March 2016


Tax Court Ruling with Implications for Split Dollar Arrangements

On March 28, the Tax Court filed Memorandum Opinion 2016-55 in which the court determined that certain payments made by a corporation into the Sterling Benefit Plan (“SBP”), a purported welfare benefit plan, were not deductible and that the employees needed to record them in their gross income accrued benefits. Participation in the Sterling Benefit Plan was determined to be a nonqualified deferred compensation arrangement subject to section 402(b)(4); this same plan design was the subject of the U.S. Tax Court Ruling from July 13, 2015 which we covered in the July 2015 LRA.

The SBP included a compensatory split-dollar arrangement. The Tax Court’s ruling included some notable conclusions with respect to the split-dollar arrangement, particularly as it relates to determining whether a pre-9/17/2003 arrangement has been “materially modified” under 26 CFR 1.61-22.

The IRS contended that the split-dollar arrangement was materially modified for three reasons. The table below summarizes each contention and the Tax Court’s respective rulings.

# Contention Ruling
1 The plan participant took actions that were not within the regulation’s list of changes that are not considered to be material modifications; therefore, the actions must have represented material modifications The court rejected this argument; noting that the regulations explicitly state that the list of changes not considered “material” is not exclusive
2 The plan participant allowed the split-dollar insurance policy to lapse and then went through a process to reinstate the policy in 2005 (including medical underwriting review and payment of premium) The court rejected this argument, noting that the life insurance policy had extensive provisions related to its lapse and reinstatement, and that no evidence in the record supported a finding that the parties to the life insurance contract entered into a new agreement or changed any provisions related to the policy
3 The SBP had been amended in 2005 by adding a preretirement health expense reimbursement benefit The court ruled that adding this new benefit resulted in the creation of a new right under the existing split-dollar life insurance arrangement (not a change in the split-dollar life insurance policy); the court further ruled that the change was material

It is interesting that the court applied a broader view of what a split-dollar arrangement is, emphasizing the word “arrangement” and stating that the word contemplates “not a life insurance contract itself, but an arrangement as a whole between an owner and a non-owner of that life insurance contract.”

It is also noteworthy that neither party offered any authority for a bright-line rule that would allow the court to quantify what modification is “material” within the meaning of the split-dollar regulations. Thus, the court looked at whether the modification “went beyond merely ministerial actions and created different legal entitlements for the owner and non-owner of a life insurance policy.”

Impact of the Split-Dollar Rulings

Because there was a material modification effective as of January 1, 2005, the plan falls under the split-dollar insurance arrangement regulations. Under the regulations, the economic benefit provided by the arrangement each applicable year must be included in income. The economic benefit is the sum of: (1) the cost of current life insurance protection provided to the non-owner during the year, and (2) the amount of the policy cash value in which the non-owner has current access during that year.

The petitioners argued that they had already reported as income (reported on Form W-2, box 12(c)) the current cost of insurance in each year. However, the court concluded that the amounts reported on the W-2 were different from the actual costs of the death benefits for 2005 and 2006. The ruling did not further explain either the computation of the original amounts nor what computation should apply in determining the correct amounts.

In this instance, the participant was found to have current access to the cash value of the policy. Hence, the previously unreported and untaxed portions of the accumulation value were subject to tax as well.



Federal Reserve Re-Proposes Single-Counterparty Credit Limits

On March 4, the Federal Reserve re-proposed the single-counterparty credit limits required by section 165(e) of the Dodd-Frank Act. The law prohibits covered companies from having credit exposure to any unaffiliated company that exceeds 25% of the capital stock and surplus of the covered company.

The requirements in section 165(e) operate as a separate and independent limit from the investment securities limits and lending limits in the National Bank Act and Federal Reserve Act.

The Federal Reserve’s re-proposed rule takes into account (1) the large volume of comments received on the original proposal; (2) revised lending limits rules applicable to national banks; (3) the introduction of a “large exposures” standard by the Basel Committee; and (4) the results of quantitative impact studies and related analyses by the Federal Reserve.

The comment period for this proposal closes June 3, 2016.



Transamerica Class Action Complaint relating to COI Rate Increases

On March 25, a class action complaint was filed in the US District Court (Southern District of Florida) alleging that Transamerica’s recent drastic increase of COI rates under its universal life insurance policies is a means of circumventing the minimum guaranteed crediting rates of the contracts.

