OFFSHORE LIFE INSURANCE
by
J. Richard Duke, Esq.
Attorney and Professor of Law
Duke Law Firm, P.C.
400 Vestavia Parkway, Suite 100
Birmingham, AL35216-3750
Telephone: (205) 823-3900
Fax: (205) 823-2630
E-mail:
Web site:
St. ThomasUniversitySchool of Law:
TABLE OF CONTENTS
I.General Aspects of Offshore Life Insurance
A.Advantages
1.Lower Premium and Internal Costs
2.World's Leading Investment Managers
3.Individually-Customized Investment Vehicles
4.Flexible Investment Opportunities
5.Choice of Currencies
6.Larger Face Values
7.Favorable Governing Law
8.Avoid Entity-Level Taxation
9.Avoid State Premium Tax
10.Wealth Preservation and Protection (Asset Protection)
(a)Protection from Insolvency of Carrier
(b)Insured Protected Against Claims from Creditors
11.Increased Confidentiality
12.Avoid Registration Requirements Under the Securities Laws
13.Avoid Rule Against Perpetuities
B.Avoid Registration Requirements for Offshore Funds
1.Classification of a Variable Life Insurance Policy as a Security
2.Offshore Funds Generally Rely on Reg S
3.Principal Requirements for Avoiding Registration Requirements Under the 1933 Act
4.Definition of a U.S. Person
C.Acquiring Insurance Direct From a Foreign Carrier
1.Complying With the Reg D Exemption for Issuance of a Variable Life Policy
2.Complying With the Reg S Exemption for Issuance of a Variable Life Policy
(a)U.S. Insurance Agent
(b)Lawyers, Accountants, Registered Investment Advisors
3.Investments of the Policy
4.The 1933 Act Applies to the Foreign Insurance Carrier
D.State Department of Insurance Laws
E.Tax Advantages of a Qualifying Life Insurance Policy
F.Tax Advantages of a Variable Life Insurance Policy
1.Tax Deferral During the Insured's Life
2.Insurance Proceeds Income Tax-Free
3.Insurance Proceeds May Pass Estate Tax-Free
4.Access to Insurance Policy Through Fund Borrowing
II.Requirements for Classification as a Variable Life Insurance Policy
A.Classification as a Life Insurance Policy
1.Requirements for Recognition as Life Insurance
(a)Guideline Premium Test
(b)CashValue Corridor Test
(c)Test Used by Most Carriers
2.Modified Endowment Contract
3.Non-Modified Endowment Contract
B.Insurance Policy Must be Subject to Insurance Risk
1.Internal Revenue Service Focus on Risk
2.Notice 2003-34
3.Abusive Offshore Tax Avoidance Schemes
C.Definition of Variable Life Insurance Policy
D.International Variable Life Policy
E.Diversification of Investments
1.Diversification Rules
2.Single Investments
3.Look-Through Rule
(a)Treasury Regulations—Hedge Fund Investments
(b)Private Letter Ruling—Hedge Fund Investments
F.Required Control of Insurance Company over the Management of the Policy Assets
1.Wrap Around Rules
2.Policyowner Control
3.Control by Insurance Company
4.Independent Investment Advisor
III.Legal Structures for Acquiring Variable Life Insurance
A.Foreign Trustee as Non-U.S. Person
B.Methods of Acquiring Offshore Variable Life Insurance Policy
1.Foreign Irrevocable Life Insurance Trust
2.Domestic Irrevocable Trust and Foreign Asset Protection Trust.....
3.Domestic Irrevocable Trust and Foreign Nongrantor Trust
IV.Tax consequences of Acquiring Offshore Insurance
A.Payment of Premium
B.Excise Tax
1.Premium Payments
2.Reinsurance Premium Payments
C.Filing the Gift Tax Return
D.TD F 90-22.1–Report of Foreign Bank and Financial Accounts
V.Death of the Insured
A.Estate and Generation-Skipping Tax Avoidance
B.Income Taxation of Offshore Life Insurance Proceeds
1.Transfer of Appreciated Property—General Rules
2.Tax Treatment of Appreciated Property Passing at Death
VI.Using Limited Partnerships and LLCs in Life Insurance Planning
A.Wealth Protection and Estate Planning Through LLCs and Limited Partnerships
1.Insurance Payable to Third Party
2.Insurance Payable to the Partnership
3.Incidents of Ownership of General Partners or Manager
4.Drafting to Avoid Incidents of Ownership by General Partners–Life Insurance
B.Foreign LLCs or Foreign Partnerships Avoid Taxation Under I.R.C. §684
C.Use of Crummey Powers With LLCs and Limited Partnerships
VII.Conclusion
Copyright J. Richard Duke (2006).
