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Life Insurance in DB Plan


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We have a takeover plan that has life insurance. The plan document says that the administrator may purchase life insurance in a non-disciminatory manner. The death benefit payable from the plan is based on the amount of life insurance in effect. The 2003 contribution to the trust included a side fund amount and a mortality amount. The plan administrator did not purchase life insurance.

Since the plan administrator did not purchase life insurance, is the mortality amount deductible?

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I doubt it. I don't see the valid business reason for the deduction, based on the facts given.

However, it was not on your watch. You have a valid reason to ask the prior actuary for the justification, but you are not responsible for their certification of minimum funding nor maximum deduction.

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The effective date of the plan was 1/1/03. The death benefits under the plan are equal to the present value of the accrued benefit plus the face amount of life insurance less the cash value of the life insurance. The purchase of life insurance is optional. For 2003, the "Split Funding" method was used. Under this method the side fund normal cost is the amount needed to accumulate to pay the present value of retirement benefits at normal retirement less the accumulated cash value of the insurance at normal retirement. The mortality cost is the annual premium for the purchase of the life insurnace.

The insurnace policies were never purchased. The mortality cost or the annual premiums has remained in the plan.

The prior actuary has been fired (a Schedule B was not filed) and we have to redo the valuation for 2003 and prepare the 2003 Schedule B.

Since the life insurance was not purchased, it is my opinion that the portion of the normal cost attributable to the annual life insurnace premium is unreasonable. In preparing our 2003 valuation and Schedule B, we are not going to include any life insurance. The employer did not purchase life insurnace for 2003 or 2004 and has no plans to purchase any in the future.

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Every valuation has assumptions. To assume that life insurance would be purchased can be one of those assumptions. The only criterion is for that assumption to be reasonable at the valuation date. Just because the life insurance was not actually purchased does not invalidate the assumption necessarily.

"What's in the big salad?"

"Big lettuce, big carrots, tomatoes like volleyballs."

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Yes but, the results of the assumption were never used for the purpose intended. So what happens now. The question was is the amount deductible?

However, I have other concerns.

I will assume that the term mortality cost is being used as synonymous to life insurance premiums although they are different things. Other than Yearly Renewable Term a life insurance contract usually requires continuing or on going premiums, the exception being Single Premium Life. YRT would not usually be used in these circumstances so it should be some longer durantion policy. If such a cash value policy was purchased in the past, it should have required that premiums be paid for 2003 which if not paid would have caused automatic premium loans for continuation or if there was insufficient cash value to pay such premiums, there would have been a lapse of coverage. If Term was used with no cash value a lapse should have occurred.

So I have to wonder what has happened to the life insurance,. Maybe the premiums are being treated as delinquent and so the amount set aside could be paid to the insurance company. If so then I would think that it would be deductible for 2003 although paid in 2005 because it was "set aside" or contributed to the Plan in 2003.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Yes but, the results of the assumption were never used for the purpose intended. So what happens now. The question was is the amount deductible?

The only question is whether the assumption at the time of the valuation was reasonable, not anything else.

As for the rest of your post George, ac said the insurance wasn't purchased, so I am not sure I understand what you are saying.

"What's in the big salad?"

"Big lettuce, big carrots, tomatoes like volleyballs."

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Since the prior actuary is not available to stand up for their work, the current actuary has to make reasonable decisions. Does the current actuary agree with the prior proposed assumptions? If not, redo the entire valuation by making decisions you believe to be defendable.

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Blinky and SoCalActuary

The question is not whether the assumptions are valid or not or the decisions are defendable. The question was:

"Since the plan administrator did not purchase life insurance, is the mortality amount deductible?"

What is your response? Is the amount deductible?

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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The life insurance premium is deductible becaue it is being used to fund the death benefit of the plan. However, the death benefit of the plan is based on the amount of life insurance in place. If the life insurance was not purchased, the benefit which justifies the deduction does not exist. I believe the IRS would disallow the deduction since it is not funding a benefit.

I also don't believe the IRS would view the contingency of the purchase of life insurance or not as an assumption. I believe the purchase of the life insurance is more of a method to fund the benefit rather than an assumption as to the amount of the benefit, although, the benefit is contingent on the purchase of the life insurance. Around and around we go.

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So ac you have to decide where and how to get off.

Is keeping the money in an account really regardable as funding the death benefit? Or does funding the DB need the life insurance? Does the PD allow any other method of funding the DB other than purchasing the LI?

You might still have to pay the insurance premium, which would then remove all questions about deductibility. But, Is the life insurance even still in force?

What happens if it is not in force? Is there now an operational failure of some sort? Would it cause any loss of assets or loss of benefits ?

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Whether you consider the assumed purchase of life insurance as an assumption or part of the funding method is merely semantics. You are choosing this method of funding the plan, which is based on an assumption that life insurance will be purchased, henceforth, the purchase of life insurance is an assumption.

I believe you to be incorrect in your belief that the IRS would disallow this deduction. Think of what the result was because of the assumption that life insurance was purchased. As you state, some of the premium was used to fund the death benefit, and therefore the contribution was increased. This is no different than a valuation that uses 83 IAF mortality setback 7 years with a 5% interest rate. This is no different that using a salary scale. In other words this is no different than any assumption that effectively increases the contribution. But the main point is that each of those items I listed have to be reasonable and that is it.