The complaint does not provide a detailed analysis of Transamerica’s policy language as it relates to discretion in setting or increasing COI charges. It simply asserts that the discretion is “constrained” and then states that Transamerica is specifically not authorized to do any of the following:

  • Set or increase the COI at whatever amount or by whatever method it determines;
  • Set or increase the COI to recoup past losses on the policies due to the failure of credited interest, policy lapse rates, or other assumptions Transamerica made when originally pricing the policies;
  • Set or increase the COI to recoup losses on the policies due to diminished returns on Transamerica’s general investment portfolio; or
  • Set or increase the COI to negate or offset Transamerica’s obligation to pay credited interest to the policies at the minimum guaranteed rates.

 Case Citation: 1:16-cv-21074 (SD FL)



FASB Proposed Accounting Standards Update – Comments re BOLI Cash Flows

As we reported in the January LRA, FASB recently issued a Proposed Accounting Standards Update applicable to the Statement of Cash Flows (Topic 230). On March 29 the comment period closed.

Questions six and seven in FASB’s request for comments were specifically applicable to BOLI/COLI:

Question 6: Should cash proceeds received from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, be classified as cash inflows from investing activities? If not, what classification is more appropriate and why?

Question 7: Should cash payments made for premiums of corporate-owned life insurance policies, including bank-owned life insurance policies, be permitted to be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities? If not, what classification is more appropriate and why?

In total, 22 companies and individuals submitted comments; of these, half directly addressed questions 6 and 7. All eleven responding companies agreed with FASB on Question 6. On Question 7, six commenters took the view that cash payments made for premiums should only be allowed to be classified as investing activities and not operating activities. The remaining five generally agreed with FASB’s proposal.

We will continue to monitor for the release of a final standard.



NAIC Cybersecurity Model Law Proposal

On March 2, the NAIC proposed a Cybersecurity Model Law entitled Insurance Data Security Model Law. Comments were open until March 23. This action shows that cybersecurity is an important trend. The model law covers topics including a written security program, oversight of the program, investigation of breaches, consumer rights before and after a breach, and penalties for non-compliance. The model law, if adopted by the NAIC, would need to be adopted by the states in order for it to become applicable.


JCT Revenue Estimates of Obama Budget Proposal

On March 24, the Joint Committee on Taxation (JCT) released its estimated budget effects of the President’s Fiscal Year 2017 Budget Proposal. Below is a comparison of the JCT’s projections and Treasury’s projections for certain insurance-related proposals from the last two years. The estimates are for the respective ten-year periods (i.e., 2016–2025 and 2017–2026).

Proposal 2016 Fiscal Year Projections Obama/Treasury 2016 Fiscal Year Projections Obama/JCT 2017 Fiscal Year Projections Obama/Treasury 2017 Fiscal Year Projections Obama/JCT
264(f) Interest Expense Disallowance $6.3 billion $7.2 billion $6.3 billion $7.2 billion
Proration Rules for Life Insurance Companies $7.5 billion $6.1 billion $7.5 billion $6.1 billion
Life Settlements/
Transfer for Value
$500 million $1 billion $500 million $1.1 billion


Florida Bill Requires Insurance Companies to Search DMF

On March 10 Florida passed bill HB 1041, and the senate companion SB 966, which requires insurance companies to prospectively and retroactively to 1992, search their records against the United States Social Security Death Master File (DMF) and make a reasonable effort to investigate a claim when they have actual knowledge of a life insurance policyholder’s death.

As we reported previously, in August 2014, Florida’s First District Court of Appeal reversed a declaratory statement issued by Florida’s Department of Financial Services in which Thrivent Financial was required to actively monitor the DMF records. Notably, the court had interpreted the plain language of the statute and ruled that the DFS interpretations were clearly erroneous. The court further stated that any requirement for insurers to actively search death records must be addressed by the state’s legislature.


MetLife’s SIFI Designation Overturned

On March 30, the U.S. District Court for the District of Columbia ordered that the Financial Stability Oversight Council’s (FSOC) designation of MetLife as a Systemically Important Financial Institution (SIFI) be rescinded. The ruling is subject to appeal.

MetLife issued a statement on the ruling.


FINRA Target Exam Letter on Firm Culture

In February FINRA posted a Target Exam Letter on Firm Culture. In the letter FINRA states “A culture that consistently places ethical considerations and client interests at the center of business decisions helps protect investors and the integrity of the markets.” Our firm vigorously supports the statement that culture and values are of the utmost importance.

At MBSA, we hold the following views:

  • We favor mandatory full-disclosure of all compensation
  • We favor adoption of a uniform fiduciary standard for both investment advisers and broker-dealers

We support state-mandated disclosure of all life insurance product commissions and broker/agent compensation.