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Lance Wallach, Expert Witness, Section 79 Help
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ABUSIVE INSURANCE PLANS GET RED FLAG 345 views, 45 likes
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IRS Wants You to Know About Schemes, Scams and Cons
Lance Wallach
If it sounds too good to be true, it probably is!" Seek professional advice from the IRS or a Tax Professional before you subscribe to any scheme that offers exemption from your obligation as a United States Citizen to pay taxes. Buying into a tax evasion scheme can be very costly.
Department of Justice Press Releases on Civil and Criminal Actions Taken as a Result of IRS Enforcement Activities
The Department of Justice issues press releases on IRS enforcement activities.
Tax Scams: How to Recognize and Avoid Them
To help the public recognize and avoid abusive tax schemes, the IRS offers an abundance of educational materials. Participating in an illegal scheme to avoid paying taxes can result in imprisonment and fines, as well as the repayment of taxes owed with penalties and interest. Education is the best way to avoid the pitfalls of these “too good to be true” tax scams.
Tax Scams/Consumer Alerts
Don't fall victim to tax scams. The IRS issues News Releases on some of the common scams, including the annual Dirty Dozen news release.
Special Advice for Law Enforcement on Avoiding Tax Preparer Scams
Enforcing the Laws and Paying Taxes: Is there a Connection?
This is one of many outreach articles the IRS prepares to help educate the public about tax scams.
Examples of Fraud Investigations
In addition to the Tax Fraud Alerts page, Criminal Investigation (CI) wants you to know about other areas of fraud in which individuals have been criminally prosecuted.
How Do You Report Suspected Tax Fraud Activity?
If you have information about an individual or company you suspect is not complying with the tax law, report this activity.
If you have information about an individual or company you suspect is not complying with the tax law, report this activity.
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
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Insurance companies are in big trouble and most do not know it.
Insurance companies are in big trouble and most do not know it.
Many life insurance companies are using captive insurance to alter their books and look better. This could lead to another taxpayer bailout and insurance companies being taken over. This would put benefits in policies at risk for some policyholders.
By using a captive many insurance companies allow the companies to describe themselves as richer and stronger. This misleads regulators, the ratings agency and consumers who rely on rating. The NY insurance dept. said the insurance based in New York had burnished their books by $48 billion using captive insurance companies, often owned by the insurers.
I have been writing about some problems with captives for years, and this is one of the problems. The use of a captive to mislead people is not what captives are for, but some of them do this.
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Captive Insurance Companies and Risk Retention Groups
Captive Insurance Companies and Risk Retention Groups
Managed properly, a captive insurance company can be an effective way of financing the cost of risk. And a key member of a successful captive management team is the actuary. The actuary can help the management team answer the many questions faced by a captive such as:
- Are the premiums adequate?
- How are the premiums allocated?
- Is there sufficient capital?
- Is the reserve adequate?
- What is the appropriate retention?
- What insurance coverage is to be provided?
- Is reinsurance to be purchased?
- What is the appropriate investment strategy?
- What are appropriate financial performance measures?
- How is the health of reinsurers or fronting insurers?
- What are the ratings from the rating agencies?
- What are the data capture needs?
- Are you compliant with regulatory requirements?
- How is the transfer of risk being supported?
- How are the premiums allocated?
- Is there sufficient capital?
- Is the reserve adequate?
- What is the appropriate retention?
- What insurance coverage is to be provided?
- Is reinsurance to be purchased?
- What is the appropriate investment strategy?
- What are appropriate financial performance measures?
- How is the health of reinsurers or fronting insurers?
- What are the ratings from the rating agencies?
- What are the data capture needs?
- Are you compliant with regulatory requirements?
- How is the transfer of risk being supported?
