Overview
It has been a while since I have written anything. Oh, the indignity of having to make a living! Most of you know by now that I am a quirky guy with quirky interests and quirky points of view. In that realm, I must say that I have always been a great fan of the Godfather of Soul, James Brown. Is it the great horn section (Maceo Parker, Fred Wesley, and Pee Wee Ellis), or is it my great dancing ability (highly unlikely)? So great was my affection for the Godfather of Soul and his horn section, that I have referred to myself as Soul Brother #2. I am most likely #99 or 100 on the list.
Most of you know that I have written frequently on the subject on Private Placement Life Insurance (“PPLI”) but unlike others, my articles usually discuss tax planning using PPLI. Yes, it is nice to know that PPLI is a no-load institutionally priced variable life insurance product, but that knowledge and a dime may only get you a cup of coffee but not a client. I have also provided my own state of the union regarding the PPLI industry which may be described as the “Great Continental Divide.”
If PPLI were likened to the Moon, the industry would be divided between the sunny side and the dark side of the Moon. I have been involved in the PPLI since 1999 on full-time basis professionally in various capacities – Home Office executive (MassMutual and Philadelphia Financial), large insurance broker (Marsh) and as sole practitioner tax lawyer. During this time period. I have seen the industry lean hard to the right to become “cousin” of the Corporate Owned Life Insurance (COLI) and retail variable universal life insurance (“VUL”) marketplaces. High net worth PPLI has increasingly become a low load version of VUL but with different investment options such as hedge funds. I call this the “sunny side” of the Moon.
Arguably, the large life insurers and specialty domestic life insurers issuing PPLI policies are winning the hearts and minds of potential policyholders. Part of this in my view is driven by the market success of the Separate Account Life Insurance (SALI) Insurance Dedicated Fund platform which has grown to a very significant size (more than $15 billion).
Over time offshore life insurers who have their beginning on the dark side of the Moon and steadily traversed the landscape to the sunny side of the Moon. As the carriers became more successful, they did not need to take the same level of business risk anymore. Large life insurers left the arguably niche PPLI marketplace, leaving these specialty life insurers in a good position. As FATCA and FBAR reporting became more of an issue for clients and carriers, some of these offshore life insurers created onshore subsidiaries.
PPLI has a lot to offer, and I am not talking about the Tea for Two version of PPLI, e.g., policies with conventional investment options featuring institutional investment advisors. I am talking about PPLI featuring intellectual property, equipment leasing, and derivative contracts. Not only can these strategies withstand the scrutiny of investor control, but the strategies also deliver significant tax benefits at the policyholder and operating company level.
PPLI Using Intellectual Property
I am not a corporate tax attorney but this much I know! Most large multinational corporations have used low tax jurisdictions and intellectual property as part of their global tax plan. Every successful business has some sort of intellectual property – patents, trademarks, trade secret or “secret sauce” that has allowed the business to succeed. The transfer and licensing of this intellectual property provides tax deductible payments to the business as trade or business expenses and non-taxable life insurance separate account investment income to the Policy.
PPLI Using Private Derivatives
David Handler of Kirkland Ellis innovated the use of private derivative contracts in high-net-worth income and estate tax planning. A derivative is a financial instrument that gives the holder a right to a payment from the counterparty to the instrument if certain events occur during the term of the contract. Derivatives can be tied to the price or performance of a stock, or the performance of a portfolio or index. They can also be tied to prices of commodities, or any other asset as a reference asset for that matter.
A private derivative contract is a derivative agreement entered into between family members or family trusts for their benefit. A private derivative can be used as a way to transfer wealth from one generation to another based on the financial performance of an asset (whether or not the family owns that asset).
A private derivative contract is enhanced significantly when combined with the tax advantages of life insurance are considered. Option and Put contracts can be utilized within PPLI contracts to capture investment gain within the investment fund of the PPLI contract. Swap contracts can be utilized between counterparties to transfer the appreciation and income of a capital assets used as reference assets. The use of private derivative contracts arguably enhances arguments against violation of the investor control doctrine.
Summary
The high-net-worth PPLI marketplace has started to resemble the retail VUL marketplace but with institutional pricing and investment options that are more sophisticated. In my view this has occurred for two reasons. First, specialty life insurers have achieved a level of success that they no longer have to incur unnecessary business and tax risk. Second, large fund aggregators such as the SALI Fund have such a dominant competitive footprint in the domestic marketplace, so that the Moon is increasingly sunny with very few dark spaces left. Third, retail life insurers continue to have a difficult time from a compliance standpoint to sell offshore private placement life insurance.
Despite the aforementioned comments on the state of PPLI, great planning opportunities continue to exist using cutting edge tax and estate planning techniques that the best tax planners use with a structure (PPLI) that too few of them use. As Socrates said, “Life (PPLI) unexamined is not worth living.” Maybe, Socrates was not referring to PPLI, but he would have been if he were living today.