What is Private Placement Life Insurance?

Private Placement Life Insurance (“PPLI”) is a variable universal life insurance product designed for high-net-worth investors. It is offered by both domestic and foreign insurance companies and provides policy holders with customized asset management opportunities. A thin layer of life insurance is wrapped around policy assets.

Why are investors interested in PPLI?

Generally, the core motivation for acquiring a PPLI product is to establish a tax-free investment environment, at the lowest possible cost. The death benefit component of the policy usually is considered a secondary benefit.

What are the income tax advantages of life insurance?

The income tax benefits of life insurance include: (1) tax-free compounding growth on policy assets; (2) the ability to withdraw and to borrow assets from the policy cash value free of income tax (with proper structuring); and (3) Income tax-free and if properly structured, estate tax-free life insurance proceeds.

What are the main differences between PPLI and retail life insurance?

• The policy owner has broader flexibility with regard to the policy’s underlying investments. Depending on the structure, liquid and illiquid assets may be allocated to the structure.
• Policy purchasers must meet “qualified purchaser” and “accredited investor” guidelines under SEC rules.
• The PPLI structure costs transparent and significantly less than the tax drag of income and capital gain taxes on asset growth.

What factors influence whether a PPLI policy should be acquired from an offshore versus a domestic life insurance company?

• Premium payments to non-U.S. life insurance companies generally are not subject to U.S. state premium taxes, which can range from .05%-3% of premium. In addition, the U.S. “DAC” tax (1% with domestic carriers) is sometimes lower offshore. Although many offshore carriers elect to be taxed as a U.S. corporation, a U.S. federal excise tax of 1% is imposed on policy premiums on U.S. lives that are paid to foreign life insurance companies that are not taxed as U.S. corporations.
• Investment flexibility may be greater offshore due to the absence of SEC and state insurance and security law regulation; also, in many cases, the insurance-related fees are lower than the domestic policy equivalent.
• With proper planning, a higher level of asset protection is available with offshore PPLI policy purchases.

How should investors acquire a PPLI product?

Although most investors are drawn to PPLI for its tax benefits, investment flexibility, and price structure, few regard the life insurance benefit as an important feature. However, the life insurance component of the product is critical and there are many technical insurance issues to address in the process of acquiring a PPLI product. We would advise to engage both legal counsel with insurance and estate planning expertise, and highly knowledgeable insurance team with specific and broad PPLI experience.

How much should an investor commit to PPLI?

To optimize efficiency, the total premium commitment should be $5,000,000. If the investor wants to have the flexibility to withdraw or borrow policy assets on a tax-advantaged basis, the total premium commitment should be paid in equal installments over a period of time, typically three to five years.

What are the fees typically associated with PPLI?

There are three primary insurance-related fees associated with PPLI products: the premium load which consists various elements, the “mortality and expense” charge, and the cost of insurance charge. The premium load will vary, but should typically be approximately 1% of premium, and the combination of the mortality and expense charge and the cost of insurance charge should average, over the life of the contract, less than 1% per year. Asset management fees will depend on the asset manager(s) selected to manage the insurance portfolio.

What is involved in the acquisition process?

Acquiring PPLI requires that the prospective insured undergo full medical and financial underwriting. Every PPLI structure is customized and tailored to accomplish the goals and objectives of the client. Depending on the client fact pattern, assets that the client would like to place into the structure, and jurisdictional issues will dictate complexity. In addition, there are several important insurance design elements that must be carefully addressed in the process.

What will the policy beneficiaries receive when the insured dies?

The tax-free life insurance benefit consists of the cash value of the policy (the premiums paid, plus growth, less account charges) plus the “risk,” or pure insurance element. The insurance element is minimized to the extent possible in the design process as defined by U.S. tax rules under Section 7702.

Are the insurance carriers that offer PPLI solid companies?

There are a number of high-quality carriers in both the domestic and offshore markets. Some of the offshore carriers are subsidiaries of large, well-known U.S. carriers. Few offshore insurance companies have credit ratings in their own right. Some describe their claims-paying ability with reference to the ratings of their parents or principal reinsurer(s). Others have claims-paying guarantees from their parent company. Capitalization levels vary widely among foreign life insurance companies. Carrier due diligence is an important exercise in the policy acquisition process.

Where is the investment account of the policy located and is it safe?

The separate account(s) of the policy will be custodied in accordance with the asset manager’s normal custodial arrangement. Thus, in the case of an offshore policy purchase, there is no requirement of offshore custody. The separate account of the policy is protected by law in the state or foreign jurisdiction where the insurance carrier is located from both the creditors of the insurance carrier. Whether the policy is protected against claims of the policy owner’s creditors depends on a number of factors, including where the policy was issued and where the policy owner resides.

