Eliminating the insurance in a fully insured plan

[Guest Mr. Relaxation]

A potential client has what sounds like a 412(i) plan. I'm told its a DB plan funded entirely with insurance. The new investment rep wants to keep it as a DB plan for the next 2 years before eliminating it and starting a 401(k). Between now and then however, he would like to relace the whole life policies with term policies, and use the cash value from the existing policies to invest in non-insurance related products (most likely mutual funds).

There's a lot going on here and I realize that BLink is not the place to sort all of this out, but if you have a good reference place to point me at regarding how to go about getting rid of insurance in a fully insured plan (eg, terminate the plan, amend it, do the participants get distribution options, etc) I would appreciate it. Maybe pointing out some obvious hurdles that have to be jumped would be helpful as well.

Thanks for your help.

[SoCalActuary]

Having encountered this issue before, I offer these concerns:

1. Once you stop using level pay life insurance policies or annuities, you simply loose the 412i exemption. So, by changing the investment strategy, you have to start compliance with the rest of 412, and look at PBGC coverage, among other issues. You then include the actuary in your administration work.

2. If the insurance policies are still in the early surrender stage, with high surrender charges, you can choose to keep the policies, sell them to the participant, or allow them to lapse. A proper cost-benefit analysis is needed. Compare the value of future benefits by keeping the policies against the cost of future premiums to get the benefit.

Don't forget to include the surrender terms of the policies if premiums stop.

3. Watch out for liability issues if the 412i was aggressively pushing or exceeding the current IRS position. Is the plan vulnerable to audit for the past few years? Did the 412i advantages disappear with the new rules?

Good luck with the analysis.

[david rigby]

Cart before the horse.

What does the plan sponsor want to accomplish by having a(ny) plan? What level of benefit/contribution? What commitment is the sponsor willing to make? How many other EEs are/may be covered? Short term? Long term? What level/type of admin expenses is the sponsor expecting? willing to pay? have the plan pay?

Who benefits by any particular action (the "investment rep" for example)? This is not necessarily a deal breaker, but just remember that certain solutions may be better for advisors.

Need some analysis of demographics. May need to include the sponsor's auditor if the level of deduction is a driving force. Competive concerns, perhaps geographically, or industry?

The list goes on and on.

[Guest Mr. Relaxation]

Pax - Everything you said makes sense. I'll be addressing these matters at the meeting, whenever that occurs. I haven't met or even talked to the client yet. An investment agent called me about this and it sounds like they are already on the path of eliminating the insurance. I'll know more by next week.

SoCal - I'm confused about the part where you said that the owner can either let them keep the policies, sell it to them, or let them lapse. I understand the last 2 options, but if the plan sponsor wants to eliminate the universal insurance (I said whole life initially but the current policies are in fact universal), why would/could they still let participants keep them? If the sponsor does not want any universal life policies in the plan at all, can he force them to either buy them out of the plan or let them lapse? And if they buy them from the plan, isn't that considered a distribution, which would be allowed only if a distributable event occurred, which would not apply in this case? Please clarify if possible.

Thanks

[SoCalActuary]

Sorry for the short answer. I meant to say that the Plan can keep the policies in effect as a general investment of the trust after dropping out of 412i compliance. Insurance face amounts could be frozen with no new issues.

This approach may be the best fiduciary duty if the policies have surrender charges that go away by keeping the policies in force for a few more years.

You could also instruct the insurer that the face amount must be reduced if needed. An example of this occurs when the benefit formula is amended and the existing face amount would violate the incidental benefit rules.

Finally, buying the policies is an exempted party-in-interest transaction if the participant pays the plan for the fair-market-value of the policy and takes ownership. This is very important when an individual is no longer insurable at standard rates. It is not a distribution if the participant makes a purchase with other funds (after-tax funds - not transfers from other plans).

[Guest smhjr]

You might also want to look into a reduced paid up policy. I am not very familiar with universal life policies, but you may be able reduce the face amount enough so that there are no more premiums due, or possibly do a 1035 exchange into a different type of insurance policy. Allowing the policies to lapse is usually the worst option because of the surrender charges.

[Belgarath]

"A potential client has what sounds like a 412(i) plan. I'm told its a DB plan funded entirely with insurance."

I'd add that IF this is true, they already have problems. Even before the recent IRS guidance, it was not permissible for a 412(i) plan to invest exclusively in life insurance contracts. 412(i) plans are subject to the incidental limits on life insurance purchases just like any other DB plan. There are, or were, some misguided "advisors" who interpreted the code to allow 100% to life insurance, usually with the sole purpose of lining their own pockets. I wonder if they are sleeping well at night now...

[SoCalActuary]

It would be sarcastic to mention that Milken & Keating survived ripping people off.

Why would an insurance agent feel guilty?

But seriously, this sounds like someone who bought into the big promises of 412i, lost faith in their advisor, and now is trying to move on. I still caution against ripping out the policies before you do a proper cost-benefit comparison.

The new IRS rules have sobered up some of the more aggressive 412i people, so the numbers are now only about twice what a normal DB plan would offer, instead of 5 times higher.