What Type Of Life Insurance Is Best?

Posted on March 20, 2017 in Uncategorized

Life Insurance (though it shouldn’t be) is to this day a very controversial issue. There seems to be a lot of different types of life insurance out there, but there are really only two kinds. They are Term Insurance and Whole Life (Cash Value) Insurance. Term Insurance is pure insurance. It protects you over a certain period of time. Whole Life Insurance is insurance plus a side account known as cash value. Generally speaking, consumer reports recommend term insurance as the most economical choice and they have for some time. But still, whole life insurance is the most prevalent in today’s society. Which one should we buy?

Let’s talk about the purpose of life insurance. Once we get the proper purpose of insurance down to a science, then everything else will fall into place. The purpose of life insurance is the same purpose as any other type of insurance. It is to “insure against loss of”. Car insurance is to insure your car or someone else’s car in case of an accident. So in other words, since you probably couldn’t pay for the damage yourself, insurance is in place. Home owners insurance is to insure against loss of your home or items in it. So since you probably couldn’t pay for a new house, you buy an insurance policy to cover it.

Life insurance is the same way. It is to insure against loss of your life. If you had a family, it would be impossible to support them after you died, so you buy life insurance so that if something were to happen to you, your family could replace your income. Life insurance is not to make you or your descendants rich or give them a reason to kill you. Life insurance is not to help you retire (or else it would be called retirement insurance)! Life insurance is to replace your income if you die. But the wicked ones have made us believe otherwise, so that they can overcharge us and sell all kinds of other things to us to get paid.

How Does Life Insurance Work?

Rather than make this complicated, I will give a very simple explanation on how and what goes down in an insurance policy. As a matter of fact, it will be over simplified because we would otherwise be here all day. This is an example. Let’s say that you are 31 years old. A typical term insurance policy for 20 years for $200,000 would be about $20/month. Now… if you wanted to buy a whole life insurance policy for $200,000 you might pay $100/month for it. So instead of charging you $20 (which is the true cost) you will be overcharged by $80, which will then be put into a savings account.

Now, this $80 will continue to accumulate in a separate account for you. Typically speaking, if you want to get some of YOUR money out of the account, you can then BORROW IT from the account and pay it back with interest. Now… let’s say you were to take $80 dollars a month and give it to your bank. If you went to withdraw the money from your bank account and they told you that you had to BORROW your own money from them and pay it back with interest, you would probably go clean upside somebody’s head. But somehow, when it comes to insurance, this is okay

This stems from the fact that most people don’t realize that they are borrowing their own money. The “agent” (of the insurance Matrix) rarely will explain it that way. You see, one of the ways that companies get rich, is by getting people to pay them, and then turn around and borrow their own money back and pay more interest! Home equity loans are another example of this, but that is a whole different sermon.

Deal or No Deal

Let us stick with the previous illustration. Let us say the one thousand 31 year olds ( all in good health) bought the aforementioned term policy (20 years, $200,000 dollars at $20/month). If these people were paying $20/month, that is $240 per year. If you take that and multiply it over the 20 year term then you will have $4800. So each individual will pay $4800 over the life of the term. Since one thousand individuals bought the policy, they will end up paying 4.8 million in premiums to the company. The insurance company has already calculated that around 20 people with good health (between the ages of 31 and 51) will die. So if 20 people pass away, then the company will have to pay out 20 x $200,000 or $4,000,000. So, if the company pays out $4,000,000 and takes in $4,800,000 it will then make a $800,000 profit.

This is of course OVER simplifying because a lot of people will cancel the policy (which will also bring down the number of death claims paid), and some of those premiums can be used to accumulate interest, but you can get a general idea of how things work.

On the other hand, let’s look at whole life insurance. Let us say the one thousand 31 year olds (all in good health) bought the aforementioned whole life policy ($200,000 dollars at $100/month). These people are paying $100/month. That is $1200 per year. If the average person’s lifespan (in good health people) goes to 75, then on average, the people will pay 44 years worth of premiums. If you take that and multiply it by $1200 you will get $52,800. So each individual will pay $52,800 over the life of the policy. Since one thousand individuals bought the policy, they will end up paying 52.8 million in premiums to the company. If you buy a whole life policy, the insurance company has already calculated the probability that you will die. What is that probability? 100%, because it is a whole life (till death do us part) insurance policy! This means that if everyone kept their policies, the insurance company would have to pay out 1000 x $200,000 = $2,000,000,000) That’s right, two billion dollars!

