Worthune’s Ultimate Guide to Private Placement Life Insurance provides in-depth information and nuanced perspectives about an innovative investment plus insurance vehicle that may be appropriate for the high net worth and ultra-high net worth individuals and families.  (There is a companion product – the private placement variable annuity (PPVA) which may also be a complement to the PPLI structure.)

Before you sneer, “I don’t need yet another insurance policy. I have them up to my wazoo,” it is essential to understand the conceptual structure of a PPLI (Private Placement Life Insurance) which is fundamentally an insurance veneer with an ability to pursue advanced investment strategies and vehicles with a slew of tax benefits.   Think of PPLI policies as a way to build wealth on a tax-efficient basis and potentially leave a legacy to your heir or charities with minimal or no estate tax concerns – subject to some considerations and constraints, which we will address along the way.

In addition to market fluctuations, faulty construction of the PPLI structure or poor investment choices will adversely impact the integrity of the insurance component and affect the overall performance.

You may skip or jump to any part of the Worthune’s ultimate guide to private placement insurance. However, for the sake of context and flow, we suggest reading the article entirely.

Content Outline of the Ultimate Guide to Private Placement Life Insurance

What is Private Placement Life Insurance?

How does Private Placement Life Insurance Work?

What are the key features of a PPLI policy?

What assets can one hold in a Private Placement Insurance Policy?

What investments are available through Private Placement Life Insurance Contracts?

Who should buy Private Placement Life Insurance Policies?

What are the fees and expenses of a Private Placement Life Insurance?

What are the tax benefits of Private Placement Life Insurance Policies?

Which providers issue Private Placement Life Insurance?

What are the differences between Onshore and Offshore Private Placement Insurance Providers?

What are the advantages of Private Placement Life Insurance?

What are the disadvantages of Private Placement Life Insurance?

How to keep the PPLI policy compliant?

So, let’s delve into the nuts and bolts, intricacies and nuances of the Private Placement Life Insurance and why it is potentially an integral strategy in optimizing wealth and minimizing taxes for the wealthy investors.

What is Private Placement Life Insurance?  A simple definition of PPLI

Private Placement Life Insurance (PPLI)  is a sophisticated vehicle that acts as an insurance policy that provides death benefit coverage, while at the same time allowing for a variety of registered and non-registered investment options and a potential for significant growth in cash surrender value in a tax-efficient manner.

Let’s unlock the PPLI definition a little bit:

Private Placement Life Insurance is a permanent insurance policy.  The PPLI structure allows for the tax-deferred growth of assets inside the insurance policy structure.  Since the Private Placement Life Insurance policy is for HNW (High Net Worth) and UHNW (Ultra-High Net Worth) investors, (whom SEC considers as Accredited Investors), firms offer investment options such as hedge funds, private equity, and other individual structured products. Based on the policy structure and ownership considerations, one may be able to defer not only ongoing taxes but also estate taxes.

How does Private Placement Life Insurance Work?

Given the relative sophistication of the private placement life insurance, most customers work with a financial advisor or an insurance agent (with a license to sell securities).  For this discussion, we will generalize how private placement life insurance works and not go into too many details into the primary differences between onshore PPLI and offshore PPLI. Also, each state may have different rules regarding tax on premiums and other features.

The Process Steps of how Private Placement Life Insurance Works:

