Draft Bill Attacks Wealthy Families' Private Placement Life Policies

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A new draft bill could cripple the private placement life insurance policies and annuity contracts that some ultra-high-net-worth investors use to manage their finances.

With the Protecting Proper Life Insurance From Abuse Act, Senate Finance Committee Chairman Ron Wyden has proposed classifying private placement life insurance arrangements as ordinary investment funds.

The Oregon Democrat wants to add a line that would exclude private placement arrangements from the Internal Revenue Code Section 7702 definition of life insurance and classify the products as "private placement contracts."

The provision would apply to private placement arrangements that were already in place. Taxpayers with existing private placement arrangements would have 180 days to liquidate them or move the assets into other arrangements.

Wyden has posted a summary and a copy of the draft bill on the Senate Finance Committee website.

What it means: If passed and implemented as written, Wyden's proposal could create big headaches for wealthy people and their financial professionals.

Even if the bill goes nowhere, stopping it could use up time and energy financial services groups would rather invest in other projects.

The backdrop: Wealthy individuals, wealthy families and business owners buy big life insurance policies and life annuity contracts through the private placement market to handle complicated financial needs and get a high level of control over the assets inside the arrangements and the design of the policy.

Defenders of private placement products contend that they may be a necessity for large, complicated taxpayers with assets in many different countries and benefit needs larger than ordinary life insurance policies can accommodate.

Statistics for the private placement life and annuity market are scarce, but the Senate Finance Committee reported in February that seven large players in the market were managing $9.5 billion in private placement life insurance assets supporting about $40 billion in death obligations for 3,061 PPLI policies.

The administrators were averaging about $3 million in assets and $13 million in death benefits per PPLI policy.

Tax policy analysts at the U.S. Treasury Department and the Joint Committee on Taxation, an arm of Congress that helps lawmakers analyze tax proposals, have been looking for ways to reduce or tax use of PPLI arrangements for years.

Proposal details: The Wyden proposal would define a life or annuity arrangement as a private placement contract if the reserves were held in a segregated account at a company with fewer than 25 other contract holders.

To keep one wealthy client from simply putting assets in 25 separate contracts, "all PPCs held directly or indirectly by a holder will be treated as a single PPC," according to the bill summary.

Insurers that issued or reinsured private placement contracts would have to report on the creation of the PPCs within 30 days or pay a $1 million penalty along with a $1 million penalty for each additional 30-day reporting delay.

A non-U.S. arrangement would be treated as a PPC if the PPC would be treated as a life insurance or annuity in the United States or was a life insurance policy or annuity contract under local law.

For a non-U.S. private placement life policy, "the contract will be a PPC if the death benefit amount is adjusted on the basis of investment return and the market value of at least one asset supporting the contract," according to the summary.

The budget impact: Joint Committee on Taxation analysts suggested in November that a proposal that would treat some of the cash coming out of private placement life or annuity arrangements as ordinary income would raise $9.8 billion in extra federal taxes over the 10-year period from 2025 through 2034.

Reactions: The committee's analysts noted that "deferral of income tax on inside buildup of life insurance and annuity contracts has been the same for decades, starting in the previous millennium."

"Some might question the idea of identifying a specific type of contract that may arguably be abusive and changing its tax treatment," the analysts said.

A proposal could be overly broad and tax non-abusive contracts inappropriately, and seeing Congress change life insurance tax rules might frighten people away from buying ordinary life and annuity products, the analysts warned.

Marc Cadin, the chief executive officer of Finseca, called the bill draft "disappointing."

"We've had many meetings with Senator Wyden and his team to emphasize the importance of preserving the core tax treatment of life insurance, and we strongly disagree with the legislation being proposed," Cadin said. "This legislation is an attack on all forms of permanent life insurance and, by extension, an attack on holistic financial planning."

The American Council of Life Insurers also opposes the proposal.

"Individuals, families and businesses make financial plans based on the long-standing policy for the tax treatment of life insurance and annuities," the ACLI said through a spokesman. "Changing these rules would undermine the certainty they sought from the guarantees that these life insurance products provide."

Sen. Ron Wyden, D-Ore. Handout photo.