Ladies and gentleman, how can a company afford to pay out two billion dollars knowing that it will only take in 52.8 million? Now just like in the previous example, this is an oversimplification as policies will lapse. As a matter of fact, MOST whole life policies do lapse because people can’t afford them, I hope you see my point. Let’s take the individual. A 31 year old male bought a policy in which he is suppose to pay in $52,800 and get $200,000 back? There no such thing as a free lunch. The company somehow has to weasel $147,200 out of him, JUST TO BREAK EVEN on this policy! Not to mention, pay the agents (who get paid much higher commissions on whole life policies), underwriters, insurance fees, advertising fees, 30 story buildings… etc, etc.

This doesn’t even take into account these variable life and universal life policies that claim to be so good for your retirement. So you are going to pay $52,800 into a policy and this policy will make you rich, AND pay you the $200,000 death benefit, AND pay the agents, staff and fees? This has to be a rip off.

Well, how could they rip you off? Maybe for the first five years of the policy, no cash value will accumulate (you may want to check your policy). Maybe it’s misrepresenting the value of the return (this is easy if the customer is not knowledgeable on exactly how investments work). Also, if you read my article on the Rule of 72 you can clearly see that giving your money to someone else to invest can lose you millions! You see, you may pay in $52,800 but that doesn’t take into account how much money you LOSE by not investing it yourself! This is regardless of how well your agent may tell you the company will invest your money! Plain and simple, they have to get over on you somehow or they would go out of business!

How long do you need life insurance?

Let me explain what is called The Theory of Decreasing Responsibility, and maybe we can answer this question. Let’s say that you and your spouse just got married and have a child. Like most people, when they are young they are also crazy, so they go out and buy a new car and a new house. Now, here you are with a young child and debt up to the neck! In this particular case, if one of you were to pass away, the loss of income would be devastating to the other spouse and the child. This is the case for life insurance. BUT, this is what happens. You and your spouse begin to pay off that debt. Your child gets older and less dependent on you. You start to build up your assets. Keep in mind that I am talking about REAL assets, not fake or phantom assets like equity in a home (which is just a fixed interest rate credit card)

In the end, the situation is like this. The child is out of the house and no longer dependent on you. You don’t have any debt. You have enough money to live off of, and pay for your funeral (which now costs thousands of dollars because the DEATH INDUSTRY has found new ways to make money by having people spend more honor and money on a person after they die then they did while that person was alive). So… at this point, what do you need insurance for? Exactly… absolutely nothing! So why would you buy Whole Life (a.k.a. DEATH) Insurance? The idea of a 179 year old person with grown children who don’t depend on him/her still paying insurance premiums is asinine to say the least.

As a matter of fact, the need for life insurance could be greatly decreased and quickly eliminated, if one would learn not to accumulate liabilities, and quickly accumulate wealth first. But I realize that this is almost impossible for most people in this materialistic, Middle Classed matrixed society. But anyway, let’s take it a step further.

Confused Insurance Policies

This next statement is very obvious, but very profound. Living and dying are exact opposites of each other. Why do I say this? The purpose of investing is to accumulate enough money in case you live to retire. The purpose of buying insurance is to protect your family and loved ones if you die before you can retire. These are two diametrically opposed actions! So, if an “agent” waltzes into your home selling you a whole life insurance policy and telling you that it can insure your life AND it can help you retire, your Red Pill Question should be this:

“If this plan will help me retire securely, why will I always need insurance? And on the other hand, if I will be broke enough later on in life that I will still need insurance, then how is this a good retirement plan?”

Now if you ask an insurance agent those questions, she/he may become confused. This of course comes from selling confused policies that do two opposites at once.

Norman Dacey said it best in the book “What’s Wrong With Your Life Insurance”

“No one could ever quarrel with the idea of providing protection for one’s family while at the same time accumulating a fund for some such purpose as education or retirement. But if you try to do both of these jobs through the medium of one insurance policy, it is inevitable that both jobs will be done badly.”