1. An advisor suggests a PPLI concept to high net worth or ultra-high net worth individual or family.
2. The investor learns the details and understands the PPLI concept and is willing to pursue the insurance plus investment option.
3. The wealth planner, in consultation with the client, and his/her other advisors (accountant and attorney) designs a policy to meet the specific needs of the family and generates a policy proposal and hypothetical illustrations.
4. They identify an insurance firm and purchases the policy after a medical exam and other underwriting requirements.
5. The policyholder pays the premium and transfers any allowable assets. Typically, the cash premiums exceed the insurance costs and are primarily for building cash surrender value.
6. The insurer is the “Ultimate Beneficial Owner,” and the policyholder will have a claim on the insurer to the extent of the value of the policy.
7. The insurer nominates an investment manager (who could be the primary advisor or a specialist investment manager) who will manage the assets on a discretionary basis and opens an account at the custodian bank.
8. Then they select appropriate investments vehicles and managers. And rebalance as required. (Due to the tax laws and ownership/control issues, the policy holder’s involvement will be defined and structured as needed but generally he/she will not choose the individual subaccount managers or the allocations and does not make rebalancing decisions.)
9. The client continues to invest additional monies as planned.
10. The advisor/investment manager manage the accounts on a discretionary basis, oversee the underlying portfolio managers (which could include hedge funds, separately managed accounts, private equity, et al.) and make rebalancing decisions.
11. The assets grow tax-deferred.
12. The policyholder has access to the cash value at any time, and there is no age or amount restrictions (except for the fact that there should be sufficient cash left to pay for the premiums and keep the policy in force.) And if structured well, there will be no income taxes on the withdrawals.
13. The policyholder may withdraw monies or surrender, but in the initial years, that may come with penalties and the risk of a policy
14. If the investor dies the proceeds which include the net asset value and death benefit (minus expenses and premiums) will go the heirs or charities whoever is designated as beneficiaries.

Critical Players in the PPLI Value Chain:

The following are the key players in the purchase and management of a PPLI policy and their respective responsibilities:

The Life Insurance Company:  The life insurance company underwrites and issues the plan and is typically the “Ultimate Beneficial Owner.” The insurance firm takes the risk of death benefit coverage and other policy terms. Inside the insurance company, many team members such as underwriters, actuaries, case designers will play a role.

The Policy Holder:  The policyholder is the person who takes out the contract and is accountable for paying the premiums. The policy owner can be the person who is being insured or a third party or a trust, or a foundation can be the policyholder.

The Insured: The insured is the person whose life is protected through the insurance. This can be the policyholder or some other person in which the policyholder has an insurable interest.

The Asset Manager: The asset manager or investment manager is the person or entity which has discretion over the investment strategy, asset allocation, manager selection, and rebalancing.  There is typically a “Chinese Wall” between the insured/policyholder and the asset/investment manager. While the policyholder may recommend the asset manager, the insurer is technically the one who has the power of appointment.

The Custodial Bank: The custodian is where the assets are custodied for safekeeping and management. The custodian may also be a broker-dealer and may offer proprietary or third-party products and services.

The Beneficiaries: Those who receive full or partial proceeds of the value of the private placement insurance contract or the death benefit or a combination thereof at a specified time or an insurance event.

The Sales Person or the Wealth Advisor: The PPLI policy is a highly sophisticated and complex strategy and typically a salesperson – an insurance agent with securities license or a registered representative aligned with a Broker-Dealer – will be a part of the transaction. The advisor may also act as an asset manager – assuming they are qualified and licensed to provide investment advice and money management services.

Other Players in the PPLI Lifecycle:

• Attorneys – to provide a legal opinion, guide through the process, and draft paperwork
• Tax Accountants – to assess the tax impact of various decisions and suggest appropriate assets for transferring to the policy
• Reinsurer – an insurer typically brings in a reinsurer to distribute and minimize risk on the underlying policy

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What are the key features of a PPLI policy and how is it different than a traditional Life Insurance Policy?

Here is a simple chart to lay out the key features and pertinent differences between a traditional life insurance policy and a private placement life insurance policy.

Fun is like life insurance; the older you get, the more it costs. – Frank McKinney Hubbard

What assets can one hold in a Private Placement Insurance Policy?

Since the PPLI is sold to high net worth clients, there is a lot of flexibility in the types of assets one can hold in the policy structure. The asset types include:

• Cash
• General stocks, bonds, and other securities
• Real estate
• Hedge funds, private equity, and other private corporations and private foreign corporations
• Closely held companies
• S. based operating businesses and entities
• Rights to images, Patents, Trademarks, etc.
• Art and collectibles

So assuming hedge fund investing or private equity investing is something that you are considering, a PPLI structure may provide a tax-sheltered way of doing so.

