INTRODUCTION. The only things certain in life are death and taxes. Benjamin Franklin

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1 SOPHISTICATED LIFE INSURANCE PRODUCTS FOR TAX AND FINANCIAL PLANNING By Norse N. Blazzard and Judith A. Hasenauer Attorneys at Law Blazzard & Hasenauer, P.C. INTRODUCTION The only things certain in life are death and taxes. Benjamin Franklin Americans who have achieved a degree of financial success in life have to plan for the inevitability of both death and taxes. Moreover, in addition to planning to avoid the usual taxes charged during life, successful Americans must also plan for taxes resulting from death the so called estate and inheritance taxes. The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or otherwise avoid them, by means the law permits, cannot be doubted. United States Supreme Court Justice George Sutherland in Gregory v. Helvering (1934-5) 293 U.S. 465, 460. It is only logical for Americans to search for legal means to minimize their tax burden. It is an anomaly that the more financially successful one becomes, the more likely it is that the tax burden will increase. Recent years have seen fewer and fewer tools available for financially successful people to legally avoid taxes. One of the few remaining mechanisms available to accomplish this goal is the use of sophisticated life insurance products. The federal tax laws permit the payment of death proceeds from a life insurance policy free from federal income taxes. Most state income tax statutes follow the federal model. This tax-favored treatment of life insurance proceeds has remained a constant for most of the existence of the income tax in America. The objective of this paper is to present a brief description of sophisticated life insurance products, their uses and features. By necessity, we will also discuss less sophisticated types of life insurance in order to contrast sophisticated products from more routine types of life insurance that are more familiar to everyone. WHAT ARE SOPHISTICATED LIFE INSURANCE PRODUCTS? All life insurance products purchased by American taxpayers enjoy the tax-free receipt of death proceeds not just sophisticated life insurance products. However, sophisticated life insurance products tend to have more appeal to financially successful Americans than is true of the more routine life insurance products. Routine life insurance products do the job for the average person: they provide financial security on a tax effective basis; they 1

2 provide for tax-free or tax-deferred accumulation of investment gain; and, they provide a disciplined method of laying away funds for the future. Sophisticated life insurance products generally have more investment options available than is the case with routine products. Often, they permit the assets underlying the policies to be invested in more exotic investments that might otherwise be unavailable to the average person. They are usually more competitively priced than are the life insurance products purchased by the average consumer. In addition, they often provide more flexibility than is the case with routine life insurance products. Sophisticated life insurance products are often characterized as variable universal life insurance. The discussions in the remainder of this paper will be directed primarily toward variable universal life insurance, although other types of insurance and annuities will also be mentioned. Sophisticated life insurance products are frequently sold on a private placement basis. This means that the products and the methods for distributing them are designed for sophisticated purchasers with greater than average financial acumen. Often, the purchasers of these sophisticated life insurance products rely on trusted advisors to assist them in understanding what they are purchasing and to help them to implement the purchase of the products. Such trusted advisors are often attorneys, accountants, trust officers and financial advisors who regularly work with their clients in handling their financial needs. These sophisticated life insurance products are often issued by life insurers that are domiciled in the United States. However, many sophisticated purchasers choose to purchase some or all of their life insurance products from insurers domiciled outside of the United States. A great many of these insurers domiciled outside of the United States issue their life insurance policies in US dollar denominations. This is particularly true of insurers domiciled in international financial centers such as Bermuda, the Channel Islands and some of the Caribbean. In this paper we will discuss both domestic and nondomestic sophisticated life insurance products and outline the advantages and disadvantages of both. Often, non-americans purchase these sophisticated life insurance products from insurers domiciled outside of the United States. In many instances these purchases are made when non-americans are coming to the United States, either to become permanent residents or for temporary visits of a long-term nature. Anyone residing in the United States for significant periods of time or who has United States source income, becomes liable for the American income tax both federal and state. Utilizing a sophisticated life insurance policy issued in a non-american country and left there may have significant tax advantages to people coming to the United States. VARIABLE UNIVERSAL LIFE INSURANCE Variable universal life insurance is a cash value type of life insurance. This means that the life insurance policies provide more than temporary financial protection on the death of the insured. Cash value life insurance is contrasted with term insurance. Term 2

