipping transfers taxes. The major features of the tax in effect in 2011 reflect a maximum tax rate of 55 percent and an exemption of $1,000,000, with a full exemption for spousal and charitable bequests. The tax provides for a credit for state death taxes at a maximum rate of 16 percent of the federal taxable estate, which effectively reduces the Federal marginal tax rate for the wealthiest estates to a maximum of 39 percent. Temporary features of the tax in effect in 2010 reflect provisions introduced in 2001 which are dramatically different than those in effect in 2011 and beyond.

This manuscript traces the evolution of the estate tax since its enactment. It provides a brief legislative history and description of the structure and features of the tax. Next it reviews the fiscal contribution of each of the estate and gift taxes. In addition, it provides trends on the number of individuals and households touched by the tax as reflected by the number of returns filed over time. It also provides a comprehensive review of the behavioral effects of the tax. Estate and gift taxes may have considerable implications for economic behavior. The latter include the effects on saving, labor supply, charitable giving, migration, capital gains realizations, and timing of transfers among others.

This manuscript is a work in progress and is made available given the timeliness of the subject. It is a companion to my earlier “The Federal Gift Tax: History, Law, and Economics” manuscript which exclusively focused on the gift tax. Comments, corrections, and feedback are greatly appreciated.

Wait one second, life insurance Death Benefits are supposed to tax-free.  Why would this case be any different?  In 2006 congress created an exception to the general rule that life insurance proceeds are a tax-free benefit with IRC section 101(j).  This section of the code was created to stave off abuses such as the so called “Janitor’s Insurance” (ahem, Walmart).  With one broad swoop the IRS succeeded in preventing such abuses, while putting the legitimate uses of employer owned life insurance in a pickle.

101(j) deals with employer owned life insurance contracts (EOLI).  It states that proceeds from EOLI will be taxed as income on the amounts received in excess of the premiums paid into the contract unless certain consent requirements are met.  With the numerous uses of EOLI such as split dollar arrangements, key employee insurance, buy-sell agreements, creditor insurance, deferred compensation, etc.. - How many of your clients are compliant?

If certain notice and consent requirements are met prior to the issuance of the policy, your client’s EOLI policy will retain it’s tax favored death benefit.  These requirements are met if:

1. The policyowner provides written notice that they intend to purchase insurance on the employee’s life and disclose the maximum amount which can be purchased.
2. The employee provides written consent to be insured and that coverage will continue even after the employment agreement terminates.
3. The employee is informed that the policyowner will be the beneficiary of insurance proceeds upon the death of the employee.

Clearly, section 101(j) created many questions (and caused dismay for many advisors) when it was created.  Just recently, the IRS provided some answers.  In May of 2009 the IRS released IRS Notice 2009-48.  This notice provides guidance for the treatment of EOLI under section 101(j) in a question and answer format.  While it answers many questions, it leaves some unanswered, and still creates more.  I’ll dive into Notice 2009-48 in my next post.

-Jamison Hibbard

Is this the beginning of the end for the  industry or the beginning of something huge?  You decide.

Sometimes, when asked what it is that we do, I describe us as “Forensic Insurance Analysts“.  Well, what does that mean?  Forensics is defined as:

The accepted scholarly or scientific methodology and norms under which the facts regarding an event are ascertained. Related to the notion of authentication, where by an interest outside of a legal form exists in determining whether an object is what it purports to be, or is alleged as being.

Thank you wikipedia.

When an insurance policy is sold, it is purported(alleged) to meet a need of the owner.  It is our job to authenticate whether the insurance policy will meet those needs.  Regardless of whether we are hired at the point of sale, 10 years down the road, or when the owner receives the dreaded lapse notice – we will apply our analysis to determine the policy’s viability.  If you haven’t yet, read this for some insight into the coming wave of life insurance policy crashes

Ideally, we are there to periodically use our forensic know-how before it is too late.  As a fee based service, it is our job to consult – not sell.  We are here to recommend the correct course of action based off facts and not simply recommend the alleged latest and greatest product that is available on the market.

In order to help a client achieve their goals for this valuable asset, we assess the critical areas that will affect the ability of this asset to meet the expectations of the client and their advisor.  I’ll get into these in detail later.

But for now position us in your mind as any of the following:

• Forensic Insurance Analysts
• Insurance CSI
• a BS Meter (a very technical term, if you don’t know, ask)
• Life Insurance Policy Management Experts

-Jamison Hibbard

CASE STUDY

Facts:

Attorney contacted our office for advice – existing Premium Finance program for $50 million SUL coverage, collaterally assigned, $5,000,000 of net worth, no exit strategy AND new collateral calls.

It’s a mess! And, this premium financing program will only work if both insureds die earlier than their individual and joint life expectancies.

LIPM Approach:

Analysis and opinion of existing situation, Personalized Life Expectancies, Medical File Rehabilitation.

Results:

Join us on March 4th for “The Rest of the Story”.  To register, follow this link:

https://www1.gotomeeting.com/register/951039648

Policy information is often unverified….

Many policies we are asked to manage have been purchased in sophisticated strategies such as split dollar arrangements.  We often find that no one has verified the correctness of all the policy information (with the insurance company) and associated documents.

A Real Life Scenario:

We were recently asked to help a corporation decide how to manage the premium payments on a series of policies purchased to support a Collateral Assignment Split-Dollar arrangement.  When we obtained all the documents together along with the policies we found that the corporate agreements were for an Endorsement Split-Dollar arrangement while all the policy information supported a Collateral Assignment arrangement.  This was a really big problem.