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Internal Revenue Code Section 79 Plans and Captive Insurance History
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A Pure Captive Insurance Company
A pure captive insurance company is an insurance company created by the owners of an operating business to provide supplemental property and casualty insurance to such operating business. The shares of the captive insurance company can be owned by owners of the operating business or an irrevocable trust for the benefit of such owner’s heirs. For many years the IRS argued that premiums paid into a captive insurance company were not deductible due to the related ownership of the insured and insurer (referred to as the “economic family doctrine”). In 2001, after consistently losing in tax court on this premise, the IRS abandoned the economic family doctrine. IRS not only abandoned the economic family doctrine but also began to provide guidance, through revenue rulings 2002-89, 2002-90 and 2002-91, as to how to properly create a captive insurance company. Since 2002, as this area of planning has evolved, the IRS has continued to provide clear guidance which uphold the validity of captive insurance arrangements. In today’s litigious environment, many large and small businesses have captive insurance arrangements in place which insure a wide range of risks not insured in their commercially procured property and casualty coverage. Certain captive arrangements may elect IRC 831 (b) status which allows the captive insurance company to receive annual premiums of less than $1.2 million income tax free. In addition, small business owners can incorporate dynastic estate planning concepts into the ownership structure of the CIC to allow for wealth preservation. Done correctly this can afford the small business owner the opportunity to transfer assets to the next generation free of gift and estate taxes. Further, by not having the captive in the owner’s name, assets of the captive are protected from certain creditors. |
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IRS Audits and Lawsuits on 419 and 412i Plans
IRS Attacks Business Owners in 419, 412, Section 79 and Captive Insurance Plans Under Section 6707A - By Lance Wallach - Taxpayers who previously adopted 419, 412i, captive insurance or Section 79 plans are in big trouble. In recent years, the IRS has identified many of these arrangements as abusive devices to funnel tax deductible dollars to shareholders and classified these arrangements as listed transactions."
These plans were sold by insurance agents, financial planners, accountants and attorneys seeking large life insurance commissions. In general, taxpayers who engage in a “listed transaction” must report such transaction to the IRS on Form 8886 every year that they “participate” in the transaction, and you do not necessarily have to make a contribution or claim a tax deduction to participate. Section 6707A of the Code imposes severe penalties for failure to file Form 8886 with respect to a listed transaction. But you are also in trouble if you file incorrectly. I have received numerous phone calls from business owners who filed and still got fined. Not only do you have to file Form 8886, but it also has to be prepared correctly. I only know of two people in the U.S. who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over 50 phones calls to various IRS personnel. The filing instructions for Form 8886 presume a timely filling. Most people file late and follow the directions for currently preparing the forms. Then the IRS fines the business owner. The tax court does not have jurisdiction to abate or lower such penalties imposed by the IRS.
"Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior years."
Many business owners adopted 412i, 419, captive insurance and Section 79 plans based upon representations provided by insurance professionals that the plans were legitimate plans and were not informed that they were engaging in a listed transaction. Upon audit, these taxpayers were shocked when the IRS asserted penalties under Section 6707A of the Code in the hundreds of thousands of dollars. Numerous complaints from these taxpayers caused Congress to impose a moratorium on assessment of Section 6707A penalties.
The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out notices proposing the imposition of Section 6707A penalties along with requests for lengthy extensions of the Statute of Limitations for the purpose of assessing tax. Many of these taxpayers stopped taking deductions for contributions to these plans years ago, and are confused and upset by the IRS’s inquiry, especially when the taxpayer had previously reached a monetary settlement with the IRS regarding its deductions. Logic and common sense dictate that a penalty should not apply if the taxpayer no longer benefits from the arrangement. Treas. Reg. Sec. 1.6011-4(c)(3)(i) provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published guidance identifying the transaction as a listed transaction or a transaction that is the same or substantially similar to a listed transaction.
Clearly, the primary benefit in the participation of these plans is the large tax deduction generated by such participation. Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior years. While the regulations do not expand on what constitutes “reflecting the tax consequences of the strategy,” it could be argued that continued benefit from a tax deferral for a previous tax deduction is within the contemplation of a “tax consequence” of the plan strategy. Also, many taxpayers who no longer make contributions or claim tax deductions continue to pay administrative fees. Sometimes, money is taken from the plan to pay premiums to keep life insurance policies in force. In these ways, it could be argued that these taxpayers are still “contributing,” and thus still must file Form 8886.