3 insurance offers only pure protection. Proceeds are payable only on death. Cash value life insurance has an investment element to it. Cash value products permit policy owners to access the cash values of their policies either through the surrender of the policy for all or part of the cash value or through policy loans. In most instances, it is preferable for a policy owner to access cash value through policy loans than by surrender of all or part of the policy. We will discuss the reasons for this later in this paper. Variable universal life insurance is referred to as variable because the amount payable on the death of the insured (the death benefit ) and the cash value of the policy vary with the performance of a portfolio of assets that are held by the insurer to underlie the policy. Thus, the death benefit and the amount obtainable via surrenders or loans will vary in accordance with the value of these underlying assets. Universal life insurance is a name used within the life insurance industry to describe a cash value life insurance policy that does not have a scheduled premium required to keep the policy in force. With a universal life insurance policy, the policy will remain in force for so long as there is sufficient cash value to cover the cost for the death benefit provided in excess of the cash value. Unlike more traditional types of life insurance, there is no requirement to pay premiums on a scheduled basis. There are other elements that differentiate universal life insurance from more traditional forms of life insurance, but these are not relevant to this paper. Universal life insurance also usually permits the payment of additional premiums that can increase death benefits and cash values. However, the insurer may limit the amount of such premiums and there are limitations imposed on American taxpayers by the Internal Revenue Code as to the amount of cash value that can be held under a life insurance policy with respect to the amount of the death benefit. We will discuss this in greater detail later in this paper. PROTECTION OF ASSETS HELD UNDER UNIVERSAL VARIABLE LIFE INSURANCE In the United States, all states have laws that are designed to protect the assets held under variable universal life insurance from any financial difficulties that may affect the issuing insurer. The mechanisms used for this purpose are called segregated asset accounts, commonly referred to as separate accounts. These separate accounts are used to hold the assets that underlie the variable universal life insurance policies. An insurer may have many of these separate accounts and they are usually segregated from one another based on the nature of the underlying assets. In many instances, a separate account will have a specific investment orientation and may be managed by a single investment advisor or be invested in the shares of an underlying mutual fund specially created to be used with variable insurance products. State insurance laws in all of the states of the United States provide that the assets in a separate account, so long as certain requirements are met, are not chargeable with the liabilities arising from any other business the insurer conducts and that such assets are for 3

4 the sole and exclusive benefit of the variable insurance policies issued under the auspices of the separate account. To date, this insulation of separate account assets has been honored in every instance where an insurer has faced insolvency or liquidation. Many non-american countries have followed the separate account model established by the United States. Thus, these countries also provide owners of variable insurance contracts with the same type of insulation afforded by the statutes of the United States. Some non-american countries provide for separate account insulation through omnibus separate account legislation that applies to all insurers domiciled in such a country. Other countries enact special legislation on an insurer by insurer basis to afford such protection. Some jurisdictions, such as Bermuda, follow both approaches. Needless to say, prospective policy owners and their advisors need to satisfy themselves that such insulation is in effect before purchasing any type of variable insurance product. PROTECTION OF SOPHISTICATED LIFE INSURANCE PRODUCTS FROM CLAIMS OF CREDITORS There are many ways in which each jurisdiction around the world treats life insurance policies under their laws when it comes to claims of creditors. In the United States, there is a hodge-podge of different treatments as well as the requirements of the federal government with respect to bankruptcy statutes. Some jurisdictions provide protection for all assets (including life insurance policies) from claims of creditors, so long as the acquisition of the policies was not done to defraud existing creditors. The subject of asset protection is beyond the scope of this paper, but potential purchasers of sophisticated life insurance products who are concerned about this issue should seek assistance from financial advisors who are conversant with asset protection issues. COSTS, FEES AND CHARGES Although variable universal life insurance provides important financial and tax benefits, there are costs, fees and charges that must be borne by the owners of the product. One of the costs involved with variable universal life insurance is the cost for the pure insurance element. This is referred to as the cost of insurance. This is the amount charged by the insurer for providing the death benefit in excess of the amounts held as cash value under a policy. The amount of the charge for cost of insurance will vary from insurer to insurer and will also depend on the age and sex of the insured and whether the insured has special health risks or engages in hazardous activities (such as sky diving, racing or flying private aircraft) that might cause the cost of insurance to be greater. We will discuss this element in somewhat more detail later in this paper in the section on underwriting. Insurers also usually charge for the administrative costs inherent in the issuance and maintenance of the universal variable life insurance policies. Again, the amount of the charge will vary from insurer to insurer and may also vary depending on the amount of insurance protection offered or the cash value held under the policy. 4