Your distinction that the assumed purchase of life insurance is not reasonable unless it actually happens is erroneously distinguishing it from other assumptions that we all know don' t have to come to fruition.

Now take all of that and now let's take it a step further. If you go to the client and want to charge him for any redo of the work or submission of the plan to the IRS, then that is unreasonable. The prior actuary certified to those results and it's his/her head on the line if anything ever comes back. It is not your job to second guess those results to that level of detail.

"What's in the big salad?"

"Big lettuce, big carrots, tomatoes like volleyballs."

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Perhaps I'm missing something, but this sounds like a mixture of 412 and 404. There appears to be some doubt in this discussion about the "reasonableness" of the Normal Cost. That does not necessarily affect the deductible contribution limit.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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You may have missed the point I was making.

If the prior actuary's work is not used for the Schedule B, then it is irrelevant.

The new actuary must make the decision. The new actuary does not have to accept any of the assumptions of the prior actuary, including interest and mortality rates. If the new actuary achieves the same cost with different assumptions, then the deduction would be valid.

However, if the new actuary agrees to all the old assumptions, then the question is whether it was reasonable to include proposed new insurance issues in the cost of the plan. Generally, I don't assume the insurance costs are included unless the policy is in effect by the end of the year. If I do a beginning of year valuation, then I would personally find it reasonable to assume that policies will be issed. If I do end of year valuations, I have evidence of the reasonableness of the assumption.

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Just curious here - you state "is the mortality part deductible?" If the client didn't purchase the insurance, are you saying that in lieu of paying the premiums that they paid the equivalent amount to the trust, or that they only made the side fund contribution to the trust? Please clarify...

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First, I want to say that I'm not an actuary, so it is very possible that I'm way off-base.

If the assumptions must be reasonable, at what point in time do you ascertain if they have become unreasonable?

It would seem that, at least by the end of the year, it was apparent that the assumption that insurance was going to be purchased was no longer reasonable. Therefore, from at least that point in time, the costs would have to be determined assuming that no insurance will purchased. Wouldn't that change in assumptions affect any portion of the contribution for that year that had not yet been contributed?

Again, I may be way off-base here, so don't hesitate to tell me that. But please educate me as to when assumptions must be changed when it has become apparent that were wrong (if that would ever occur).

Kirk Maldonado

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As a non actuary I agree with Pax with the clarification that the the deducton of the mortaliity charge could be taken if the death benefit is a payment required under the terms of the plan regardless of whether LI is purchased. If the plan is obligated to pay the Death Benefit to the participant's benes even if the ins is not in effect then the mortality cost would be deductible. Otherwise the question is whether the contribution would be deductible under 404/412 limits.

mjb

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If the assumptions must be reasonable, at what point in time do you ascertain if they have become unreasonable?

It would seem that, at least by the end of the year, it was apparent that the assumption that insurance was going to be purchased was no longer reasonable. Therefore, from at least that point in time, the costs would have to be determined assuming that no insurance will purchased. Wouldn't that change in assumptions affect any portion of the contribution for that year that had not yet been contributed?

Kirk, there is no point in time after the fact at which the assumptions become unreasonable. There is only the valuation date, and if at that specific point in time the assumption is reasonable, then that is the only criterion that must be met. That same logic then negates the need for the insurance to be purchased by the end of the year.

"What's in the big salad?"

"Big lettuce, big carrots, tomatoes like volleyballs."

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... there is no ongoing duty to reassess the reasonableness of assumptions.

No disrespect to either Blinky or Kirk, both of whom are excellent contributors to these Boards, but I don't think Kirk’s statement is what Blinky was saying. In fact, an actuary (specifically, an Enrolled Actuary, for an ERISA plan) should always be reassessing the reasonableness of the actuarial assumptions. Importantly, "reassess" does not mean "change."

In theory, the actuary could make changes to a set of assumptions every year. Examples would include small changes in a turnover or salary scale assumption. Larger changes might include the interest/discount rate, or the mortality table. (Please, no comments about "large" or "small"; two points, what is the impact of a possible change, and what is the effort in measuring a change.) Consider, virtually every year, a small change could be appropriate (fine tune the salary scale or turnover assumption), but is ignored because it makes so little difference to the end result. Here, there is no single definition of "end result", but is most likely the annual contribution or the funded ratio.

One reason this is so, is that most actuarial funding methods are self-correcting; that is a good thing, and is exactly the reason the assets and liabilities are reevaluated and compared on a regular basis.

How does this relate to the original question? Possibly, the assumption about purchasing life insurance is unreasonable; if so, that determination is (or should have been) apparent because it has been contrary to facts for a period of time. However, one deviation of facts from assumptions is not a determination of “unreasonableness”. In this case, the actuary would converse with the plan sponsor/plan administrator to review the issues concerning the possible purchase of insurance; in reviewing the assumption, likely the most relevant facts will come from that conversation, not from observing that no insurance was purchased. The actuary’s goal is to value the death benefit under the plan; proper assumptions for this goal will be chosen; therefore, the actuary may decide to alter an assumption next year. All of this is very different from saying a portion of a contribution may not be deductible.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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From the original posting "The plan document says that the administrator may purchase life insurance in a non-disciminatory manner. The death benefit payable from the plan is based on the amount of life insurance in effect."

To Kirk and mbozek:

This is common to many small insured plans. If the policy was not purchased, then the death benefit does not include the insurance benefit.

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