It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of a particular transaction as described in the published guidance that caused such transaction to be a listed transaction. Revenue Ruling 2004-20, which classifies 419(e) transactions, appears to be concerned with the employer’s contribution/deduction amount rather than the continued deferral of the income in previous years. Another important issue is that the IRS has called CPAs material advisors if they signed tax returns containing the plan, and got paid a certain amount of money for tax advice on the plan. The fine is $100,000 for the CPA, or $200,000 if the CPA is incorporated. To avoid the fine, the CPA has to properly file Form 8918.
These plans were sold by insurance agents, financial planners, accountants and attorneys seeking large life insurance commissions. In general, taxpayers who engage in a “listed transaction” must report such transaction to the IRS on Form 8886 every year that they “participate” in the transaction, and you do not necessarily have to make a contribution or claim a tax deduction to participate. Section 6707A of the Code imposes severe penalties for failure to file Form 8886 with respect to a listed transaction. But you are also in trouble if you file incorrectly. I have received numerous phone calls from business owners who filed and still got fined. Not only do you have to file Form 8886, but it also has to be prepared correctly. I only know of two people in the U.S. who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over 50 phones calls to various IRS personnel. The filing instructions for Form 8886 presume a timely filling. Most people file late and follow the directions for currently preparing the forms. Then the IRS fines the business owner. The tax court does not have jurisdiction to abate or lower such penalties imposed by the IRS.
"Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior years."
Many business owners adopted 412i, 419, captive insurance and Section 79 plans based upon representations provided by insurance professionals that the plans were legitimate plans and were not informed that they were engaging in a listed transaction. Upon audit, these taxpayers were shocked when the IRS asserted penalties under Section 6707A of the Code in the hundreds of thousands of dollars. Numerous complaints from these taxpayers caused Congress to impose a moratorium on assessment of Section 6707A penalties.
The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out notices proposing the imposition of Section 6707A penalties along with requests for lengthy extensions of the Statute of Limitations for the purpose of assessing tax. Many of these taxpayers stopped taking deductions for contributions to these plans years ago, and are confused and upset by the IRS’s inquiry, especially when the taxpayer had previously reached a monetary settlement with the IRS regarding its deductions. Logic and common sense dictate that a penalty should not apply if the taxpayer no longer benefits from the arrangement. Treas. Reg. Sec. 1.6011-4(c)(3)(i) provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published guidance identifying the transaction as a listed transaction or a transaction that is the same or substantially similar to a listed transaction.
Clearly, the primary benefit in the participation of these plans is the large tax deduction generated by such participation. Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior years. While the regulations do not expand on what constitutes “reflecting the tax consequences of the strategy,” it could be argued that continued benefit from a tax deferral for a previous tax deduction is within the contemplation of a “tax consequence” of the plan strategy. Also, many taxpayers who no longer make contributions or claim tax deductions continue to pay administrative fees. Sometimes, money is taken from the plan to pay premiums to keep life insurance policies in force. In these ways, it could be argued that these taxpayers are still “contributing,” and thus still must file Form 8886.
It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of a particular transaction as described in the published guidance that caused such transaction to be a listed transaction. Revenue Ruling 2004-20, which classifies 419(e) transactions, appears to be concerned with the employer’s contribution/deduction amount rather than the continued deferral of the income in previous years. Another important issue is that the IRS has called CPAs material advisors if they signed tax returns containing the plan, and got paid a certain amount of money for tax advice on the plan. The fine is $100,000 for the CPA, or $200,000 if the CPA is incorporated. To avoid the fine, the CPA has to properly file Form 8918.