5 Variable universal life insurance policies also often include costs for the distribution of the policies. These amounts are charged to compensate insurance agents and consultants for their services in assisting purchasers to understand and implement the policies. These amounts also reimburse the insurer for costs encountered in preparing sales materials, sales programs, advertising, etc. Depending on the domicile of the purchaser of a variable universal life insurance policy there may also be deductions from premiums or cash values for taxes charged by governmental entities on the issue of a life insurance policy. We will discuss premium taxes later in this paper under the section captioned taxes. Sophisticated purchasers of variable universal life insurance policies are almost always provided with disclosure materials, often in the form of a private placement memorandum or offering memorandum, that will discuss costs, fees and charges in detail. UNDERWRITING A fundamental element of all life insurance is the concept of underwriting the risks assumed by the insurer when it issues a policy. Life insurance policies are usually issued on the lives of people who are determined to have normal health risks and who do not engage in hazardous activities. These risks are referred to as standard risks and policies issued on this basis are called standard risk policies. Standard risk policies are based on the statistical tables that measure the risk of death of large numbers of people people with no special health issues and people who are not unhealthier than the statistical average. Life insurance policies are also issued on what is called a preferred basis. These policies apply to people who have health standards that are less likely to result in premature death than for the statistical norm. Life insurance policies are also issued o people who have a greater risk of premature death than would apply to the statistical norm. These policies are referred to as sub-standard policies. There are some people who have such significant health issues that they do not qualify for life insurance and are referred to as uninsurable. REINSURANCE Virtually all insurers transfer some or all of their risk under the life insurance policies they issue to other insurers. This process is referred to as reinsurance. Reinsurance is usually a contractual relationship between insurers and is not visible to the owners of policies or the persons insured. However, with sophisticated life insurance products, the reinsurance process often is more visible than in more routine types of life insurance. Often the reinsurance contracts between the insurer issuing the policy to the insured and the reinsurer will contain provisions designed to protect the policy owner in the event the issuing insurer cannot meet its obligations with respect to payment of death benefits. Sometimes these reinsurance arrangements will provide for the reinsurer to make payment of death benefits directly into the separate account of the issuing insurer. In 5

