In 2017, the Tax Cut and Jobs Act proposed sweeping tax reforms. In the midst of a flurry of executive orders, regulatory rollback and panic in the media, the Trump administration managed to deliver on its promise for tax reform, and the TCJA was signed into law. This article introduces the private placement life insurance industry and reveals planning opportunities for its products in light of the Trump administration’s tax reforms.
As of 2018 (and expiring in 2025), the new tax rates became 10%, 12%, 22%, 24%, 32%, 35% and 37%. Donald Trump’s tax reform decreased tax rates for high net worth individuals and couples. The tax rate in 2017 for high net worth couples making $470,701 or more was 39.6%, while the tax rate in 2019 (filed in 2020) for those same couples caps at 37%.
The reform also targeted a significant reduction in itemized deductions (mortgage interest deductions were reduced from a maximum of $1,000,000 debt in 2017 to $750,000 in 2019, for example). The standard deduction increased to $12,200 in 2019 (filed in 2020) for single taxpayers and $24,400 for married couples filing jointly.
Contrary to what was anticipated, the federal estate tax was not repealed. The gift tax also remains intact, and both the federal estate tax exemption and gift exemption were doubled.
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 appeared and disappeared 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 the 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 salesmen 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 believe that anything with the word “insurance” is inherently bad.
As a result, this market segment never enjoyed more than 25 capable salesmen 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 20 people 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. What’s more, they don’t have to go it alone. Investment professionals will form joint venture arrangements with life insurance professionals to utilize private placement insurance products.
As noted above, 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% 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.
[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: The Legal & Tax Aspect of Investing: Asset Protection, Estate Planning and Tax Efficiency and Goal Based Investing – Planning for Key Life Events. This is an updated version of an article originally published on February 8, 2017.]
©All Rights Reserved. April, 2020. DailyDAC™, LLC d/b/a/ Financial Poise™
Gerry Nowotny is a tax and estate planning attorney. He focuses on income and estate tax reduction and deferral strategies. Gerry has spent the last three decades in the insurance and financial planning industries. Gerry has CFP®, CLU® and ChFC® professional designations.
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