Market volatility and heightened tax uncertainty have caused increased interest in private placement life insurance (PPLI) in recent years. However, those same factors have led to increased scrutiny for high-net-worth families. In this blog, we’ll examine what PPLI covers, how it differs from private placement variable annuities (PPVAs), and what trustees should consider when being appointed to manage a PPLI.
Private Placement Life Insurance Explained
Private placement life insurance is a specialized type of life insurance product designed for high-net-worth individuals, generally with a net worth in excess of $20 million. It has high minimum investment requirements of often several million dollars.
PPLI emerged in the 1980s as an offshore product. In the 2000s, changes in the tax laws and regulations brought PPLIs to the US. Increased compliance requirements, particularly regarding tax reporting and anti-money-laundering, have led to a more regulated and transparent PPLI environment.
|Because the framework has evolved, this is a growing product. While generally promoted as a tax-efficient strategy, PPLI is also becoming a tool for estate planning.
Although it is difficult to ascertain the size of the PPLI market in terms of assets under administration, Lion Street estimates in September 2021 that the top three carriers had $46 billion of assets under administration.
PPLI differs from standard life insurance policies in several key aspects, including investment flexibility, tax benefits, and customization.
- Investment flexibility. Policyholders can invest in a diverse array of assets, including hedge funds, private equity, and other alternative investments not typically available in standard insurance products.
- Tax benefits. Investment gains within a PPLI policy aren’t subject to income tax until the money is withdrawn. As a result, policyholders benefit from compound interest.
- Customization. Policyholders can tailor their portfolios to meet their unique financial goals and specific risk tolerances.
It should be noted that investments are more compliant when purchased through an insurance company known as an insurance dedicated fund (IDF) or a separately managed account (SMA) held in custody through major financial institutions. Keep in mind that the investment gains within a PPLI policy are generally tax-deferred.
PPLI versus PPVA: Different Estate Planning Opportunities
Private placement life insurance policies can be placed in a trust to facilitate the transfer of wealth to beneficiaries. The death benefit from the PPLI policy, when paid out to the trust upon the policyholder’s death, can be used to provide liquidity for estate taxes, debts, or other expenses, or it can be distributed according to the terms of the trust. Because the death benefit is significant, trusts can provide a great degree of control over how the proceeds are distributed, like all other assets in the trust.
A private placement variable annuities (PPVA) policy is a cousin to a PPLI. Because the investment gains as well as the death benefit are not taxed and there is not a required distribution, both policies are attractive for generation-skipping transfer tax planning, special needs trusts, and charitable giving. However, while the investments available to owners of a PPVA are like those of a PPLI, the estate planning opportunities are slightly different. PPLI policies typically are invested in separate accounts managed by the policyholder or their designated investment manager. In contrast, PPVA policies are invested in sub-accounts that are managed by the insurance company.
Making Sense of a Complicated Structure
|When a trust owns the PPLI or PPVA policy, a trustee’s fiduciary duty of care includes understanding this complicated structure.
That’s why it is critical for wealth owners to work with knowledgeable legal and tax professionals to ensure the policy fits within the greater estate—especially during volatile market conditions.
As part of their continuing oversight obligation, trustees must work with all appropriate advisors, understand each aspect of the policy and investment structure, periodically review the performance of the investments, and ensure premium payments are made when necessary.
The trustee’s duty of obedience requires them to monitor the PPLI and PPVA financial performance. Trustees are responsible for following up with the insurance company responsible for administering the policy. For example, the insurance company should provide regular statements on the policy’s performance and ensure the policy remains in compliance with changing regulatory requirements.
There has been some regulatory scrutiny from the US Senate. In September 2022, US Senator Ron Wyden, chair of the Senate Finance Committee, requested information about the amount of risk transfer in PPLIs. In a letter to Lombard International, Wyden wrote, “I am concerned that these insurance vehicles are being used without a genuine insurance purpose to invest in hedge funds and other investments while avoiding billions of dollars in federal taxes.”
While there hasn’t been much recent activity, given the scrutiny of the tax strategies and investment opportunities to ultra-high-net-worth individuals, the industry should continue to monitor the regulatory environment closely. Trustees should maintain communication with the life insurance agent to ensure there aren’t any changes needed to the policy or structure.
A trustee’s fiduciary duties don’t change with the asset being managed, but a PPLI or PPVA policy is an alternative asset class and should be treated as such. To learn more about trustee responsibilities and liabilities, reach out to your Woodruff Sawyer account team.