6 other instances, reinsurance arrangements may provide for a cut-through where reinsurance proceeds are paid directly to the beneficiary under the primary life insurance policy. Offering materials provided at the time of purchase of such a contract will usually describe any of these types of reinsurance arrangements. TAXATION Many countries have different processes when it comes to the taxation of owners of life insurance policies, cash values and death benefits. It is not possible in a paper of this nature to discuss the tax ramifications of every jurisdiction where a purchaser of a sophisticated life insurance policy may be subject. American taxpayers have special requirements that apply to any life insurance policies that they may own. Although we will discuss these requirements on a general basis, every taxpayer s situation is different. General tax principles applicable to life insurance may be helpful to readers of this paper, but everyone should seek tax advice relative to their own peculiar circumstances from knowledgeable tax practitioners. Most non-american jurisdictions (e.g., Bermuda) do not charge taxes as the result of the sale or existence of an insurance policy. All references in this paper to the Code mean the Internal Revenue Code of 1986, as amended. The Definition of Life Insurance for Tax Purposes Section 7702 of the Code contains a requirement that must be met by all cash value life insurance policies issued to American taxpayers if they are to enjoy the favorable federal income tax status afforded to life insurance policies. This is true regardless of where the policy is issued. This requirement necessitates that such policies have a minimum amount of pure insurance coverage in relation to the premium paid for the policy or the cash value maintained under such a policy. The computations required to ensure that a cash value life insurance policy satisfies these requirements are complex actuarial calculations and a detailed description is beyond the scope of this paper. It is sufficient to say that all cash value life insurance policies that are designed to be acquired by American taxpayers will have been designed in accordance with the requirements imposed by Section 7702 of the Code. Purchasers of sophisticated life insurance policies should look for assurances from the insurer with respect to these requirements in any disclosure materials provided. If a cash value life insurance policy fails to meet the requirements of Section 7702 of the Code then any increases in cash value over the taxpayer s basis in the policy would be included in current income for purposes of calculating any federal income tax payable. Modified Endowment Contracts Section 7702A of the Code creates a classification of cash value life insurance called modified endowment contracts (sometimes referred to as MECs ). A MEC is a life insurance policy or similar contract that, by its design, will become a fully paid up insurance policy on other than a 7 year payment basis. (Note the 7 pay design requirement does not necessarily mean that premiums can only be paid over a 7 year period. It is possible to use different payment schedules and still keep the policy from being a MEC. Most MEC policies are designed to be sold with a single premium, rather 6

7 than a series of premiums.) MECs are taxable on distributions other than on the death of the insured (and certain other hardship situations and for persons over the age of 59 1/2) in the same manner as applies to deferred annuities. Thus, a MEC is taxed like any other life insurance policy on the death of the insured i.e. amounts payable as death proceeds are free from federal income tax. However, for distributions of cash value other than on the death of the insured, the amounts distributed are treated as earnings on the policy and are currently includable in gross income for tax purposes. Moreover, if the recipient of the distributions is under the age of 59 ½, there may be a tax penalty assessed equal to 10% of the taxable portion of the distribution. Once all earnings on the policy have been distributed on a taxable basis, the remainder that represents the basis in the contract can be recovered income tax free. MECs can be very useful for American taxpayers who are interested in providing taxefficient assets to future generations and do not foresee any likelihood that they will need access to the assets during the remainder of life. It is one of the most tax-efficient methods to pass assets inter-generationally that there is. A non-mec life insurance policy permits the policy owner access to the cash values of the life insurance policy prior to death on what can be a very tax-efficient basis. There are two methods to accomplish this goal. If a policy owner owns a non-mec and needs access to the cash values prior to death of the insured, it is possible to make a withdrawal (assuming the insurance contract permits withdrawals) of an amount up to the policy owner s basis (i.e. the amount paid in as premiums). Such a withdrawal, so long as it does not exceed the policy owner s basis in the contract, is free from current income taxes. A better method to access a non-mec life insurance policy s cash values is through a policy loan. Since a policy loan will eventually be repaid, either at the time of the death of the insured or at the option of the policy owner prior to the death of the insured, any amounts received as policy loans are free from current income taxes. This, in effect, permits a policy owner to accumulate investment income credited to the policy on a taxfree basis and to receive funds to supplement current income also on a tax-free basis. In essence, this is a tax-free investment. It is important to note that a policy owner who borrows cash values pursuant to a policy loan has no obligation to repay the loan. The amount borrowed will accumulate unpaid interest until either the death of the insured or when the amount of the loan and the accumulated interest on the loan, combined with other charges against the policy, cause the cash value to drop below a level that can continue to sustain the policy. This will cause the policy to lapse and could trigger a taxable event to the policy owner if the amount borrowed exceeds the basis in the policy. Such a taxable event can also occur for variable universal life policies where market conditions have caused a diminution of cash values. Most insurers issuing non-mec policies have in effect administrative procedures to warn policy owners if a policy is likely to lapse as a result of decreases in cash value in order to prevent unexpected taxable events. 7