As an expert witness Lance Wallach's side has never lost a case. People need to be careful of 419 Welfare Benefit Plans, 412i plans, Section 79 plans and Captive Insurance Plans. Most of these plans are sold by insurance agents. If you are in an abusive, listed or similar transaction plan you need to file under IRS 6707a. The participant files form 8886, and the salesmen or accountant who signs the tax returns files form 8918 if they got paid over $10,000. They are called Material Advisors and face a minimum $100,000 fine. Some plans are offshore which could involve FBAR or OVDI filings. If you have money overseas you probably need to file for IRS tax amnesty. If you want to reduce the tax we suggest that you first file and then opt out. For more information Google Lance Wallach.
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
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Captive Insurance
Choosing a domicile.
- Regulatory environment. Some jurisdictions are friendlier than others, or their statutes may permit different used and forms of captives.
- Minimum capitalization requirements – varies between jurisdictions from $150,000 to $750,000. Separate series of a group captive requires risk-based amount of capital, typically
- Start-up costs and annual maintenance – typical start-up costs range from $50,000 to $80,000 for pure captive (plus required capital) and from $20,000 to $25,000 for cell (or series) of group captive.
- Underwriting risk classification
- Traditional coverage or non-traditional coverage, such as loss of license.
- Tax implications.
- Small insurance company with premiums less than $1,200,000. See Section 831(b) of the Internal Revenue Code. Applies to US tax-law compliant companies.
- Excise taxes on premiums paid for non-US captives.
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The Benefits of Captive Insurance Companies
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Captive Insurance and Other Tax Reduction Strategies – The Good, Bad, and Ugly
By Lance Wallach May 14th
Every accountant knows that increased cash flow and cost savings are critical for businesses. What is uncertain is the best path to recommend to garner these benefits.
Over the past decade business owners have been overwhelmed by a plethora of choices designed to reduce the cost of providing employee benefits while increasing their own retirement savings. The solutions ranged from traditional pension and profit sharing plans to more advanced strategies.
Some strategies, such as IRS section 419 and 412(i) plans, used life insurance as vehicles to bring about benefits. Unfortunately, the high life insurance commissions (often 90% of the contribution, or more) fostered an environment that led to aggressive and noncompliant plans.
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion. For unknowing clients, the tax consequences are enormous. For their accountant advisors, the liability may be equally extreme.
Recently, there has been an explosion in the marketing of a financial product called Captive Insurance. These so called “Captives” are typically small insurance companies designed to insure the risks of an individual business under IRS code section 831(b). When properly designed, a business can make tax-deductible premium payments to a related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed as capital gains.
While captives can be a great cost saving tool, they also are expensive to build and manage. Also, captives are allowed to garner tax benefits because they operate as real insurance companies. Advisors and business owners who misuse captives or market them as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose of an insurance company face grave regulatory and tax consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives under section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable at corporate rates, and then will be taxable again when distributed. The consequence of this double taxation is to devastate the efficacy of the life insurance, and it extends serious liability to any accountant who recommends the plan or even signs the tax return of the business that pays premiums to the captive.
Over the past decade business owners have been overwhelmed by a plethora of choices designed to reduce the cost of providing employee benefits while increasing their own retirement savings. The solutions ranged from traditional pension and profit sharing plans to more advanced strategies.
Some strategies, such as IRS section 419 and 412(i) plans, used life insurance as vehicles to bring about benefits. Unfortunately, the high life insurance commissions (often 90% of the contribution, or more) fostered an environment that led to aggressive and noncompliant plans.
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion. For unknowing clients, the tax consequences are enormous. For their accountant advisors, the liability may be equally extreme.
Recently, there has been an explosion in the marketing of a financial product called Captive Insurance. These so called “Captives” are typically small insurance companies designed to insure the risks of an individual business under IRS code section 831(b). When properly designed, a business can make tax-deductible premium payments to a related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed as capital gains.
While captives can be a great cost saving tool, they also are expensive to build and manage. Also, captives are allowed to garner tax benefits because they operate as real insurance companies. Advisors and business owners who misuse captives or market them as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose of an insurance company face grave regulatory and tax consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives under section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable at corporate rates, and then will be taxable again when distributed. The consequence of this double taxation is to devastate the efficacy of the life insurance, and it extends serious liability to any accountant who recommends the plan or even signs the tax return of the business that pays premiums to the captive.