So you see, even though there are a lot of new variations of whole life, like variable life and universal life, with various bells and whistles (claiming to be better than the original, typical whole life policies), the Red Pill Question must always be asked! If you are going to buy insurance, then buy insurance! If you are going to invest, then invest. It’s that simple. Don’t let an insurance agent trick you into buying a whole life policy based on the assumption that you are too incompetent and undisciplined to invest your own money.

If you are afraid to invest your money because you don’t know how, then educate yourself! It may take some time, but it is better than giving your money to somebody else so they can invest it for you (and get rich with it). How can a company be profitable when it takes the money from it’s customers, invests it, and turns around and gives it’s customers all of the profits?

And don’t fall for the old “What if the term runs out and you can’t get re-insured trick”. Listen, there are a lot of term policies out there that are guaranteed renewable until an old age (75-100). Yes, the price is a lot higher, but you must realize that if you buy a whole life policy, you will have been duped out of even more money by the time you get to that point (if that even happens). This is also yet another reason to be smart with your money. Don’t buy confused policies.

How much should you buy?

I normally recommend 8-10 times your yearly income as a good face amount for your insurance. Why so high? Here is the reason. Let’s say that you make $50,000 per year. If you were to pass away, your family could take $500,000 (10 times $50,000) and put it into a fund that pays 10 percent (which will give them $40,000 per year) and not touch the principle. So what you have done is replaced your income.

This is another reason why Whole Life insurance is bad. It is impossible to afford the amount of insurance you need trying to buy super high priced policies. Term insurance is much cheaper. To add to this, don’t let high face values scare you. If you have a lot of liabilities and you are worried about your family, it is much better to be underinsured than to have no insurance at all. Buy what you can manage. Don’t get sold what you can’t manage.

40+ Home Insurance Savings Tips

Posted on March 19, 2017 in Uncategorized

Your dwelling is often your most precious asset that you need to protect. We created a list of all savings opportunities associated with Home insurance. This list is the most complete perspective on home insurance savings tips. Numerous insurance brokers contributed to this list. So, let’s start!

1. Change your content coverage: Renting a Condo? You can often lower your content coverage. No need to insure your belongings to up to $250,000 if you only have a laptop and some IKEA furniture!

2. Renovations: Renovating your house can result in lower home insurance premiums, as home insurance premiums for older, poorly maintained dwellings are usually higher. Additionally, renovating only parts of your dwelling (e.g. the roof) can lead to insurance savings.

3. Pool: Adding a swimming pool to your house will likely lead to an increase in your insurance rates since your liability ( e.g. the risk of someone drowning) and the value of your house have increased.

4. Pipes: Insurers prefer copper or plastic plumbing – maybe it is a good idea to upgrade your galvanized / lead pipes during your next renovation cycle.

5. Shop around: Search, Compare, and switch insurance companies. There are many insurance providers and their price offerings for the same policies can be very different, therefore use multiple online tools and talk to several brokers since each will cover a limited number of insurance companies.

6. Wiring: Some wiring types are more expensive or cheaper than others to insure. Make sure you have approved wiring types, and by all means avoid aluminum wirings which can be really expensive to insure. Not all insurers will cover houses with aluminum wirings, and those that would, will require a full electrical inspection of the house.

7. Home Insurance deductibles: Like auto insurance, you can also choose higher home insurance deductibles to reduce your insurance premiums.

8. Bundle: Do you need Home and Auto Insurance? Most companies will offer you a discount if you bundle them together.

9. New Home: Check if insurer has a new home discount, some insurers will have them.

10. Claims-free discount: Some companies recognize the fact that you have not submitted any claims and reward it with a claim-free discount.

11. Mortgage-free home: When you complete paying down your house in full, some insurers will reward you with lower premiums.

12. Professional Membership: Are you a member of a professional organization (e.g. Certified Management Accountants of Canada or The Air Canada Pilots Association)? Then some insurance companies offer you a discount.

13. Seniors: Many companies offer special pricing to seniors.

14. Annual vs. monthly payments: In comparison to monthly payments, annual payments save insurers administrative costs (e.g. sending bills) and therefore they reward you lower premiums.

15. Annual review: Review your policies and coverage every year, since new discounts could apply to your new life situation if it has changed.

