How to measure discrimination with respect to benefits rights and features.

[Guest flogger]

An "insurance guy" has sold a client a DB plan and funded it with individual variable life policies. (No need to go into the wisdom of this decision.)

There is one HCE owner and 9 NHCE's. There are 10 policies in the plan all designed to provide 100 times death benefit.

The policies are all the same type and with the same carrier and have the same provisions for everyone. However, what is of note it that the policies for the NHCE's are only funded at the minimum levels necessary to keep them from lapsing. Therefore, extremely low cash values (if any) are building in the NHCE's policies. The owner's policy is being funded as much as possible, but just below the level that would cause the policies to become a MECs (modified endowment contract). Is there an issue with benefits right and feature here?

As a further thought on this issue, when benefits right and features are measured for discrimination purposes, how is this testing done? Do we assume that a person either has the benefit right or feature or they don't?

In some cases, it is possible to put a value of the benefit right and/or feature. Consider a case where the plan buys whole life policies on the owner and a couple of NHCE's. For the rest of the NHCE's however, the plan provides term insurance that is not renewable after age 65. The feature provided by the whole life insurance that is not included with the term is the ability to distribute and continue the policy beyond age 65. The value of being able to continue the policy beyond 65 can be measure the same way a guaranteed insurability rider is priced.

It seems to me that we can go through the testing process by valuing the feature and testing on the magnitude of that value.

Does anyone have any thoughts or knowledge regarding these issues?

[Belgarath]

I'll give you thoughts. I wouldn't dare attempt to classify it as knowledge.

Just on the surface, it doesn't pass the smell test. Under the guidance provided in RR 2004-21, it might be argued that the rights of the NHC when purchasing the policy from the plan, or having it assigned to them, are not "inherently equal or greater than" the rights of the HC.

I'm not sure how you would quantify or put a value on this "right or feature." But I'm inclined to think that the IRS could indeed find justification for calling this discriminatory if they wanted to. I find it hard to justify in a DB plan - since the employer has to fund the full benefit to which the participant is entitled, having a life policy that is paid up to a larger extent than the policies on the NHC doesn't seem justifiable to me.

In a DC plan with self-directed investments, then I wouldn't see a problem with it, as all participants would have the option to do so if they wished.