What investments are available through Private Placement Life Insurance Contracts?

It all depends on the insurer, the custodian and the types of investments they make available for the investment manager.

As you can hold any asset including cash, securities, art and collectibles, real estate, hedge funds, private equity, fund of funds, ownership in foreign corporations, ownership in domestic corporations, and rights to intellectual property, the sky is the limit as to what investments may be held within the PPLI structure. However, some of the assets may be transferred in kind whereas others may be invested through the available vehicles and channels.

Who should buy Private Placement Life Insurance Policies?

The PPLI policies are the purview of the rich and the famous, and the wealthy and the fabulous.  Technically, the threshold of qualification may be for an investor to be considered “Accredited Investor,” the reality is the policy does not make sense for most people.

In general, wealthy professionals such as doctors and lawyers, athletes, film and TV stars, top executives, successful entrepreneurs have the right profile and sufficient wealth for structuring private placement insurance.

While this is not a hard and fast rule, we at Worthune suggest the following rules of thumb.

1. At least U.S. $20 million in net worth
2. More than the S. $10 million in liquid net worth
3. Set up and maximized general tax and estate planning strategies. For example, optimizing investments into tax-qualified vehicles, setting up an inter vivos or a QTIP trust, creation of 529 C plans and/or UGMA/UTMA or a combination thereof, etc.

Life Insurance offers a man the only way where he can make his will before he makes his money. – Anonymous

Why are private placement insurance policies “Hot” now?

There are several reasons for the popularity of the private placement life insurance and private placement variable annuity products in the marketplace.

• In many states, there is a high tax on investment income
• The ~U.S. $ 11.18 million lifetime gift tax exemption helps in funding the PPLI policies (For 2018 according to the IRS announcements.)
• A PPLI can act as a hedge against poor investment performance
• A well-structured PPLI policy provides for Asset Protection
• Ability to own exotic assets – Private Equity, Hedge Funds, Real Estate, Patents, and Trademarks et al.
• Ability to set up offshore PPLI trusts to avoid some of the state-level premium taxes
• The clear demarcation of insurance and investments along with a legally minimum life insurance coverage
• The potential estate tax benefits offered by Life Insurance
• The incredible flexibility a private placement insurance policy offers regarding the structure, investments, management, and disbursal

What are the fees and expenses of a Private Placement Life Insurance?

As private placement life insurance is an insurance wrapper, there are several costs and expenses.

• Annual Mortality and Expense Fee: This is the fee for the insurer
• Cost of insurance: This is the monthly cost of providing the insurance coverage.
• Asset Management Fee: This is the fee an advisor/investment manager charges for managing assets. Generally, the asset management fee is a percentage of the net asset value.
• Custodial Fee: Custodians will charge money for recordkeeping, reconciliation, safekeeping, and reporting services. Again, the custodial fee is a few basis points.
• Federal Deferred Acquisition Cost Premium Tax: This is a federal tax on premiums and averages to about 1%.
• State Premium Tax: Varies per state.
• Distribution Charges: These are for commissions and incentives. Sometimes, these distribution charges are a part of the Mortality and Expense Charges.
• Other Expenses: There may be other expenses such as the fee due to professionals such as accountants and attorneys who assist in this process, as well as other service providers

What are the tax consequences of Private Placement Life Insurance Policies?

• Tax-Deferred Growth: Since a PPLI policy has an insurance wrapper, the assets inside grow on a tax-deferred basis and not subject to income tax on growth and dividends.
• Tax-Free Asset Movement: Inside a private placement insurance policy, one can move assets from one asset class to another or one sector to another without triggering any capital gains consequences.
• Tax-Free Access to Cash: A proper structure will ensure that one can access the cash value in a PPLI policy tax-free. There are withdrawal and loan rights as well as constraints such as the percentage of withdrawal from the cash surrender value.  For example, tax-free withdrawals up to the basis and tax-free loans against the contract.
• MEC Considerations: If a policy becomes a modified endowment contract, there will be adverse consequences such as treating all the lifetime distributions as ordinary income. Plus if PPLI converts to a MEC, there will be a penalty of 10% if the withdrawals happen before age 59 ½.
• Tax-Free Death Benefits: At death, the policy value and the actual life insurance death coverage may transfer to beneficiaries tax-free. The death benefit could also help provide a small hedge against poor investment performance in the investable assets.