The IRS is aware that several large insurance companies are promoting their life insurance policies as investments with small captives. The outcome looks eerily like that of the 419 and 412(i) plans mentioned above.
Remember, if something looks too good to be true, it usually is. There are safe and conservative ways to use captive insurance structures to lower costs and obtain benefits for businesses. And, some types of captive insurance products do have statutory protection for deducting life insurance premiums (although not 831(b) captives). Learning what works and is safe is the first step an accountant should take in helping his or her clients use these powerful, but highly technical insurance tools.
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Lance Wallach speaks and writes extensively about VEBAs, retirement plans, and tax reduction strategies. He speaks at more than 70 conventions annually, writes for 50 publications, and was the National Society of Accountants Speaker of the Year. Contact him at 516.938.5007 or visit www.vebaplan.com.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
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Variable Life Insurance's Bear Market Headaches
JUNE
What do you do if you have new clients burdened with severely underfunded variable universal life policies?
It's a problem that tends to rear its ugly head in a bear market. In fact, individuals, who purchased variable universal life (VUL) at the market peak in 1999 and bet heavily on the stock market saw their investments drop at least 20% in 2000 and 2001. And those who underfunded their policies and relied on market appreciation of the cash value may have had to kick in higher premiums to keep their policies in force.
It can be a particular problem when combined with the high cost of some VUL policies, says James Hunt, a former Vermont state insurance commissioner who runs an insurance policy evaluation service for the Consumer Federation of America. Mortality and expense charges, commissions, administrative fees and fund expenses can take a big bite out of cash-value total returns, Hunt says. There also are state premium taxes. The internal rates of return on a policy's cash value can be as high as 500 basis points with an unfavorable policy. At the low end, internal rates of return run about 200 basis points less.
Paula Hogan, a Milwaukee-based financial planner, says she has worked with a couple of new clients who were hit badly with variable universal life policies. Fortunately, the policies had sufficient cash surrender values. She did 1035 tax-free exchanges out of the variable universal life policies into low-cost deferred variable annuities.
When the policyholder annuitizes the contract, she notes, capital is withdrawn from the immediate annuity at a tax loss. "The caveat is if you leave the life insurance policy intact, the stock market may turn around and policyholders will profit," she says.
Given the outlook for the stock market today, Hogan says it may be wise to keep a client in an underfunded policy. Ordinarily, Hogan favors term insurance. But for clients who want a cash-value policy, she recommends whole life. "They don't need to take risks with their life insurance," she believes. "They can invest in stock funds in their retirement plans."
However, Peter Katt, a Mattawan, Mich.-based CFP and insurance agent, believes that defined-benefit variable universal life policies should be changed. Otherwise, over the years, policyholders will underfund or overfund their policies.
He believes that they may be changed to defined-contribution designs with high premium payments relative to the low initial death benefits. This way, the benefits are almost certain to increase significantly without any changes to the premium payments. Another option, he says, is to convert to a special premium management system.
Insurance analysts say that underfunding of variable universal life isn't as widespread as it may appear. Nevertheless, some of those affected by policy losses are concerned that they will lose their life insurance coverage after sinking a fortune into their policies. "I've looked at quite a few variables (VUL) for consumers as well as financial advisors," Hunt says. "I haven't heard about it being a major problem."
James Finnegan, senior vice president of Moody's Insurance Group, N.Y., agrees that for the most part the policies are being properly funded. Nevertheless, a physician recently contacted Hunt about a high-cost $2 million policy. The insurance costs ran $1 per $1,000 over coverage. By contrast, similar term insurance would have cost just 25 cents per $1,000.
She purchased the policy in October 2001, and paid monthly premiums of $1,250 for 30 months. The cash value was invested in 15 different stock funds as directed by her financial advisor. But the surrender value of the policy was $6,000 below the surrender charge. If she had cashed out the policy she would end up with nothing.
"It was a serious mistake to buy a $2 million policy at a level premium," Hunt says. "The risks are great in the early years of the policy."