8 Again, the actuarial calculations necessary to differentiate a MEC insurance policy from a non-mec policy are not within the purview of this paper. Virtually all insurers issuing life insurance policies to American taxpayers are aware of the provisions of the Code affecting the status of a policy and will disclose adequate information to policy owners to ensure they understand the type of policy they own. Diversification Requirements for Variable Universal Life Insurance Variable universal life insurance and variable annuities owned by American taxpayers have additional qualifications they must meet in order to qualify for the favorable tax treatment afforded to such contracts. These requirements are imposed by Section 817(h) of the Code and by certain interpretations of the United States Treasury and the Internal Revenue Service. These qualifications relate to the nature of the investments that are held under variable life insurance policies and variable annuity contracts and must comply with the qualifications at the end of each calendar quarter. Section 817(h) of the Code requires that the assets held in a separate account underlying variable insurance products be adequately diversified. In accordance with the Code and the Treasury Regulations promulgated under the Code, this means that a separate account holding assets for variable life insurance or variable annuities must have no more than 55% of its assets in the interests of a single issuer of assets, no more than 70% of its assets in the interests of two issuers of assets, no more than 80% of its assets in the interests of three issuers of assets and no more than 90% in the interests of any four issuers of assets. In effect, this means that any separate account holding variable insurance assets must have holdings of at least five issuers. Moreover, the appropriate percentages must comply with the requirements specified. It is possible for a separate account of an insurer that holds variable insurance assets to qualify for the diversification requirements by directly holding assets within the separate account itself. This is often referred to as a managed separate account. This type of separate account purchases assets on the open market in accordance with the investment policies of the insurer relating to the separate account and holds such assets directly in the separate account. Diversification testing then takes place at the separate account. However, in recent years most variable insurance separate accounts have had as their underlying assets instruments that are managed by another entity. Often these entities are mutual funds, hedge funds, limited partnerships or similar entities. In such an event, the separate account may own only a single class of assets issued by a single investment entity. Obviously, if the diversification requirements were imposed on such a separate account directly, the account would not be adequately diversified. In recognition of the prevailing practice of the life insurance industry to have separate accounts invest their assets in various types of investment entities, the Code and Treasury Regulations permit diversification testing to be accomplished by looking through to the underlying entity. Thus, if the underlying mutual fund, hedge fund, limited partnership or other similar entity is adequately diversified, the separate account of the insurer can rely on such diversification to meet the requirements of the Code. 8

9 In order for a separate account to be able to use the look-through for diversification testing, the entity underlying the assets must be an insurance dedicated investment entity whose assets are not available for investment by other than a life insurance company. If the underlying investment entity is publicly available other than through investment in a variable insurance product, then the look-through is not available and the separate account must be diversified itself through ownership of assets issued by at least five different issuers in the appropriate percentages. Thus, it is possible for an insurer to have a separate account that meets the diversification requirements if the separate account checks its diversification levels directly at the separate account level even though underlying investment entities are not insurance dedicated and are available to the general public outside of variable insurance products so long as the diversification requirements are met. The Investor Control Concept The United States Treasury Department and the Internal Revenue Service ( IRS ) have long taken the view that an owner of a variable insurance product who exerts too much control over the assets underlying the product will cause any investment gain on such a product to be currently taxed to the contract owner and thereby lose the tax advantages that otherwise accrue to such products. The IRS has issued a number of private letter rulings, revenue rulings and other pronouncements dealing with this issue. The position of the IRS seems to be that exercising undue control over assets underlying a variable insurance contract is inconsistent with ownership of such assets by the insurer a requirement if such assets are to be afforded the tax treatment that applies to life insurance reserves. Although there has been no detailed guidance as to how much investment control is too much investment control in the minds of the IRS, it is possible to glean some principles that help to understand. Policy owners can always select the general type of investments that will underlie their variable insurance products. Thus, most variable annuities and variable life insurance policies issued to American taxpayers permit selection from a vast array of underlying investment orientations. Most major mutual fund families in the United States have numbers of insurance dedicated mutual funds that underlie variable insurance products issued by a number of insurers. Policy owners are permitted to select from among these underlying investment entities, many of which have widely divergent investment orientations. Policy owners are also permitted to change underlying investments from time to time as they perceive market conditions dictate. They can also turn to trusted advisors to provide advice with respect to the selection and subsequent reallocation of underlying assets. Thus, the degree of investment control that permits selection from among numerous investments does not run afoul of the investor control concept. However, it seems clear that a policy owner who communicates with the entity or person managing the 9

