Deconstructing a Leveraged Life Insurance Plan

In my recent article, I noted that some leveraged life insurance plans could be heading for trouble, if they haven’t already arrived. I primarily confined my observations to loan-based split-dollar and third-party premium financing plans that involve irrevocable life insurance trusts (ILITs). I noted how both plans are exquisitely sensitive to, among other things, the relationship of the loan interest rates to the overall performance of the policy. I also noted that, the economics aside, both types of plans look to get additional leverage from current income, gift and estate tax treatment of grantor trusts. While certain tax changes that would have negatively impacted grantor trust were proposed last year, they didn’t come to fruition. We’ll just have to see how things reconcile in the coming months.

Which Plans To Review

Which plans are on borrowed time and should be reviewed? I’ve been repeatedly asked this question since the “Borrowed Time” article was published. While I can make a reasonable case that any plan that involves an ILIT supported by any form of split-dollar or third-party premium financing is a candidate for review, that’s probably too sweeping a generalization to be practical. So, how about any plans involving an ILIT and one or more loans, as well as any other split-dollar plans with ILITs that don’t have an exit strategy other than the insured’s death?

Now, of course, a great follow-up question would be, “OK, your criteria are reasonable, but who’s going to identify the plans and start the conversation? For example, who’s going to know that a plan has no exit strategy” And to that I would respond, “There are at least four parties on the planning team who could speak up, namely the insurance professional, the estate-planning attorney, the tax advisor who’s handling the gift tax compliance for the plan and the ILIT’s trustee. My nod goes to the insurance professional, who should have the best perspective on the plan and where it’s headed, the most information and resources at the ready and the most ability by far to get the conversation started. In fact, I wouldn’t be surprised if the insurance professional hadn’t already tried to start this conversation, but was always put on hold.” Incidentally, for sake of (my) convenience, I’ll refer to the attorneys, the tax advisors and the trustee as the “estate planners.”

Client Authorization

Will the client authorize (read “pay for”) the review? Someone will have to tell the client why it’s a good idea for the team to review the plan and policy. The premise and rationale for that review is woven into the “Borrowed Time” article as well as in the articles noted below. I think it’s fair to tell the client that if the process is well orchestrated, it should be pretty efficient and produce an attractive cost/benefit outcome. The rest of this article is about that orchestration.

Five Steps

I would break down the task facing the planning team into these steps:

  1. A conference to assess the plan at a high level;
  2. Get the client’s buy-in to take a closer look;
  3. Reconvene to fine-tune the analysis and identify solutions to the problem that won’t create new problems;
  4. Present to the client; and
  5. Bring the plan and/or policy into the shop for necessary repairs.

Implementing the Steps

At the first conference, all team members should pitch in to lay out as much information as possible about the plan, the policy, the insured, the ILIT, the trustee and the tax planning and compliance, respectively. Here’s some suggested advanced prep, though the particular plan could call for far more extensive material.

    • The insurance people should send the estate planners materials that describe the both the specific plan and the policy.

      • They should send the current policy statement from the carrier.
      • A current in-force policy illustration is helpful, but it’s not enough. What the team will really need to see is an in-force illustration rendered in an integrated fashion that shows the policy and plan as a unified structure. The integrated illustration will show, column by column, year by year through policy maturity, all the working parts of the given plan, meaning cash flows, values and benefits, loan and interest and tax items. Without this illustration, the team can’t “see” the plan. And if they can’t see it, they can’t tell how it’s doing and if anything needs to be fixed. It will also make it much easier to explain things to the client. If the carrier can’t produce this integrated illustration, the insurance people will have to create one themselves, which is a lot of work. in any case, I wouldn’t convene this conference until the integrated illustration is ready. It’s that important.

    • The estate planners should send the insurance people the operative documents for the plan, a summary of the ILIT and its funding and a high-level description of how the ILIT is working from a tax compliance perspective.
    • Everyone should review the materials as appropriate and ask for any supplemental material before the conference.

Ready to Go

We’re ready! Now what should we be looking for? This is the key question! Last year, Larry Brody and I offered some guidance for how to go about looking at these plans.  What’s more, although my article on composing a melodious life insurance presentation focuses on proposed plans, the guidelines I discuss can be retrofitted for plans in place today. Once again, I nominate the life insurance professional to take the lead. If that doesn’t happen, the orchestration will descend into cacophony.

Shore It Up or Ship It Out?

Once around the table or computer screen, as the case may be, there should be robust discussion on a “type of plan-adjusted basis” about what the client was hoping to accomplish, what the client’s original expectations were (especially for out-of-pocket outlay), what the client understands about the plan and policy today and how well or not the plan and policy are tracking those expectations. The conversation may happily conclude that all systems are functioning properly. If not, the team should highlight the parts of the plan or policy that are on an unsustainable path. That will make it easier for the team to move on to options for repairing or, if necessary, replacing the plan or policy. I suspect that in most cases, the team will conclude that what’s called for is a repair. A good example of a repair would be creating or shoring-up an exit strategy by funding the ILIT with income-producing property.

The extent to which the options for remediation are explored or perhaps modeled, as well as the extent to which those options should be presented in the team’s report to the client, will depend on their sense of what the client expects at this juncture. I’ll leave that to the team. One thing I would definitely recommend is that they be ready with whatever questions they’ll need to ask to determine if a given solution is appropriate and worthy of pursuit.

The Endgame

This is the crucial step and the most difficult for the team. How do they distill all that technically nuanced information and all their well-informed judgments into a message that has a reasonable chance to be “heard” by a busy client with a lot on the mind and probably only so much attention span for this stuff? Of course, if the plan and policy are doing well, then someone gets to deliver a pleasant message and set a date for another review. But if things aren’t going well? The team will have to lay it out, with that integrated illustration and an overall preference for numbers and pictures over words. Above all else, assume that the client is far less interested in the principle of the thing than the money! After all, wouldn’t you be? So be prepared when the client says, “How much cash will it cost me to fix the problem now and how much will it cost me (or the kids) if I wait? Ballpark is fine. Once I know that, I’ll get back to you.”