Private placement life insurance ("PPLI") is a type of variable universal life insurance ("VUL") that is only offered privately to Accredited Investor, under Rule 501(a)(1)- (8) of Regulation D of the Securities Act of 1933 and a Qualified Purchaser under Section 2(a)(51) of the Investment Company Act of 1940. It is typically utilized as a tax strategy that transforms ordinary taxable income and capital gains into tax-free income without any reporting requirements. According to the IRS Private Letter Ruling, May 2, 2002, for any U.S. individuals with investment income, a PPLI policy will provide compliant, tax-free compounded earnings. In addition, Code Section 7702 defines the requirements that must be met to qualify as a life insurance product.

A PPLI policy is variable in nature, which allows the insurance company to invest the majority of the premiums in a legally separate, segregated account to be managed by an investment manager or through the use of insurance dedicated funds (IDF) on the insurance company PPLI platform. PPLI has cash value linked to the performance of one or more investment accounts within the policy structure and is offered without a formal securities registration.

Advantages of U.S. Tax Compliant PPLI

• Assets inside a PPLI grow and compound tax-free,
• Ability to borrow against the cash value of the policy without a tax impact,
• Creditor protection,
• Reduced IRS audit risks, and
• Life insurance proceeds paid income tax free

Investment Diversification and U.S. Tax Requirements

To be considered a life insurance policy for U.S. income tax purposes and have the associated tax benefits, the policy must satisfy certain requirements under the U.S. IRS code. The VUL must be a shifting of mortality risk from the policy purchaser to the life insurance carrier.

The investment made for the benefit of the policy must satisfy the diversification requirement of Treasury Regulations Secion1.817-5. Currently, as of the end of any calendar quarter, the policy assets must be invested in five or more investments as follows:

• Not more than 55% of the value of the assets can be in one investment;
• Not more than 70% of the value of the assets can be in two investments;
• Not more than 80% of the value of the assets can be in three investments, and
• Not more than 90% of the value of the assets can be in four investments.

• Tax sensitivity is on the upswing. More family enterprises are searching for tax mitigation strategies as the “wealth effect” has significantly increased. It is all about what you keep rather than earn!
• Interest in generational wealth growth has become a higher priority
• Several new developments within the PPLI market have garnered more interest
• Wealth preservation, efficient asset growth, tax elimination and/or mitigation
• Wealth Management firm consolidation and competition is accelerating and the need to differentiate has become paramount
• Tax inefficient investments, hedge funds, managing volatility has gained more attention
• Clients are looking for answers and many wealth advisory teams are figuring out how to play in this sand box….it is a process
• PPLI is a fairly low risk tax mitigation strategy as insurance has been coded in the law for generations.
• Charitable strategies have expanded the use of PPLI
• One of the more impactful factors has been the acceptance of the PPLI market to allow financial advisors to manage customized discretionary mandates through separately managed accounts (SMA)

Let’s dig a little deeper into the SMA

For much of the history of PPLI, wealth advisory firms who wanted to manage the money inside the PPLI structure had the arduous process of setting up a co-mingled investment offering through an IDF (Insurance Dedicated Fund). The minimum size is $25M and that is quite a big bite to chew, and the “mechanics” were more cumbersome than they are today. The advantage to setting up the IDF is the leveraging effect of tax mitigation (eliminating taxes on the compounding growth of allocated assets), the assets are quite sticky, and the ability to aggregate assets across multiple clients is attractive.

As wealth has ballooned over the last couple of decades, there are many more players in the financial advisory field. What has helped advisory firms’ interest in PPLI is the fact that insurance companies are now allowing them to set up a SMA so they can customize the IPS and investments inside the PPLI structure. This has translated into a bit of excitement among clients as they can maintain their relationships with the advisors they know, like, and trust. The minimum can be as low as $5M. Another attractive factor is the SMA is attached to only one policy and insurance company, and this significantly reduces administrative and pass-through costs.

There are two guiding regulatory and IRS rules to abide by:

1. SMA must be broadly diversified under Section 817(h).
   • There must be 5 investments with no 1 investment > 55%,
   • No 2 investments > 70%,
   • No 3 investments > 80%,
   • No 4 investments > 90%,
   • Therefore, we need to have 5 investments and you need to rebalance within 6 mos. on an annual basis
2. SMA advisor needs to follow the investor control doctrine that prohibits policy owners from directing the underlying selection of funds or securities. The policy owner can help set the IPS guidelines, review the strategy, and recommended managers. They can also change the IPS strategy, but the SMA manager has complete control over how it is implemented.

The objective of structuring wealth is to:

• Grow it
• Preserve it
• Spend it when needed
• And, finally, transfer it to the next generation or to your most cherished passions

Advisors want to help their clients accomplish this in a tax controlled and tax-efficient manner. Private Placement Life insurance is one of the critical tools available to accomplish these objectives.

