by Gerry Nowotny, J.D., CLU, ChFC, CFP
This article introduces the private placement life insurance industry and reveals planning opportunities for its products in a Trump presidency—especially in light of his proposed tax reforms.
I grew up in the Panama Canal Zone during the 1960’s and 1970’s during the Vietnam War, which, as an American teenager, provided me an interesting perspective.
I was on the outside looking in. Quite literally.
The primary outlet to American culture came through the U.S. Military’s AFRTS radio and TV. American TV was available only eight hours per day, while the radio provided 24-hour coverage. Casey Kasem’s American Top Forty provided the connection to the rock-and-roll trends of the day. (I was a very average trombone and baritone player through junior high school and high school and naturally gravitated to horn bands—Blood Sweat and Tears, Chicago and Tower of Power.)
Chicago was recently inducted to the Rock and Roll of Fame, finally overcoming a 20-year bias against horn bands.
One of the early hits of Chicago was Does Anybody Really Know What Time It Is? It is a classic song with an excellent trumpet solo by Lee Loughnane.
Speculation about the lyrics for Does Anybody Really Know What Time It Is? suggest that it was an anti-war song. It dealt with the disconnect between a war fought by poor kids in a faraway land (Vietnam), while rich kids in the USA seemed to lead of normal life with no concern for anything outside their individual pursuits.
Let’s flash forward.
After two weeks of the new President Trump administration and a flurry of executive orders on immigration and regulatory rollback, there seems to be a lot of confusion and panic in the media—but apparently none by the President’s supporters.
The real problem seems to be the surprise and unfamiliarity with a President actually delivering on campaign promises. As it turns out, Trump meant what he said on the trail.
The anticipation of Trump’s proposed tax reforms created much speculation regarding the possible repeal of the estate tax. If Republicans cannot deliver estate tax repeal with a GOP-controlled House and Senate, then repeal may never happen.
Donald Trump’s tax reform proposal offers three marginal tax brackets: 12%; 25%; and 33%.
The reform proposal also targets a significant reduction in itemized deductions—$100,000 for single taxpayers and $200,000 for married couples filing jointly. The standard deduction would increase to $15,000 for single taxpayers and $30,000 for married couples filing jointly.
One potential scenario involves the repeal of the federal estate tax, while the gift tax remains intact (citing the importance of the gift tax from an income tax standpoint regarding the historical cost basis of an asset).
The plans include a repeal of the step-up in basis of a capital asset at death.
This leads us to two important questions circulating in the financial services industry:
The question of changes in the taxation of life insurance seem to arise every time that tax reform looms. Between the life insurance industry’s lobbying group (the American Council of Life Insurers) and the agent’s lobby group (NAIFA, National Association of Insurance and Financial Advisors), opponents of reform face plenty of wealth and influence.
In the past, proposed changes in the taxation of life insurance appear and disappear in a day or two. The life insurance industry is just that powerful.
Life insurance is the most tax-advantaged financial product under the Sun. Accept it!
Life insurance isn’t perfect. Consumers often worry about the high frontend, or “heaped,” commission loads in most permanent life insurance products.
That’s where private placement life insurance (PPLI) and deferred annuities come in. In the PPLI market segment, every policy is a customized deal. Buyers purchase PPLI because they want the death protection and tax advantages of life insurance within a low-cost policy and with customized investment options. Virtually all of the mortality or death benefit risk is reinsured with large investment grade reinsurers. Statutory exemptions in the jurisdiction where the policy is issued protect the policy assets from the claims of the insurer’s creditors.
These products are customized variable insurance products, are institutionally priced and are essentially “no load” insurance products with the ability to customize the policies with virtually any type of investment asset class.
PPLI is a niche product in a high-niche industry that largely went unnoticed over the last two decades. This is because private placement life insurance industry went through several iterations of “stop and starts” since the mid-1990’s. Unfortunately, the product never reached its full potential.
(During this timeframe, hundreds of billions of dollars flooded in and out of tax-inefficient hedge funds. All the while, a perfect tax solution for these investments laid by the wayside.)
In my view, the primary reason is a lack of distribution (i.e. people selling the product). Life insurance salesman like to sell fully commissionable products rather than low-load or no-load products. Non-life insurance salesmen struggle selling a complex product like private placement life insurance. In some cases, they feel that selling life insurance is professionally beneath them. Investment professionals and RIAS have not previously embraced PPLI. Culturally, they culturally believe that anything with the word “insurance” is instinctively bad.
As a result, this market segment never enjoyed more than 25 capable salesman at any given time. It’s obvious that you can’t build an industry on the backs of 25 people.,
The PPLI industry probably has approximately $15 billion of assets under management in the onshore and offshore marketplace.
At one point or another, any number of private banks and wirehouses looked at PPLI. Typically, the due diligence process within the bank would take so long that the executives heading the project would leave somewhere in the middle of the project for a new job. The end result was nothing ever got started.
At the same time, the “churn and burn” mentality of investment brokers was not well suited for a long-term product like PPLI.
Tax and estate planning attorneys never pushed the product. They get too much business from retail life insurance agents. Once CPAs got a dose of retail commission selling life insurance, they turned their backs on PPLI as well.
The life insurers in the PPLI marketplace are the antithesis of the large life insurers. Most buyers want the largest, oldest and most financially solvent life insurer.
There is nothing wrong with that model—except in the PPLI marketplace.
Without exception, every large life insurer exited the high net worth PPLI marketplace: New York Life, Sun Life, American General, MassMutual and Nationwide. As a result, the industry is left with small closely held life insurers that are very sophisticated but without the cache of Northwestern Mutual.
