Life Insurance Watchers Warn of Unintended Consequences in $12.7 Billion Treasury Plan

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May 26, 2009 Tuesday 09:51 AM EST

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Life Insurance Watchers Warn of Unintended Consequences in $12.7 Billion Treasury Plan

Sean P Carr

WASHINGTON

Industry watchers warn that an Obama administration proposal to raise $12.7 billion from addressing loopholes and compliance issues with life insurance products could result in unintended consequences.

Of particular concern is a proposal to effectively disallow more deductions for employer-owned life insurance polices -- also known as corporate-owned life insurance, or COLI -- by expanding the pro rate interest expense disallowance. In announcing the proposed tax and disclosure changes, the Treasury Department cited mostly technical changes and the need for increased compliance (BestWire, May 12, 2009).

But taking away an employee exemption and disallowing general-interest deductions on new COLI policies would be counterproductive, said Lee Nunn, senior vice president of executive benefits for Aon Consulting.

"It would discourage some companies from buying COLI in the future," he said. "Congress needs to tread carefully here."

The administration may position the changes as affecting insurers, "but they're really tagging companies that use COLI," said Steven Schwartz, senior vice president of equity research for Raymond James & Associates. Insurers thought they were done with this issue when Congress adopted reforms in 2006, he said.

Until recently, Congress had last dealt with the use of COLIs for tax advantages in a pension bill that was signed into law in August of 2006 (BestWire, Aug. 4, 2006). A provision within the pension bill specifically limited the use of COLI policies to the top 35% of income earners in a company, or those earning more than $100,000 per year to allay concerns about "janitor's insurance," the use of COLI policies to insure the lives of employees who earn minimal wages and who are not crucial to the continuation of a business. That legislation also required companies to report information on their COLI practices to the Internal Revenue Service.

In January, U.S. Rep. Gene Green, D-Texas, introduced the Life Insurance Employee Notification Act, under which employers would be required to disclose any life insurance held on employees, with violations policed by the Federal Trade Commission (BestWire, Jan. 30, 2009).

Life insurance industry representatives are lobbying against the Treasury proposals. They have argued that COLI policies are needed for business continuation planning. Actions they see as limiting the availability of such policies would hurt insurance agents and insurance companies and U.S. business in general.

The administration's proposals "are not sound public policy," said Marc Cadin, vice president of legislative affairs at the Association for Advanced Life Underwriting. "Proposing to disallow the deductible interest expenses of businesses to the extent they own life insurance is an attack on basic tax treatment of life insurance. This proposal has been rejected on a bipartisan basis in the past and we believe that it will be rejected again in the future, particularly since Congress codified best practices on COLI in 2006," he said.

The Treasury's proposed changes for life insurance products are part of a 10-year, $58 billion plan to support new health care initiatives. In addition to the COLI provision, the Treasury plan calls for limiting dividends-received deductions claimed by life insurers when a company's separate account assets, liabilities, and income are segregated from those of the company's general account in order to support variable life insurance and variable annuity contracts. A third provision, which has drawn the least attention from the industry, would enforce greater tax compliance through mandated reporting requirements for life settlement transactions (BestWire, May 12, 2009).

The dividends-received deductions provision could "wipe out" separate-account DRDs, Schwartz said. In theory, this could impact companies to a notable but not rating-changing effect. In practice, he said, any financial impact would be spread around to fall on consumers.

"Effective tax rates are lower because this product exists, Schwartz said. "If the DRD provision does not exist, fees are going to go up."

(By Sean Carr, [email protected])

May 28, 2009