Proposal Restricting Use of Private Placement Life Insurance Introduced

Senate Finance Committee Chair Ron Wyden (D-OR) has released draft legislation titled Protecting Proper Life Insurance from Abuse Act. According to a press release, the proposal follows an 18-month committee investigation and release of a report in February.

Contracts meeting the definition of “life insurance” under the Internal Revenue Code provide tax-free payments to designated beneficiaries upon the death of the insured.

Private placement life insurance (“PPLI”) is offered to certain accredited investors where the amount payable upon the death of the insured reflects an investment allocation of the policy’s cash value among a menu of separate account investments offered through the insurance carrier issuing the contract.

The type of PPLI targeted by the proposal focuses on policies with one or more separate accounts that support the policy value of fewer than 25 insurance contracts held by unrelated policy holders. Wyden’s concern is that the policy holder with access to investments that are not available generally to policy holders in effect allows a policy holder to designate the specific assets to be held under the contract, thus sheltering the value of the designated assets from income taxation when the policy holder dies.

The proposal disqualifies the targeted PPLI from the favorable tax treatment afforded to life insurance and instead taxes the contract similar to an investment partnership in which the annual items of gain and loss allocable to the holder from all of the separate accounts held through the policy are taxable to the holder each tax year, regardless of whether such items are distributed. Any distributions including withdrawals, distributions of policy loans and ultimately death proceeds are taxable as ordinary income to the recipient to the extent they exceed the basis in the contract.

Additionally, the proposal would impose IRS reporting requirements on insurance companies within 30 days of a PPLI contract becoming a taxable contract under the proposal and annual reporting of the investment gains, losses and adjustments to basis, with substantial penalties for non-compliance.  If enacted, the proposal would apply to all PPLI contracts with segregated investment accounts that do not meet the 25-contract requirement, including contracts issued prior to the effective date. There would be a 180-day period following enactment that would permit contract holders to exchange or convert their policies into compliant contracts or to liquidate their contracts.

The proposal has not been formally introduced in Congress. The Senate Finance Committee will be under new leadership in the next legislative session with Republicans taking control of the Senate.