UHNW Advisors and their Families may not realize it, but they have an asset that needs their attention…. their insurance capacity. What? We all know that the Internal Revenue Code provides 2 key tax benefits for life insurance: tax-free compound growth and the tax-free treatment of life insurance proceeds under IRC Section 7702(G)(1)(A). These 2 utilities of life insurance are quite compelling.

In the world of UHNW family enterprises tax mitigation strategies garner a lot of attention. Private Placement Life Insurance (PPLI) provides the “tax umbrella” that eliminates income taxes on the growth of the assets inside the structure and with the proper set of circumstances, can be placed outside the estate for wealth preservation purposes.

Each PPLI structure is custom designed to meet the needs of the family enterprise. Here are some highlights:

• Wealth creation - Assets placed within the structure grow and compound tax-free.
• The tax drag from income and capital gain taxes, the biggest impediment to asset growth, is eliminated
• Based on new developments regarding capacity constraints, family enterprises can now “move the needle” with virtually any amount of assets they desire to be placed into the PPLI structure
• Allows for the Family Enterprise qualifying investment advisory team to continue to manage the assets utilizing a separate managed account (SMA)
• Living benefit - There is the ability to borrow up to 90% of the cash value
• Asset Protection - Creditor protected
• Wealth Transfer - Life insurance proceeds are distributed to beneficiaries tax-free and if properly constructed, estate tax free
• Reduced IRS audit risks
• This structure can be designed as a multi-purpose, multi-decade investment structure

When we have been asked this question, our answer is in the form of a question, “Can you forget all you know about life insurance?” If so, then we can dig deeper into why our clients consider implementing and utilizing life insurance as a tool within their planning. It is a very good and legitimate question and there are several reasons families of any size may want to consider the use of life insurance. Some may resonate more than others, and some may hit an emotional string that you may want to explore deeper for more clarity and a better understanding.

The psychology of the UHNW and/or family enterprise is unique. They want to be wise in their decision making. Building wealth vs. maintaining and preserving wealth are not necessarily the same. Wealth is generally created by concentrating risk and wealth is preserved by managing and diversifying risk. The drivers for success of a wealthy family usually are centered around, high risk tolerance, self-reliance, self-confidence, and control. These tend not to be the best characteristics when dealing with the management and understanding of risk.

With that said, why would someone of tremendous means consider life insurance as a wise investment with not only their money but with the necessary time to become clear about how it may or may not make sense for their situation.

Life insurance has two unique utilities coded in the law:

• Tax-free growth
• Tax-free life insurance benefits

If these are compelling attributes, then the question is, based on the client fact pattern is there a life insurance design that would produce a valued outcome?

Wealth Maximization

If you happen to fall into this category with at least $25M investable assets Private Placement Life Insurance (PPLI) provides a compelling story. By its very nature, PPLI enhances risk adjusted returns due to the simple fact that a PPLI structure eliminates income taxes at a fraction of the tax drag and you harvest all the compound growth tax free as life insurance proceeds. There are several structures of PPLI which for the “right fit” family are worth exploring.

Unlike retail life insurance, PPLI is a thin layer of cost efficient institutionally price life insurance that “wraps” around allocated assets allowing them to compound tax free and can be managed by your current investment or wealth management team.

Asset Protection

Life insurance can be implemented to shelter assets from creditors depending on jurisdictional laws). The high net worth would have to assess their concern and need for asset protection. There are ways to accomplish the task without life insurance, but many practitioners see it as a basic tool to be considered.

Preservation

As one comes into wealth whether by the sale of their company, a high and prestigious position in the corporate world, or by whatever means, the planning for such people can be quite complex. It generally moves the HNW individual out of their comfort zone. They do not necessarily feel they are in control due to the nature of the complexity of estate planning and decision making. There is what I call a “ceiling of complexity” reached in planning that can cause one to “freeze” in their tracks and the planning stalls. When this “ceiling of complexity” is reached significant gaps may exist and cause undue shrinkage to an estate due to an untimely death. Many have had complicated lives, stress builds up over time and when the event finally happens, i.e., monetizing one’s estate, human nature many times wants to simplify life, yet as I have mentioned, planning at this level is complex and requires time.

If you happen to be young (age 45-65) and you are in a position of wealth, estate planning involves the transfer of wealth to the next generation in order to preserve all your hard work. It is very difficult to start to transfer wealth as goals may not yet have clear, the family may be too young, or you do not want to transfer too much too early. But as the law operates, the estate planning techniques to transfer wealth provides the family with the most leverage when you are young. As you get older and your thoughts, goals and family mature these techniques lose their leverage and effectiveness. Control is the main culprit.