10 investments underlying his variable insurance product, or who has a pre-existing scheme to dictate what investments will be made does violate the investor control concept. Most insurers issuing variable insurance products to American taxpayers have in place procedures to protect them and their policy owners from any activities that might be considered to exert impermissible investor control over the assets underlying variable insurance products. Premium Taxes As previously noted, some states within the United States levy taxes on premiums paid under life insurance policies and, in some instances, annuity contracts. These premium taxes can be as high as 3% of premiums paid. Premium taxes are usually payable to the state where the policy owner resides, although it is also possible that they may be levied in the state where the policy is delivered. Most insurers pass premium taxes through to policy owners particularly with variable insurance products. Insurance products issued by insurers outside of the United States may not incur premium taxes. This is one reason why sophisticated purchasers of life insurance products often seek non-american insurers for the purchase of variable universal life insurance products. DAC Taxes Insurers that are subject to income taxes in the United States are required to account for certain deferred acquisition costs upon the issuance of life insurance policies and annuity contracts in a manner that increases the tax burden paid by such insurers. Such insurers usually pass on this tax burden to purchasers of such policies and contracts. Insurers that are domiciled out of the United States may, even if they have elected to be taxed as a United States insurer, have a somewhat reduced DAC tax. This may make insurance products issued by non-american insurers less expensive than for similar products issued by an American domiciled insurer. The disclosure materials for both American domiciled insurers and non-american domiciled insurers will contain information about the applicability of DAC taxes to any purchaser of a sophisticated life insurance product such as a variable universal life insurance policy. Excise Taxes American taxpayers who purchase a life insurance product from an insurer domiciled outside of the United States where such an insurer has not elected to be taxed as though it is an American insurer may be subject to payment of an excise tax as a result of such a purchase. Disclosure materials that are provided to purchasers will describe this excise and disclose whether it will be applicable to the particular purchase contemplated. 10