This physician is not alone. Since the beginning of 2001, the National Association of Securities Dealers has taken disciplinary actions against eight brokerage firms for the sale of variable life insurance. There were none in 2000.
The brokerage firms and individual brokers settled charges without admitting or denying NASD Regulation allegations. Monetary sanctions in the settled actions totaled in the hundreds of thousands of dollars, according to a NASD spokesperson.
The firms were charged with lack of supervision, unsuitable sales and failure to communicate material facts about the VUL policies they sold. There also have been a number of class action lawsuits filed against brokers and insurance companies.
"There is a lot of litigation involving the sale of variable life products," says John Yanchunis, partner with James & Hoyer, a Tampa, Fla.-based law firm. "The illustrations are not supported by the facts. The elderly were put in unsuitable investments."
Yanchunis says his firm is involved in 50 class action lawsuits. Elderly clients allegedly were switched out of their whole-life policies into variable universal policies. The seniors were told they were buying vanishing-premium policies. Meanwhile, younger people were allegedly sold VUL as retirement-savings accounts with level premiums.
In both instances, Yanchunis says the policies are beginning to explode. The premiums and cash values are insufficient to cover the cost of the insurance. The problem with VULs may rest with the hypothetical policy illustrations, stresses Norse Blazzard, chairman of the National Association of Variable Annuities' committee on variable life. Regulations require that policyholders review illustrations based on hypothetical returns. During the bull market of the 1990s, premiums were often based on 10% to 12% annual rates of return.
"The SEC (Securities and Exchange Commission) requires the illustrations, but they are meant to show people how the policy works," Blazzard says. "Most people don't minimum fund, but there are always bound to be problems."
Ted Kilkuskie, chief marketing officer with Hartford Life Insurance Co., says that the few problems that arise industrywide with variable universal life insurance are blown out of proportion by the media. Hartford deals with affluent clients who typically fund their policies to the maximum allowable limit.
The company's average annual VUL premium is $10,700 with a face amount, or death benefit, of $520,000. He stresses that his firm's 200 wholesalers work closely with account executives to make sure that VULs are properly funded and diversified.
"We have seen no significant increase in VUL complaints by our policyholders," says Kilkuskie, whose company is the second-largest seller of VUL policies, according to Tillinghast-Towers Perrin, a New York-based consulting firm. "We have had no problems with policies being underfunded or blowing up."
At Nationwide Financial, the sixth-largest seller of VULs, there are few problems, says John Keenan, vice president of brokerage life. That's because a number of safeguards limit policyholders' risks. Premiums for many policies are invested first in a money fund subaccount, he says. Insurance fees are deducted from the money fund account. Then money is invested in the stock funds, free and clear of any charges.
Policyholders also can set up an automatic dollar-cost-averaging program that moves money into stock funds. In addition, Nationwide's average VUL premium is $18,000, while the face amount is just $350,000.
"It's [underfunded policies] pretty rare," Keenan says. "Our average premiums are large, and the average policy size is relatively small. There are sufficient values to maintain the policies."
Even though insurers stress that VUL should be funded to the maximum allowable limits, Blazzard stresses you can't assume policyholders will earn the illustrated policy rate.
"What is needed is a random walk or Monte Carlo simulation to show the volatility of the policy," Blazzard says.
These types of illustrations help policyholders understand the volatility of a VUL. The analysis, he says, would help them properly fund their policies.
CFP and insurance agent Katt believes that in some instances, variable policies are sold the wrong way.
"Tumbling stock values can cause poorly designed variable life policies to become so underfunded that they require the equivalent of a margin call," Katt says. "A defined-benefit policy type is a very poor design.
"Defined-benefit type policies have level-to-maturity death benefits that purport to also define the premium costs via comforting pre-sale and in-force illustrations." But, he adds that "the illustrations are an illusion because they are based on assuming a constant investment yield that in reality will be very volatile, as we have recently experienced. A defined-benefit policy's premiums cannot be known in advance. It will need to be managed to avoid overfunding and underfunding."
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