Private placement life insurance
Private placement life insurance describes a type of variable universal life insurance that is offered privately. It is a form of life insurance that consists of a cash value linked to the performance of one or more investment accounts wrapped within the confines of the policy. This allows policyholders to invest in a wider array of products including hedge funds. The unique investment features of Private placement life insurance enable carriers in the United States to register offerings of variable life insurance with federal and state securities regulators. It should be noted that not all investments are suitable to be included within these particular types of policies. Historically, absolute return and hedged strategies have been more compatible with these policies than equity based investments. Due to the volatility experienced in the stock market, drawdowns seen in the investment portfolio have a tendency to be more sizable and the owner may have to inject more funds into the policy to maintain it if the account value drops notably.
Private placement life insurance can also be a strong tool with respect to estate planning. Hedge fund investments within an insurance policy will allow the value to grow tax-free. Therefore, the beneficiaries will receive the cash value of the policy tax free upon the death of the insured. It should also be noted that private placement life insurance is offered without a formal securities registration. The main advantage of using this approach is that the carrier has the ability to customize the particular investment options within the policy to adjust to the desires of each prospective investor. The main disadvantage with using this approach is that it usually costs more for a carrier to offer a customized policy to a client. Private placement life insurance policies are only provided for accredited investors as defined by the SEC, with aspirations to invest large sums of capital in the policy; often the investment is greater than one million dollars. This form of investment requires the aid of an attorney, which can add to the total expense.
Private placement life insurance was first developed in the United States. However, since its inception, the industry has experienced significant growth in the placement of the insurance vehicle offshore. Offshore insurance companies specializing in private placement life insurance will usually work with high net worth clients and price their services as a provider, rather than as a traditional insurance carrier. In most cases they will offer the product as a financial service. It should be noted that a majority of offshore carriers are not allowed to have a domestic sales force; this means that their products often do not include significant sales loads and commissions. Also, offshore carriers do not usually advertise their products. Because of the lack of marketing costs, it allows the offshore carrier to provide their high net worth clients with private placement life insurance at a substantial discount.
Private placement life insurance (“PPLI”) provides a comprehensive solution to the planning challenges faced by advisors of high net worth individuals. As a product specifically developed for the investing and insurance needs of the high net worth individual, its mention is virtually mandatory in any estate planning discussion with such individuals. Generally, the core motivation for acquiring a PPLI product is to establish a tax-free investment environment, at the lowest possible cost. The client may designate hedge fund or traditional money manager(s) to manage assets paid into the PPLI policy. However, the death benefit component of PPLI should not be overlooked, as it provides tremendous wealth transfer and estate tax mitigation strategies, and may also be used to fund the client’s philanthropic desires, such as a favorite charity or the creation of a family foundation.
As an investment and income tax planning tool, PPLI enables access to sophisticated investment strategies used regularly by high net worth investors, such as hedge funds and hedge funds of funds, and reduces income tax liabilities, permitting such investments to grow income tax-free. Because PPLI is a life insurance product, it capitalizes on the income tax benefits of life insurance, which include: (i) tax-free accretion of investment earnings (dividends, interest, and capital gain) on policy assets; (ii) the ability, with proper structuring, to withdraw and borrow assets from the policy cash value free of income tax; and (iii) the income tax-free receipt of death benefit proceeds by the policy beneficiaries at the death of the insured.
As an estate planning tool, PPLI mitigates estate tax liabilities while facilitating the orderly disposition of assets at death. Most importantly, the death benefit proceeds of a PPLI policy pass to the policy’s beneficiaries free of any federal income tax, and if structured properly, free of any estate tax. The liquidity provided from the policy’s death benefit may be used to eliminate or mitigate the need to liquidate other family assets in order to pay estate tax. These proceeds can also be used as a powerful tool for augmenting a client’s philanthropic goals. As an asset protection vehicle, PPLI offers financial privacy and, in some cases, significant protection from future creditors.
While the PPLI product is similar to a traditional variable universal life insurance policy in its mechanics, PPLI has some exceptional differences that separate it in the context of the high net worth client:
- The policy owner has broader flexibility with regard to the policy’s underlying investments, and many hedge funds and other tax-inefficient investment choices are available. However, the policy owner cannot exercise direct or indirect control over the investment of the policy asset.