11 FINANCIAL AND ESTATE PLANNING WITH LIFE INSURANCE PRODUCTS We previously noted Benjamin Franklin s view of the inevitability of death and taxes. Recent years have seen a great deal of confusion regarding the future of the estate tax levied against American taxpayers on their death. It seems likely that the estate tax will, in some form, be reinstituted in 2010 or earlier. If this happens, financially successful persons will, once again, have to take this type of tax into consideration in planning for intergenerational transfers of assets. Estate planning attorneys, accountants, trust officers and financial planners have been adept in developing programs using life insurance products to minimize or eliminate estate and inheritance taxes in the past. As the estate tax is re-implemented, it is likely that the use of such estate planning tools as irrevocable life insurance trusts will continue to be used to ameliorate estate and inheritance taxes. Even if estate planning cannot completely avoid payment of estate and inheritance taxes, the availability of income tax free life insurance proceeds can be helpful to pay such taxes with assets that have grown income tax free. It is important to remember that the IRS expects to have estate taxes paid promptly after death often before assets other than life insurance proceeds are sufficiently liquid to avoid the necessity for a sale of such assets at a time that is not optimal. SOPHISTICATED LIFE INSURANCE POLICIES ISSUED BY AN AMERICAN DOMICILED INSURER VERSUS SIMILAR PRODUCTS ISSUED BY A NON- AMERICAN DOMICILED INSURER There are a number of insurers domiciled in the United States that offer variable universal life insurance products for sophisticated purchasers. These products range from traditional life insurance products sold by traditional life insurance agents to more sophisticated private placement products that may be offered by traditional life insurance agents or may be offered by financial consultants or financial planners. Private placement products generally have fewer features added to them and therefore tend to be lower cost to the purchaser. It is also common for private placement products to have lower commissions (or in some instances, no commissions) payable on the issuance of the products. Instead, the insurance agent, consultant or financial planner may charge a fee for his or her services. Private placement products are usually available only to sophisticated purchasers who meet certain qualification standards before they will be permitted to purchase such products. Persons who do not meet these qualification standards must purchase products that have been registered with the United Sates Securities and Exchange Commission and where a standard prospectus must be used. This is in addition to any requirements that may be imposed by the various state insurance regulators on life insurance products issued in the various states. All life insurance products sold in the United States are subject to the requirements of state insurance regulators applicable to such products. These requirements include supervision of the insurers and prior approval of the insurance policies that must be filed with the various state insurance regulators. No life insurance policy can be issued in any 11

12 state where the insurer is not authorized to do business and where the specific life insurance policy has been filed with and approved by the appropriate state insurance regulator. This is true whether the life insurance policy involved is a private placement type of product or a more traditional form of life insurance. Life insurance products issued by insurers that are not authorized to conduct business in the United States cannot be issued in any state of the United States. Such products can only be issued in a jurisdiction where such an insurer is authorized to conduct business. However, residents of the various states of the United States are permitted to purchase life insurance products in a jurisdiction where they do not reside, so long as such a purchase is permitted where it is made. Foreign insurers most often establish strict procedures for the purchase of a policy by an American taxpayer to prevent the purchase from being deemed to have been purchased in the United States Prospective purchasers of a sophisticated life insurance policy from a non-american insurer should take care in the selection of the country where the insurer is domiciled. Separate account laws and regulations should be studied and the disclosure materials provided should include a discussion of the protections provided by the laws and regulations of the jurisdiction. Likewise, information should be sought regarding protections in the event of insurer insolvency and availability of reinsurance proceeds to cover policy obligations. Some jurisdictions (such as Bermuda) have well-established laws and procedures governing separate accounts, availability of reinsurance proceeds and protection in the event of insurer insolvency. Those insurers in Bermuda which have made application to Parliament and have had private acts passed, may afford even greater protection than what is currently available to policy owners in the United States. Many of the private acts clearly insulate separate account assets and even reinsurance proceeds applicable to separate account policies. Other jurisdictions have little experience with variable insurance products, separate accounts and asset protection methods. There are advantages and there may be disadvantages to purchasing a life insurance product from an insurer that is not domiciled in the United States. The primary advantages are: Avoidance of premium taxes Possible reduction in DAC taxes Availability of underlying investments that cannot be obtained under products issued by American insurers. Lower fees and charges Whilst these do not apply in jurisdictions such as Bermuda which have private acts that provide complete policy owner protection, the primary disadvantages of purchasing a life insurance product from an insurer not domiciled in the United States are: The foreign jurisdiction may not provide the same degree of supervision and regulation afforded by American insurance and financial regulators. 12

13 The foreign jurisdiction may not provide protection against insolvency of insurers domiciled in such a jurisdiction. CONCLUSION Sophisticated life insurance products remain one of the few available products to help manage American income taxes: Cash values and death benefits grow in accordance with the investment orientation selected free from current federal income taxes. Death proceeds pass to the beneficiary under the policy free from current federal income taxes. In most jurisdictions, assets held under variable universal life insurance policies are protected from the insolvency of the insurer. Sophisticated variable universal life insurance products are often less expensive than is the case with traditional products. 13