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OFFSHORE LIFE INSURANCE
I.GeneralAspects of Offshore Life Insurance
.[1]
A.Advantages
. Life insurance is frequently used for the liquidity needs of wealthy individuals and families as a part of estate planning. Estate planning with life insurance is generally implemented by the use of an irrevocable life insurance trust established by the grantor, or sometimes through the establishment of a limited partnership to own the insurance policy. Through proper structuring, offshore variable life insurance can also be used as part of a wealthy individual's or family's estate planning. Offshore life insurance, in combination with offshore trusts, may achieve the goals of combining serious estate, gift and generation-skipping transfer tax planning along with income tax planning and wealth preservation/wealth protection (asset protection) planning. For wealthy U.S. persons, offshore variable life insurance is often highly recommended when compared with insurance issued by domestic carriers.[2] Offshore variable life insurance policies may be acquired by the trustees of foreign trusts, foreign LLCs or foreign limited partnerships, as applicants, owners and beneficiaries of policies on the lives of U.S. persons as the insured parties. In addition to tax planning benefits, cost and other distinct advantages are available to those who include the use of offshore life insurance in their planning.
1.LowerPremium and Internal Costs
. Insurance companies operating outside the U.S. generally have lower overhead costs than U.S. life insurance carriers. In general, U.S. carriers have a larger distribution system, larger commissions to agents, and are subject to higher and more costly governmental regulations.[3] The result is that many foreign carriers have lower premium charges and lower internal operating costs.
2.World'sLeading Investment Managers
. Foreign carriers provide flexibility with respect to the location and type, as well as compensation arrangements, for investment managers across the world.
3.Individually-Customized Investment Vehicles
. The recommended offshore variable life policies are individually-customized investment vehicles. Two authors write, "It is important to be cognizant of the fact that these products are not in the same class as products sold by plaid-clad insurance salesmen, but rather as individually-customized investment vehicles, available only to high net worth persons, that provide U.S. income and estate tax efficiencies offshore but completely within the parameters of U.S. tax laws."[4]
4.FlexibleInvestment Opportunities
. Subject to meeting the diversification requirements and wrap rules, both discussed below, the type of investments that can be held in the separate, segregated account under the policy is unlimited.[5] Even though a policyowner is prohibited from exercising control over the selection of the securities of such separate, segregated account, a specialized investment manager or managers, through the foreign carrier, may assist the policyowner (or the trustee of a trust established by the policyowner) in making investment decisions. In the U.S., domestic insurance carriers only offer investment options, not separate investment managers, without providing the policyowner with comparable investment advice.
5.Choiceof Currencies
. Policy investments of U.S. carriers are held in U.S. dollars. Foreign carriers frequently offer premium payments, withdrawals, borrowings and death benefits in several currencies.
6.LargerFace Values
. Larger face amount policies are generally available from foreign carriers due to the location of the world's largest reinsurers outside the U.S. Thus, the foreign marketplace is often required in order to underwrite very large policies on U.S. lives.
7.FavorableGoverning Law
. A life insurance policy is a contract that generally allows the contracting parties to designate a governing law that is respected by other jurisdictions. The application, signing, delivery or payments of the first premium in the chosen jurisdiction increases the respectability of the governing law.
8.AvoidEntity-Level Taxation
. U.S. carriers are subject to entity-level taxation (federal, state or local). Carriers from low-tax or no-tax jurisdictions are not subject to this high taxation. In addition, U.S. carriers are subject to the deferred acquisition cost tax.[6]
9.AvoidState Premium Tax
. U.S. citizens and residents may be subject to state premium taxes when paying premiums on life insurance.[7] The state premium tax is avoided through the sale of offshore life insurance to a non-U.S. person, such as a trustee of an offshore trust.
