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Wealthy Investors Need Private-Placement Insurance

By Denis Kleinfeld   |   Monday, 07 Mar 2011 06:56 AM

Private-placement insurance is being re-discovered as a tool for tax-free investing while providing considerable asset protection against liability.

There are some complexities in using this vehicle for achieving income, estate and liability goals. But the benefits are worthwhile.

Basically, private-placement insurance can be either in the form of life insurance or an annuity. For investment purposes, the policies are structured as a variable insurance product. Since 1913, the Internal Revenue Code treats the income earned under an insurance policy differently from that of income from investments that are owned directly by the investor.

It has been widely recognized that variable insurance provides a wide range of significant benefits for policy purchasers. These include, as a general rule, lower premiums and overhead costs, a wider range of investment choices, privacy and confidentiality, and in some states a means to protect assets from the clutches of creditors. And all of this without having the government siphon off taxes, which allows the compounding of investment using the full value of 100 percent dollars.

IRS rules require that the underlying investment funds that support a variable insurance contract must be held in at least a diversified account.

The specific diversification rules are, however, quite reasonable and would normally be part of a diversified investment portfolio in any event. The funds being offered must be only available through the insurance company and are not sold to the public. As a result, insurance companies create both mirror funds that are only available through the variable policy as well as creating specific special-purpose funds.

There are differences between a variable insurance policy and a fixed-return insurance policy. With a variable policy, the policy owner, and not the insurance company, assumes the risk of the underlying investments: gain or loss. This allows an investor/policy owner the opportunity to purchase various types of investment funds that may not otherwise be structured to be tax-efficient and turn them into effectively tax-free investments. Hedge funds are particularly subject to this dilemma.

The policy purchaser is not allowed to just purchase or wrap the policy with existing investments. There are rules which prohibit investor "control." This is one area where the IRS has expressed particular concern.

However, the particular tax-code section involved does specifically allow the use of independent investment advisers. As a result, private-placement insurance has a distinct advantage over just a regular fixed-insurance product since the policy investment funds can be managed individually by some of the best wealth managers, even if the particular investments cannot be chosen by the policy owner.

Without much question, variable insurance contracts, including those being offered by offshore insurance carriers, are again being used by income and estate tax planners as extremely valuable vehicles to achieve a variety of planning goals.

Foreign carriers are more likely to be willing to customize their products to a particular policy purchasers need. U.S. insurance companies tend to operate as an assembly line, trying to sell to the broadest market possible and keep compliance costs and exposures to a minimum.

Private-placement insurance offers the opportunity to create a large and liquid pool of funds. It can turn traditionally tax-inefficient investments, such as hedge funds, into investments that can compound and grow in a tax-free environment.

Policies are available that allow the use of independent investment advisers. And, when ownership is structured properly, such as by an asset-protection trust, it can maximize the protection of investments from the threat of loss due to exposures to growing power of the legal liability industry.

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