16. Alumni: Graduates from certain Canadian universities ( e.g University of Toronto, McGill University) might be eligible for a discount at certain Insurance providers.

17. Employee / Union members: Some companies offer discounts to union members ( e.g. IBM Canada or Research in Motion)

18. Mortgage insurance: Getting mortgage insurance when you have enough coverage in Life insurance is not always necessary: mortgage insurance is another name for a Life/Critical Illness / Disability insurance associated with your home only but you pay extra for a convenience of getting insurance directly when lending the money. For example a Term Life policy large enough to pay off your home is usually cheaper.

19. Drop earthquake protection: In many regions, earthquakes are not likely – you could decide not to take earthquake coverage which could lower your premiums. For example, in BC earthquake coverage can account for as much as one-third of a policy’s premium.

20. Wood stove: Choosing to use a wood stove means higher premiums – Insurance companies often decide to inspect the houses with such installations before insuring them. A decision to get rid of it means a lower risk and thus lower insurance premiums.

21. Heating: Insurers like forced-air gas furnaces or electric heat installations. If you have an oil-heated home, you might be paying more than your peers who have alternative heating sources.

22. Bicycle: You are buying a new bicycle and thinking about getting extra protection in case it is stolen when you leave it on the street e.g. when doing your groceries? Your Home insurance might be covering it already.

23. Stop smoking: Some insurers increase their premiums for the homes with smokers as there is an increased risk of fire.

24. Clean claim history: Keep a clean claim record without placing small claims, sometimes it makes sense to simply repair a small damage rather than claim it: you should consider both aspects: your deductibles and potential raise in premiums.

25. Rebuilding vs. market costs: Consider your rebuilding costs when choosing an insurance coverage, not the market price of your house (market price can be significantly higher than real rebuilding costs).

26. Welcome discount: Some insurers offer a so called welcome discount.

27. Avoid living in dangerous locations: Nature effects some locations more than others: avoid flood-, or earthquake-endangered areas when choosing a house.

28. Neighbourhood: Moving to a more secure neighbourhood with lower criminal rate will often considered in your insurance premiums.

29. Centrally-connected alarm: Installing an alarm connected to a central monitoring system will be recognized by some insurers in premiums.

30. Monitoring: Having your residence / apartment / condo monitored 24 hour can mean an insurance discount. e.g. via a security guard.

31. Hydrants and fire-station: Proximity to a water hydrant and/or fire-station can decrease your premiums as well.

32. Loyalty: Staying with one insurer longer can sometimes result in a long-term policy holder discount.

33. Water damages: Avoid buying a house which may have water damage or has a history of water damage; a check with the insurance company can help to find it out before you buy the house.

34. Decrease liability risk: Use meaningful ways to reduce your liability risk (e.g. fencing off a pool) and it can result in your liability insurance premiums going down.

35. Direct insurers: Have you always dealt with insurance brokers / agents? Getting a policy from a direct insurer (i.e. insurers working via call-center or online) often can be cheaper (but not always) since they do not pay an agent/broker commission for each policy sold.

36. Plumbing insulation: Insulating your pipes will prevent them from freezing in winter and reduce or even avoid insurance claims.

37. Dependent students: Dependent students living in their own apartment can be covered by their parents’ home insurance policy at no additional charge.

38. Retirees: Those who are retired can often get an additional discount – since they spend more time at home than somebody who works during the day and thus can prevent accidents like a fire much easier.

39. Leverage inflation: Many insurers increase your dwelling limit every year by considering the inflation of the house rebuilding costs. Make sure this adjustment is in line with reality and that you are not overpaying.

40. Credit score: Most companies use your credit score when calculating home insurance premiums. Having a good credit score can help you to get lower insurance rates.

41. Stability of residence: Some insurers may offer a stability of residence discount if you have lived at the same dwelling for a certain number of years.

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A Brief Introduction to Captive Insurance

Posted on March 18, 2017 in Uncategorized

Over the past 20 years, many small businesses have begun to insure their own risks through a product called “Captive Insurance.” Small captives (also known as single-parent captives) are insurance companies established by the owners of closely held businesses looking to insure risks that are either too costly or too difficult to insure through the traditional insurance marketplace. Brad Barros, an expert in the field of captive insurance, explains how “all captives are treated as corporations and must be managed in a method consistent with rules established with both the IRS and the appropriate insurance regulator.”