10.WealthPreservation and Protection (Asset Protection)
. Offshore variable life insurance policies offer asset protection benefits that are not available for variable life insurance policies issued by U.S. carriers.[8]
(a)Protection from Insolvency of Carrier
. U.S. persons generally do not understand that the investment assets of a variable life insurance policy issued by a U.S. carrier may not be protected in the event of the insolvency or bankruptcy of a U.S. carrier. In several favorable offshore jurisdictions, the separate, segregated account formed to fund an insurance policy by an insurance company is available solely to satisfy the insurance company's obligation to the owner of the policy. Such legislation provides that assets in the separate, segregated account of the policy formed by the insurance company are not subject to the claims of creditors or claims against other policyowners of the insurance company. For example, Cayman law authorizes certain insurance carriers to be registered as an "Exempted Segregated Portfolio Company."[9] Under Cayman law, such an exempted carrier may create one or more segregated portfolios that permit the segregation of the assets and liabilities of the insurance carrier held within each portfolio from those of both the company itself and other portfolios.[10]
(b)Insured Protected Against Claims from Creditors
. In addition, many U.S. persons are unaware that life insurance products may not be completely protected from the claims of creditors against the insured. Such protection depends on the "exemption" laws of each state and these laws may be subject to the applicable state's fraudulent transfer or fraudulent conveyance laws. Some states further provide that proof that a particular claim or debt existed at the time of the premium payment is evidence of the intent to defraud.[11]
11.Increased Confidentiality
. Many foreign jurisdictions provide that insurance policies must be held in strict confidence. Exceptions may apply with respect to disclosure of tax information, including provisions under tax treaties with the U.S.[12]
12.AvoidRegistration Requirements Under the Securities Laws
. The purchase of securities by the insurance company in the separate, segregated accounts is not subject to the registration requirements under Securities Act of 1933 (hereinafter "1933 Act"), if the necessary requirements are met.[13]
13.AvoidRule Against Perpetuities
. By forming a foreign life insurance trust in a jurisdiction that has either abolished or extended the Rule Against Perpetuities, the trust may be continued offshore for a long period of time after the death of the insured, thereby continuing asset protection benefits, investment diversification, and other benefits for the trust and its beneficiaries.[14]
B.AvoidRegistration Requirements for Offshore Funds
. Variable life insurance policies issued by foreign insurance carriers may be issued onshore or offshore in accordance with Regulation D ("Reg D") of the 1933 Act as a private placement.[15] With few exceptions,[16] Reg D requires an individual policyowner to be an "accredited investor" who is defined as (i) one having a net worth in excess of $1 million; or (ii) one who had individual income in excess of $200,000 in each of the two most recent years, or joint income with that person's spouse in excess of $300,000 in each of those years, and has a reasonable expectation of reaching the same income level in the current year.[17]
1.Classificationof a Variable Life Insurance Policy as a Security
. A variable life insurance policy is classified as a security and the sale to a U.S. person requires compliance with U.S. securities laws.[18] In accordance with Reg D, securities offered and sold outside the U.S. are not required to be registered under the 1933 Act and Regulation S ("Reg S") may be relied upon for such offers and sales, even if coincident offers and sales are made in accordance with Reg D inside the U.S.[19]
2.OffshoreFunds Generally Rely on Reg S
. Reliance on RegS is made by most offshore funds in concluding that offers and sales of shares of funds are not subject to the registration requirements under the 1933 Act. In general, the registration requirements under Section 5[20] of the 1933 Act do not apply to offers and sales of securities occurring outside the U.S.[21] Foreign insurance carriers often rely on the Reg S exemption rather than the "private placement" exemption under Reg D.[22]
3.PrincipalRequirements for Avoiding Registration Requirements Under the 1933 Act
.[23] In general, two requirements[24] are necessary to avoid registration under the 1933 Act in relying on the Reg S exemption: (i) offers of the offshore fund shares are made only to persons located outside the U.S. and buy-orders are accepted only from persons located outside the U.S.; and (ii) no activities are undertaken that have the purpose of or can reasonably be expected to have the result of "conditioning" the market in the U.S. to purchase the offshore fund shares. If the selling efforts condition the U.S. market to purchase offshore fund shares, this is deemed to be "directed selling efforts" that require registration under the 1933 Act.
4.Definitionof a U.S. Person
.[25] Under Reg S, any trust of which the trustee is a U.S. person is classified as a U.S. person. However, a trust (domestic or foreign) with a U.S. professional fiduciary is not treated as a U.S. person if the trust includes: (i) a co-trustee who has sole or shared investment discretion with respect to the trust assets; and (ii) no U.S. beneficiary (and no U.S. settlor if the trust is revocable). It is recommended that a foreign irrevocable life insurance trust, or other foreign trust of an insurance structure, include no U.S. person as a co-trustee because such trusts generally include U.S. beneficiaries. Only a trust with a foreign trustee can acquire offshore variable life insurance with policy investments in foreign funds that include securities.