The Correct Solution:

Often times and despite all good intentions, sophisticated plans are not always designed appropriately for the problem at hand.  Policy information should be reviewed frequently because situations and plans inevitably change or they just plain weren’t set up correctly in the first place.  Cross your t’s, dot your i’s and never assume anything about a life insurance contract without first getting an opinion from a Life Insurance Property Management Professional.

President’s Day Wiki

While there has been much speculation of cases of this kind to come, this is one of the first.  It brings attention to the appropriate protocols that should be followed when managing Life insurance.

Case Overview:

In 1987, Stewart Cochran created an ILIT for the benefit of his 2 daughters.  The trust was funded with 3 life insurance policies and an annuity.  The total death benefit of these policies was $4.8 million.  In 1999 Keybank, the trustee, received a call from the grantor’s life insurance agent recommending that the policies be exchanged for 2 new VUL policies with a total death benefit of $8 million.  Keybank approved this exchange.

In 2001 the market dropped and caused these policies to substantially underperform.  Following the market drop, Keybank had a third party perform an audit on these policies.  This audit revealed that the 2 VUL policies would lapse before the grantor reached life expectancy.  The market downturn also had a negative effect on Mr. Cochran’s financial situation that left him unable to supplement the policies with additional premium.

With the help of Mr. Cochran’s insurance agent, the policies were exchanged again for a guaranteed death benefit product that would remain in-force until the insured’s age 100.  This exchange was also approved by the third party consultant. The exchange resulted in a reduced death benefit of $2.87 million within the ILIT.

Soon after the exchange, Mr. Cochran died unexpectedly and the ILIT beneficiaries sued the trustee for breach of fiduciary duty.  The trial court posed the case as follows:

Was it prudent for the Trustee to move the trust assets from insurance policies with significant risk and likelihood of ultimate lapse into an insurance policy with a smaller but guaranteed death benefit?

The trial and subsequent appeals court both ruled in KeyBanks favor.  A deciding factor in this favorable ruling was that KeyBank hired and relied on the recommendations of  “an outside, independent entity with no policy to sell or any other financial stake in the outcome”

The court also noted that the use of hindsight in determining the appropriateness of the drop of death benefit to $2.78 million was not acceptable.

My Thoughts:

Life insurance is a unique asset that requires management in accordance with a state’s version of the UPIA.  Due to this asset’s complex nature, the trustee of an ILIT is in a difficult position – what is the correct course of action when managing life insurance owned by an ILIT?  Given that TOLI is held to UPIA standards, substantial increases in TOLI litigation are likely.

I believe that this case affirms that no major TOLI decision should be made by a trustee without first consulting an independent, third party policy management specialist.  Furthermore, the ongoing management of these policies by a specialist will assure that a trustee is operating within the guidelines set by a state’s UPIA.  Additionally, many of the issues in this case would have been avoided altogether had the policies been periodically reviewed by a knowledgeable 3rd party.

-Jamison Hibbard

In the current economic climate, litigation over estate planning is increasing and will continue to increase.  One area that is already seeing litigation relates to life insurance issues with estate planning.  The recent case of In re Stewart Cochran Irrevocable Trust, 901 N.E.2d 1128 (Ind. Ct. App. 2009), illustrates this exact issue.  Attorneys, clients, fiduciaries, and other advisors often mistakenly view life insurance as a stagnant asset that does not need to be managed, amended, or even overhauled.  This error can be extremely costly.  If the attorney learns to identify life insurance policies in jeopardy, he or she can improve an estate plan while assisting the trustees to fulfill their fiduciary duties.  The attorney thereby mitigates possible fiduciary liability.  For that reason, each attorney should understand the problems and solutions related to planning with life insurance.

That introduction echoes some of our thoughts on the importance of Life Insurance Policy Management and our Objectiview Process.  Keep an eye out for more on this article once I receive the full text.

-Jamison Hibbard

Believing that a Death Benefit Guarantee provision on a Universal Life Policy means the policy is guaranteed.…

The saying goes, “The only two guarantees in life are death and taxes”.  Life insurers would like us all to believe that a guaranteed universal life policy is right up there with them.  Unfortunately, there is significant room for error in these products too.

A guaranteed death benefit can be incredibly useful in an Estate Plan.  The guaranteed life insurance policy is designed to assure that the policy will be there when it is needed.

Over the last 10 years or so, most of the Universal Life policies that were sold included a Death Benefit Guarantee Provision.  But, each policy has specific performance parameters that must be met to keep the guarantee and they differ greatly from policy to policy.  These can vary by policy series even within the same company.  A small mistake can cause the loss of the coverage.  We believe as many as 50% of the existing policies with this provision are already flawed!

A Real Life Scenario

We recently had a case brought to us by the trustee of an existing ILIT.  Two years earlier they had purchased a new Universal Life policy with a Death Benefit Guarantee.  We completed our Investment Policy Statement with a Preliminary Review and discovered that the policy had already lost its Death Benefit Guarantee Provision.

Upon further research, we found that the reason for the loss was that the second year’s premium had been credited 7 days before the policy anniversary.  The policy had a higher cost-structure in year one than year two, and since the payment was credited during the first policy year, this additional cost was “captured”.  This resulted in there not being sufficient premium allocated to the second policy year to satisfy the guarantee.  This small difference destroyed the Death Benefit Guarantee Provision and highlights the problem that each Guarantee Provision is unique and must be carefully complied with in order to keep the guarantee in force.

The Correct Solution

While guarantees are extremely useful, it is prudent to monitor them and make sure they are maintained.  Our Objectiview system is an independent, fee only service that provides an objective assessment of the performance of existing permanent life insurance or the purchase of such insurance.  It is designed to handle complex issues like these and provide advisors and their clients with the information needed to make important decisions.

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