According to Barros, often single parent captives are owned by a trust, partnership or other structure established by the premium payer or his family. When properly designed and administered, a business can make tax-deductible premium payments to their related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed at capital gains.

Premium payers and their captives may garner tax benefits only when the captive operates as a real insurance company. Alternatively, advisers and business owners who use captives as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose of an insurance company may face grave regulatory and tax consequences.

Many captive insurance companies are often formed by US businesses in jurisdictions outside of the United States. The reason for this is that foreign jurisdictions offer lower costs and greater flexibility than their US counterparts. As a rule, US businesses can use foreign-based insurance companies so long as the jurisdiction meets the insurance regulatory standards required by the Internal Revenue Service (IRS).

There are several notable foreign jurisdictions whose insurance regulations are recognized as safe and effective. These include Bermuda and St. Lucia. Bermuda, while more expensive than other jurisdictions, is home to many of the largest insurance companies in the world. St. Lucia, a more reasonably priced location for smaller captives, is noteworthy for statutes that are both progressive and compliant. St. Lucia is also acclaimed for recently passing “Incorporated Cell” legislation, modeled after similar statutes in Washington, DC.

Common Captive Insurance Abuses; While captives remain highly beneficial to many businesses, some industry professionals have begun to improperly market and misuse these structures for purposes other than those intended by Congress. The abuses include the following:

1. Improper risk shifting and risk distribution, aka “Bogus Risk Pools”

2. High deductibles in captive-pooled arrangements; Re insuring captives through private placement variable life insurance schemes

3. Improper marketing

4. Inappropriate life insurance integration

Meeting the high standards imposed by the IRS and local insurance regulators can be a complex and expensive proposition and should only be done with the assistance of competent and experienced counsel. The ramifications of failing to be an insurance company can be devastating and may include the following penalties:

1. Loss of all deductions on premiums received by the insurance company

2. Loss of all deductions from the premium payer

3. Forced distribution or liquidation of all assets from the insurance company effectuating additional taxes for capital gains or dividends

4. Potential adverse tax treatment as a Controlled Foreign Corporation

5. Potential adverse tax treatment as a Personal Foreign Holding Company (PFHC)

6. Potential regulatory penalties imposed by the insuring jurisdiction

7. Potential penalties and interest imposed by the IRS.

All in all, the tax consequences may be greater than 100% of the premiums paid to the captive. In addition, attorneys, CPA’s wealth advisors and their clients may be treated as tax shelter promoters by the IRS, causing fines as great as $100,000 or more per transaction.

Clearly, establishing a captive insurance company is not something that should be taken lightly. It is critical that businesses seeking to establish a captive work with competent attorneys and accountants who have the requisite knowledge and experience necessary to avoid the pitfalls associated with abusive or poorly designed insurance structures. A general rule of thumb is that a captive insurance product should have a legal opinion covering the essential elements of the program. It is well recognized that the opinion should be provided by an independent, regional or national law firm.

Risk Shifting and Risk Distribution Abuses; Two key elements of insurance are those of shifting risk from the insured party to others (risk shifting) and subsequently allocating risk amongst a large pool of insured’s (risk distribution). After many years of litigation, in 2005 the IRS released a Revenue Ruling (2005-40) describing the essential elements required in order to meet risk shifting and distribution requirements.

For those who are self-insured, the use of the captive structure approved in Rev. Ruling 2005-40 has two advantages. First, the parent does not have to share risks with any other parties. In Ruling 2005-40, the IRS announced that the risks can be shared within the same economic family as long as the separate subsidiary companies ( a minimum of 7 are required) are formed for non-tax business reasons, and that the separateness of these subsidiaries also has a business reason. Furthermore, “risk distribution” is afforded so long as no insured subsidiary has provided more than 15% or less than 5% of the premiums held by the captive. Second, the special provisions of insurance law allowing captives to take a current deduction for an estimate of future losses, and in some circumstances shelter the income earned on the investment of the reserves, reduces the cash flow needed to fund future claims from about 25% to nearly 50%. In other words, a well-designed captive that meets the requirements of 2005-40 can bring about a cost savings of 25% or more.