A PPLI policy is a sophisticated and advanced technique for wealth optimization with severe adverse tax consequences if the policy parameters are not in compliance with the IRS regulations. So, please do consult an accountant and an attorney for specific advice.

Which providers issue Private Placement Life Insurance?

Several firms offer private placement life insurance, and we are sure there are many more, but here is a short list:

• Lombard
• BlackRock
• Wells Fargo Private Banking
• Morgan Stanley
• John Hancock
• Zurich
• Crown Global
• Investors Preferred
• Pacific Life

Please ask your financial advisor or insurance agent for a list of additional providers.

What are the differences between Onshore and Offshore Private Placement Insurance?

What are the advantages of Private Placement Life Insurance?

Many of the features and tax benefits, which we discussed during this guide, are the essential advantages and here is a summary:

• Lower insurance costs as a private placement policy use institutional pricing
• Unlimited flexibility in insurance policy design
• A wide range of investment choices
• Ability to choose onshore or offshore providers for PPLI
• Tax benefits: Tax-deferred growth, tax-free withdrawals, and loans, tax-free death benefits to beneficiaries.
• Asset Protection: Subject to some considerations the assets are protected against bankruptcy judgment, legal judgment, and duress.
• Hedge Against Poor Investment Performance: If the investments were to perform poorly, the death benefit could still be a way for beneficiaries to receive some benefits.

What are the disadvantages of Private Placement Life Insurance?

• Complexity: A PPLI policy is sophisticated and complex.
• Insurance Costs: The policyholder has to pay for insurance death benefit irrespective of whether there is a need for insurance.
• Due to high premiums and other costs, the threshold level of wealth where it makes sense is rather high.
• The costs for setting up as well as an ongoing management fee, mortality and expense ratio, and other costs add up to a bundle.
• Policies which lapse or those who convert to MECs (Modified Endowment Contracts) will lead to adverse tax consequences.
• While we are not legal experts, but we feel that some of the structural and regulatory parameters governing PPLI field may require more testing in real life.

How do you keep the PPLI policy compliant?

• Investor Control: The policyholder cannot have direct control, and this could be a big no. Please establish the necessary Chinese walls.  Technically, the insurer is the ultimate beneficial owner, and the insurance company appoints the investment manager to manage the assets.
• Insurance Tests: IRS has several provisions on what qualifies as an insurance policy. The IRS code sections are as follows:
  • 7702: Life insurance, what is life insurance.
  • 72: Annuities, what is an annuity.
  • 817(h): Diversification. The diversification rules to qualify for tax deferral on variable policies.
  • 953(d): Tax status of the insurance carrier.
• Diversification Requirements:
  • No single investment may make up more than 55% of the insurance subaccount portfolio.
  • No two investments may constitute more than 70% of the portfolio.
  • No three investments may constitute more than 80% of the portfolio.
  • No four investments can constitute more than 90% of the total assets of the account.
• Policy Status: If a policy becomes a MEC (Modified Endowment Contract), there will be adverse consequences.

Notes:

Worthune’s Ultimate Guide to Private Placement Life Insurance is general information for educational purposes only. We do not have any insurance, investment advisory, or legal certifications to provide personal advice. Please consult your tax, legal, and financial advisors before making any specific decisions.  While we strive to provide accurate and up to date information, we are not responsible for upkeeping the content or any inadvertent errors.  If you wish to receive a copy of the Ultimate Guide to Private Placement Life Insurance, please contact us.