- The policy purchasers must meet “qualified purchaser” and “accredited investor” guidelines under SEC rules.
- Insurance fees are more competitive than retail insurance products. In most cases, there are low front-end loads on premium payments, the annual charges against policy cash values are a small fraction of the annual tax cost associated with similar investments in a taxable environment, and PPLI policies typically have no surrender charges. As a general rule, total policy fees should be less than 1%-1.25% as expressed a percentage of the cash value. Stated another way, a 10% investment return of the underlying investment values will yield a return on the cash value of the policy of approximately 9% – significantly higher than an otherwise after-tax return 6.5% (assuming a 35% tax rate applied on a 10% return).
PPLI is most often used as a simple, tax-efficient investment vehicle. However, by adding varying layers of complexity and employing competent counsel and advisers, PPLI should be a part of every high net worth individual’s estate plan. Provided the policy remains in force, the tax-free accretion of investment earnings, tax-free access to the policy assets, and tax-free death benefit, present an unparalleled planning tool that simply cannot be ignored by estate planners and wealth advisors to the high net worth community.
Setting Up a PPLI Policy
After providing the client the Private Placement Life Insurance information, advanced planning teams focus on five areas:
Insurance underwriting — The overall scheme of a PPLI policy, the cost of insurance is relatively inexpensive if the insured is in good health and doesn’t bring underwriting baggage. If the insured’s health or age is an issue, advisors need to negotiate more aggressively.
Financial underwriting — The main carrier writing the policy sub-contracts chunks of the coverage with reinsurance companies, given the very large death benefits involved. Large PPLI face amount policies take longer to place than average-sized policies.
Investment research and selection — Selecting hedge funds and other alternative investment options, such as futures and commodities requires the advanced planning team’s agreement. A PPLI is usually embedded within a comprehensive financial plan, complete with growth scenarios and cash flow projections.
Funding the policy — Substantial tax planning questions lead to solutions such as private split dollar and other solutions.
Domestic vs. offshore ownership — The advanced planning group will need to analyze the benefits of domestic vs. offshore ownership — and the best ownership entity.
Facts: A PPLI policy insures a 45-year-old male, paying $2.5 million (a total of $12.5 million) in premiums for five years. The assumed rate of return is 10% (net of investment-management fees), taxed as ordinary income (at 40%, including federal and state taxes).
Results: Two huge advantages occur: the death benefit is always at the top, and in the long-run, it uses every opportunity available to get into an income tax free environment. Notice the higher amount in “cash value” after 20 years compared to “taxable investment.” Neither the cash value increases nor the “death benefit” is subject to income tax. Please note that PPLI premiums start from a low of $1 million (for example, $250,000 per year paid over four years) to a more typical $5 to $10 million or more (paid in the early years), or $5 million or more paid as a single premium at inception. Yes, $50 to $100 million polices can be arranged.
Facts: A 50-year-old male, non-smoker, with cash value compounding at a 10% annual rate after investment management fees, pays a $1 million premium for a PPLI for five years (total premium of $5 million).
Results: After 15 years, at age 65, he receives $1,213,538 per year for life. After 50 years, at age 100, $9,856,418 is payable as a death benefit. Both these payments are income tax-free.
Other advantages of PPLI:
Liquidity: When needed, you can borrow a portion of the “cash value,” which can be paid back at any time or out of the death benefit.
Asset protection: Your investments are placed in separate accounts, avoiding any risk of insurance company illiquidity.
Risk minimization: Insurance is a risk-shifting strategy in the event of a premature death, always supplementing the tax-free investment results at any age.
Estate tax free: The PPLI arrangement can be set-up so the ultimate death benefit is not subject to estate taxes.
Investment flexibility: You can, with the help of the insurance company or a third party advisor, select from a large number of hedge funds. You can even switch advisors or have more than one. It is also permissible to invest in a private equity deal that you think has great potential.
Low investment cost: Traditional agents’ commissions are eliminated; letting more funds work inside your policy — true “no-load” insurance. Typically, PPLI is placed with an offshore insurance company, further reducing the policy costs.