While some businesses can meet the requirements of 2005-40 within their own pool of related entities, most privately held companies cannot. Therefore, it is common for captives to purchase “third party risk” from other insurance companies, often spending 4% to 8% per year on the amount of coverage necessary to meet the IRS requirements.

One of the essential elements of the purchased risk is that there is a reasonable likelihood of loss. Because of this exposure, some promoters have attempted to circumvent the intention of Revenue Ruling 2005-40 by directing their clients into “bogus risk pools.” In this somewhat common scenario, an attorney or other promoter will have 10 or more of their clients’ captives enter into a collective risk-sharing agreement. Included in the agreement is a written or unwritten agreement not to make claims on the pool. The clients like this arrangement because they get all of the tax benefits of owning a captive insurance company without the risk associated with insurance. Unfortunately for these businesses, the IRS views these types of arrangements as something other than insurance.

Risk sharing agreements such as these are considered without merit and should be avoided at all costs. They amount to nothing more than a glorified pretax savings account. If it can be shown that a risk pool is bogus, the protective tax status of the captive can be denied and the severe tax ramifications described above will be enforced.

It is well known that the IRS looks at arrangements between owners of captives with great suspicion. The gold standard in the industry is to purchase third party risk from an insurance company. Anything less opens the door to potentially catastrophic consequences.

Abusively High Deductibles; Some promoters sell captives, and then have their captives participate in a large risk pool with a high deductible. Most losses fall within the deductible and are paid by the captive, not the risk pool.

These promoters may advise their clients that since the deductible is so high, there is no real likelihood of third party claims. The problem with this type of arrangement is that the deductible is so high that the captive fails to meet the standards set forth by the IRS. The captive looks more like a sophisticated pre tax savings account: not an insurance company.

A separate concern is that the clients may be advised that they can deduct all their premiums paid into the risk pool. In the case where the risk pool has few or no claims (compared to the losses retained by the participating captives using a high deductible), the premiums allocated to the risk pool are simply too high. If claims don’t occur, then premiums should be reduced. In this scenario, if challenged, the IRS will disallow the deduction made by the captive for unnecessary premiums ceded to the risk pool. The IRS may also treat the captive as something other than an insurance company because it did not meet the standards set forth in 2005-40 and previous related rulings.

Private Placement Variable Life Reinsurance Schemes; Over the years promoters have attempted to create captive solutions designed to provide abusive tax free benefits or “exit strategies” from captives. One of the more popular schemes is where a business establishes or works with a captive insurance company, and then remits to a Reinsurance Company that portion of the premium commensurate with the portion of the risk re-insured.

Typically, the Reinsurance Company is wholly-owned by a foreign life insurance company. The legal owner of the reinsurance cell is a foreign property and casualty insurance company that is not subject to U.S. income taxation. Practically, ownership of the Reinsurance Company can be traced to the cash value of a life insurance policy a foreign life insurance company issued to the principal owner of the Business, or a related party, and which insures the principle owner or a related party.

1. The IRS may apply the sham-transaction doctrine.

2. The IRS may challenge the use of a reinsurance agreement as an improper attempt to divert income from a taxable entity to a tax-exempt entity and will reallocate income.

3. The life insurance policy issued to the Company may not qualify as life insurance for U.S. Federal income tax purposes because it violates the investor control restrictions.

Investor Control; The IRS has reiterated in its published revenue rulings, its private letter rulings, and its other administrative pronouncements, that the owner of a life insurance policy will be considered the income tax owner of the assets legally owned by the life insurance policy if the policy owner possesses “incidents of ownership” in those assets. Generally, in order for the life insurance company to be considered the owner of the assets in a separate account, control over individual investment decisions must not be in the hands of the policy owner.

The IRS prohibits the policy owner, or a party related to the policy holder, from having any right, either directly or indirectly, to require the insurance company, or the separate account, to acquire any particular asset with the funds in the separate account. In effect, the policy owner cannot tell the life insurance company what particular assets to invest in. And, the IRS has announced that there cannot be any prearranged plan or oral understanding as to what specific assets can be invested in by the separate account (commonly referred to as “indirect investor control”). And, in a continuing series of private letter rulings, the IRS consistently applies a look-through approach with respect to investments made by separate accounts of life insurance policies to find indirect investor control. Recently, the IRS issued published guidelines on when the investor control restriction is violated. This guidance discusses reasonable and unreasonable levels of policy owner participation, thereby establishing safe harbors and impermissible levels of investor control.