C.AcquiringInsurance Direct From a Foreign Carrier
. The 1933 Act and securities laws and rules have no bearing on whether a variable life insurance policy is classified as an insurance contract under Internal Revenue Code (hereinafter referred to as "I.R.C.") §7702(a). In addition, compliance with the Reg D or Reg S exemptions is the responsibility of the foreign insurance carrier, not the insured. However, if the Securities and Exchange Commission finds a foreign carrier issuing policies to U.S. persons in violation of the securities laws, it can and does obtain injunctions against the foreign carrier. Such an injunction prohibits the foreign insurance carrier from issuing further policies in the U.S. and may also prohibit participation by U.S. insurance agents and others who were selling such policies in the U.S. and "conditioning the U.S. market" in violation of Reg S. Such an injunction against a foreign insurance carrier may have a negative impact on those policies issued on the lives of U.S. persons prior to the injunction. First, such prior issued policies may no longer be a priority of the foreign insurance carrier and, second, the insurance carrier may not attempt to comply with the Reg D or Reg S exemption with respect to the further issuance of the same or similar policies on the lives of U.S. persons.
1.ComplyingWith the Reg D Exemption for Issuance of a Variable Life Policy
.[26]U.S. persons who are accredited investors can acquire private placement variable life insurance under the Reg D exemption directly from a foreign insurance carrier. However, the minimum required premium is generally $1 million, $2 million, or as much as $5 million.[27] For numerous reasons, many U.S. persons may not desire to pay such high premiums for a Reg D, private placement variable life insurance policy. The alternative to private placement insurance is variable life insurance issued and purchased under the Reg S exemption by a foreign insurance carrier.
2.ComplyingWith the Reg S Exemption for Issuance of a Variable Life Policy
. A variable life insurance policy may be issued by a foreign insurance carrier on the life of a U.S. person as the insured under the Reg S exemption.[28] A U.S. person who learns of a variable life insurance policy may travel to the foreign carrier and receive an offer and acquire that policy as the insured person. However, as discussed below, the question is how did this U.S. person learn of this variable life insurance policy issue by this particular foreign insurance carrier?
(a)U.S. Insurance Agent
. A U.S. insurance agent who introduces life insurance policies, on behalf of a foreign carrier, to U.S. persons may cause the policy to be issued by the foreign insurance carrier in violation of the Reg S exemption. The activities of the U.S. insurance agent may be scrutinized to determine if there is a violation of the Reg S exemption. Since the U.S. agent's primary business activities are selling life insurance, it appears that the recommendation by such an agent to a U.S. person to acquire variable life insurance from a foreign insurance carrier is "conditioning the market" in the U.S. to acquire variable life insurance, a security, in violation of the Reg S exemption. Furthermore, the activities of the U.S. insurance agent may cause the foreign insurance carrier to be treated as the agent's principal. If the activities of the U.S. insurance agent cause the principal-agency relationship to exist, the sales of offshore variable life insurance policies may be deemed to occur in the U.S., even if the U.S. insured travels outside the U.S. to formally receive an offer and acquire the variable life insurance. In addition, the remuneration that the U.S. insurance agent receives in such circumstances will probably be deemed to be commissions, notwithstanding that the foreign insurance carrier and the U.S. insurance agent refer to the remuneration as referral fees, management fees or the like. And, the payment of such fees to a foreign entity formed by the U.S. agent will not change the fact that the activities of the U.S. insurance agent may cause the sales of the variable life insurance policies to occur in the U.S. Thus, the activities of the U.S. insurance agent in selling offshore variable life insurance may determine whether a "conditioning" of the U.S. market occurs and/or whether the agent's activities cause the foreign insurance carrier to be treated as the agent's principal.
(b)Lawyers,Accountants, Registered Investment Advisors
. A professional, such as a lawyer or Registered Investment Advisor ("RIA") is engaged in providing legal services and financial services, respectively. The recommendation of insurance is incidental to and only a part of legal and financial planning services. In addition, an attorney or RIA does not receive commissions for the sale of insurance. Because the recommendation of insurance is only incidental to the services provided by the lawyer or RIA, recommending offshore variable life insurance does not appear to be "conditioning" the market in the U.S. to acquire offshore variable life insurance, nor does it appear that the lawyer or RIA is acting as an agent for a foreign life insurance carrier. The lawyer or other professional, however, requires insurance to be offered, issued to and paid for by a foreign trustees of foreign trusts.[29] Thus, the offer of the variable life insurance policy is made by offshore insurance carriers to foreign trustees and the purchase of the policies, as well as payments of premiums, are made by foreign trustees who are not U.S. persons.[30]