Most estate planning revolves around the balance sheet of the family, but the real issues involve not how to transfer wealth in terms of money but, until you become clear of the principles, values, traditions, heritage, wisdom and what your wealth means to you it is difficult to plan thoroughly enough.

Wealth transfer taxes are significant and life insurance is an important and efficient tool to manage mortality risk and preserve your family wealth. As I like to say, “I have never had a beneficiary return any life insurance proceeds to the insurance company”!

Liquidity

Some of the wealthy families continue to have a desire to build and push the “envelope”. They want to expand their “empire” whether that is through real estate, another enterprise, etc…. Life insurance would provide the needed liquidity to maintain and preserve family assets, pay off loans, provide businesses with staying power, and bring/keep the best people to continue the mission.

Charity

The wealthy family typically has many aspirational goals and sometimes the goals are larger than their ability to fund them. Settling for less is not acceptable to these families yet many cannot get their minds around how to accomplish many of these aspirational goals and by default settle for far less. All of their charitable interests need money and lots of it but at the same time as the family explores their thoughts and goals the “family” matures and needs, and desires expand tremendously.

There are many techniques to be able to transfer wealth to charitable interests or foundations (public or private). The role of life insurance in these situations is that it can provide additional capital outside the estate to fund aspirational goals over generations. I would say that to add $10-$50mm to your Foundation or for your charitable interests has a huge impact. As your life unfolds and the older you get the desire to put more money at risk and build more wealth lessens and since life expectancy becomes more known as we age into our 80’s and beyond the return of life insurance death benefits are quite attractive and competitive along with providing large lump sums to be used to benefit many.

Life insurance can also be used to replace wealth that has been transferred to charities to make sure family objectives are met. Another way to think about it; if your children/grandchildren or long-term legacy is all in good order and the balance of your estate will go to your choice of charities or foundation then life insurance plays a role of making sure your family “stays whole” as some of the estate may be subject to wealth transfer taxes.

Tax Leverage

The HNW tend to like arbitrage opportunities. The more wealth that can be transferred without income, estate or gift tax is very beneficial. There are ways to remove Life insurance from your estate. Life insurance by law is income tax free so if you can by-pass the gift or estate tax the benefits are then leveraged by two significant tax brackets.

The “Unknown”, “Gap Insurance”, Risk Management

• When will someone die?
• What are the needs of the extended family?
• What will be the tax environment?
• How to maintain wealth?

Managing wealth is different than creating wealth. Creating wealth is accomplished by concentrating risk, led by a laser focused individual with the ability to manage their emotions and do whatever it takes, and who is an expert.

Maintaining wealth is quite different. It tends to be about diversification and risk management in order to preserve wealth…..A different set of skills and mindset.

Estate planning takes time. The tools used for estate planning add layers of complexity. Tax laws are intricate and will change over time. Tax rates change over time. Assets grow over time. Mortality in unknown. Plans and objectives change. It is rare that anyone has an “airtight” plan, therefore, unintended gaps appear. The role life insurance is that of risk management or “gap insurance”. Life insurance will allow you the time to become clearer, build your plans, and watch them mature with the ability to change as needs and life change.

Opportunity Costs/Hedge

HNW families are intelligent people. They deploy their assets wisely and for a purpose. Rarely do they set aside money for estate costs, shrinkage, or any gaps that tax law changes may create later. There is a lost opportunity for their money if it has to be diverted from their goals and aspirations to pay wealth transfer taxes. Depending on the estate asset mix and how far their planning has taken them; tax laws change, the ceiling of complexity gets in the way, gaps exist and therefore, costs emerge, and long-term opportunities are lost as assets are diverted from the family or from your aspirational goals. In some way, you can think of a portion of your estate as a tax-deferred loan from the government or a tax balloon payment.

Life insurance can be used as a hedge on health (it cannot always be purchased) and an allocation of resources (assets) that can create a capital sum to preserve family assets and the opportunities for those assets that will be lost for generations to come. You are actually spending the government’s money to pay them off in order to maintain focus on your investment opportunities.

Flexibility/Equalization/Freedom

• How does one maximize the meaning and impact of their wealth?
• How does one answer to the ever changing and expanding needs of the family?
• How does one think about treating family equally or equitably?
• Many want to spend their wealth differently so life insurance can provide the flexibility and freedom to manage your desires and surprises as life unfolds

Life insurance can give you the flexibility to stretch your mind and your goals to give your vision a high probability to be experienced.

Conclusion

These are many of the reasons, based on experience and research, that HNW families find where life insurance can play a vital and critical role in their planning. The value derived from an objective analysis and contemplation of the various roles and types of life insurance can play will bring about the clarity and ‘peace of mind’ knowing that full consideration was given to one of the most valuable tools within the planning arena. The bottom line: give yourself the opportunity to gain clarity so you can make an informed decision about whether life insurance is a useful tool for you and your family.