The ultimate factual determination is straight-forward. Any court will ask whether there was an understanding, be it orally communicated or tacitly understood, that the separate account of the life insurance policy will invest its funds in a reinsurance company that issued reinsurance for a property and casualty policy that insured the risks of a business where the life insurance policy owner and the person insured under the life insurance policy are related to or are the same person as the owner of the business deducting the payment of the property and casualty insurance premiums?

If this can be answered in the affirmative, then the IRS should be able to successfully convince the Tax Court that the investor control restriction is violated. It then follows that the income earned by the life insurance policy is taxable to the life insurance policy owner as it is earned.

The investor control restriction is violated in the structure described above as these schemes generally provide that the Reinsurance Company will be owned by the segregated account of a life insurance policy insuring the life of the owner of the Business of a person related to the owner of the Business. If one draws a circle, all of the monies paid as premiums by the Business cannot become available for unrelated, third-parties. Therefore, any court looking at this structure could easily conclude that each step in the structure was prearranged, and that the investor control restriction is violated.

Suffice it to say that the IRS announced in Notice 2002-70, 2002-2 C.B. 765, that it would apply both the sham transaction doctrine and ยงยง 482 or 845 to reallocate income from a non-taxable entity to a taxable entity to situations involving property and casualty reinsurance arrangements similar to the described reinsurance structure.

Even if the property and casualty premiums are reasonable and satisfy the risk sharing and risk distribution requirements so that the payment of these premiums is deductible in full for U.S. income tax purposes, the ability of the Business to currently deduct its premium payments on its U.S. income tax returns is entirely separate from the question of whether the life insurance policy qualifies as life insurance for U.S. income tax purposes.

Inappropriate Marketing; One of the ways in which captives are sold is through aggressive marketing designed to highlight benefits other than real business purpose. Captives are corporations. As such, they can offer valuable planning opportunities to shareholders. However, any potential benefits, including asset protection, estate planning, tax advantaged investing, etc., must be secondary to the real business purpose of the insurance company.

Recently, a large regional bank began offering “business and estate planning captives” to customers of their trust department. Again, a rule of thumb with captives is that they must operate as real insurance companies. Real insurance companies sell insurance, not “estate planning” benefits. The IRS may use abusive sales promotion materials from a promoter to deny the compliance and subsequent deductions related to a captive. Given the substantial risks associated with improper promotion, a safe bet is to only work with captive promoters whose sales materials focus on captive insurance company ownership; not estate, asset protection and investment planning benefits. Better still would be for a promoter to have a large and independent regional or national law firm review their materials for compliance and confirm in writing that the materials meet the standards set forth by the IRS.

The IRS can look back several years to abusive materials, and then suspecting that a promoter is marketing an abusive tax shelter, begin a costly and potentially devastating examination of the insured’s and marketers.

Abusive Life Insurance Arrangements; A recent concern is the integration of small captives with life insurance policies. Small captives treated under section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable to the captive, and then be taxable again when distributed to the ultimate beneficial owner. The consequence of this double taxation is to devastate the efficacy of the life insurance and, it extends serious levels of liability to any accountant recommends the plan or even signs the tax return of the business that pays premiums to the captive.

The IRS is aware that several large insurance companies are promoting their life insurance policies as investments with small captives. The outcome looks eerily like that of the thousands of 419 and 412(I) plans that are currently under audit.

All in all Captive insurance arrangements can be tremendously beneficial. Unlike in the past, there are now clear rules and case histories defining what constitutes a properly designed, marketed and managed insurance company. Unfortunately, some promoters abuse, bend and twist the rules in order to sell more captives. Often, the business owner who is purchasing a captive is unaware of the enormous risk he or she faces because the promoter acted improperly. Sadly, it is the insured and the beneficial owner of the captive who face painful consequences when their insurance company is deemed to be abusive or non-compliant. The captive industry has skilled professionals providing compliant services. Better to use an expert supported by a major law firm than a slick promoter who sells something that sounds too good to be true.

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