Blackrock, the world’s largest asset management company, owns the largest life insurance carrier in the private placement life insurance industry. Blackrock purchased Philadelphia Financial Life Assurance Company, the largest domestic PPLI carrier, and Lombard International, the largest PPLI carrier outside of the U.S, and merged the two companies with the Lombard brand.
As a result of the merger, the PPLI industry has its greatest opportunity for financial breath through. Smaller carriers will enjoy the trickle down benefit of Blackrock’s investment and entry into the marketplace.
Blackrock is the “800 lb. gorilla” in the PPLI marketplace. Nevertheless, it faces strong competition from smaller niche carriers, such as domestic and Bermuda-based carriers Crown Global, Acadia, Investors Preferred and Zurich.
In my view, every life insurer in the PPLI space, large or small, benefits from recent trends and acquisitions of carriers within this market segment.
The global investment access of large investment management firms—combined with the customized tax-advantages of PPLI—allows carriers to access buyers and sellers it might never have met. Investment firms and traders (including RIAs) are likely to become more active participants in the PPLI marketplace.
At the same time, the PPLI industry realizes that you need to have more than 20people selling the product. The entrance of large global investment management firms will fundamentally change the way large law firms look at insurance products and how these attorneys structure for foreign inbound investment planning.
Life insurance agents should recognize that the sale of PPLI products does not necessarily cannibalize the sale of retail products.
Investment professionals will form joint venture arrangements with life insurance professionals to utilize private placement insurance products.
Permanent life insurance is the most tax-advantaged investment vehicle on the planet.
Here are just four surprising tax benefits:
In plain English, the policyholder’s account value grows tax-free, can be withdrawn tax-free, and is received tax-free by beneficiaries at death.
A variable life insurance policy is a permanent life insurance contract with a cash value component and a death benefit component. The growth of the cash value is tied to the investment performance of investment subaccounts, selected by the policyholder, in retail variable insurance products. (These investment choices are mutual fund clones or sub-accounts.)
The policyholder bears all of the investment risk. The assets supporting the policy cash value are separate or segregated from the life insurer’s general account asset and its creditors. The policyholder is able to select these funds within the life insurance policy with the carrier’s fund election form.
Private placement life insurance is a form of variable universal life insurance.
With PPLI, the insurer provides the policyholder with the ability to customize the investment options within the policy. The range of investment options can include a customized fund managed by the client’s existing investment advisor as well as a range of asset classes including hedge funds, real estate and private equity.
Private Placement Variable Deferred Annuity (PPVA) products provide for income tax deferral on investment income within the policy. The product provides for the ability to customize investment options.
The purchase of private placement insurance products is limited to accredited investors and qualified purchasers as defined under federal securities law. Private placement insurance products are a non-registered security for federal and state securities law purposes. The product is available to accredited investors and qualified purchasers as defined in federal securities law. The Securities Act of 1933 provides an exemption under Section 4(2) from securities registration for accredited investors as defined in Rule 501(a) of Regulation D under the Securities Act.
An accredited investor is defined as an investor with a net worth of at least $1 million and joint income of at least $300,000 in each of the last two years, with the likelihood of continuation in the current year.
PPLI offerings are exempt from the Investment Company Act of 1940 under Section 3(c)(1) and 3(c)(7) offerings. Under Section 3(c)(1) the number of beneficial owners is limited to 99 investors. Investors must be accredited investors or qualified purchasers. A qualified purchaser has investable assets of at least $5 million. Under Section 3(c)(7) the number of beneficial owners is limited to 499 investors. The investors must be qualified purchasers. New SEC proposals would exclude the value of an investor’s principal residence from investable assets.
In order to appreciate the cost perspective of PPLI, you need to understand the cost structure of retail insurance products. Variable life insurance products have a commission structure that pays the agent 55 -95 percent of the target (commissionable) premium in the first policy year.
Commissions in subsequent years on premiums vary by carrier between 2-5% of the premium. Additionally, the agent receives 25-35 basis points (.25-.35%) of the policy’s account value each year. The policies usually have declining surrender charges of 10-12 years. These charges allow the insurer to amortize and recoup sales.
Private placement life insurance and annuities have no surrender charges and compensate the distributor (agent) with premium based commissions equal to 1-3% and asset-based commissions based on the account value of 25-35 basis points.
The impact of these charges creates a “drag” on the investment performance of approximately 1% per year over the life of the policy.
I have been active in the private placement life insurance industry on a full-time basis since 1999. I have been an independent broker, home office employee and attorney working on PPLI.
I have seen the industry take several left-turns to the Road to Nowhere.
I am very favorably encouraged for the PPLI marketplace. Here are the main reasons why:
PPLI provides a tremendous planning opportunity for high net worth clients. Investment gains will not be taxed during the policyholder’s lifetime and will be paid income tax-free at death. This allows pre-death investment gains to be passed to beneficiaries income tax-free.
The planning result: No income taxes during lifetime or at death.
The Trump administration’s tax reform may finally signal that PPLI will be recognized as a mainstream financial product for high net worth investors in their personal financial and tax planning.
Don’t you know what time it is?
Gerry Nowotny is a tax and estate planning attorney. He has a national reputation in niche tax-planning strategies, including private placement and annuity products. He is the managing partner of the Law Office of Gerald R. Nowotny.
Gerry is also an advisor with Diamond Wealth Strategies, based in Northbrook, IL, a boutique financial services firm that offers a comprehensive suite of advisory services. Diamond Wealth caters to Family Offices, ultra-high net worth individuals and business owners.
Gerry has a JD and LL.M in estate planning from the University of Miami School of Law. He has his undergraduate degree from the United States Military Academy. Since then he has earned his Chartered Life Underwriter (CLU®), Chartered Financial Consultant (ChFC®) and Certified Financial Planner (CFP®) designations. He speaks Spanish and Portuguese at the highest level for a non-native speaker.