Life Insurance in DB Plan

[ac]

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?

[SoCalActuary]

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.

[mwyatt]

Not sure that I'm reading this correctly. Are you saying that the 2003 valuation had a side fund normal cost plus insurance premiums, but that the insurance premiums were never paid (on policies that never went into effect)?

[ac]

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.

[Blinky the 3-eyed Fish]

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.

[GBurns]

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.

[Blinky the 3-eyed Fish]

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.

[AndyH]

Emily Litella: " "

Fill in the blank.

Or was that Rosanna Rosannadanna?

[SoCalActuary]

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.

[GBurns]

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?

[Blinky the 3-eyed Fish]

Yes, IF THE ASSUMPTION THAT LIFE INSURANCE WOULD BE PURCHASED WAS A REASONABLE ASSUMPTION.

[ac]

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.

[GBurns]

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 ?

[Blinky the 3-eyed Fish]

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.

[david rigby]

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.

[SoCalActuary]

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.

[mwyatt]

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...

[Kirk Maldonado]

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).

[mbozek]

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.

[could be me maybe not]

Isn't this year's "actuarial error" (if that is what it is) simply going to reduce next year's minimum and maximum deductible contribution (assuming a spread gain method)? So what is all the fuss about?

[Kirk Maldonado]

I agree with mbozek that the death benefit would be payable, even if there wasn't an insurance policy that was procured to fund those benefits.

[Blinky the 3-eyed Fish]

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.

[Kirk Maldonado]

Blinky:

Thanks for clarifying that there is no ongoing duty to reassess the reasonableness of assumptions.

[david rigby]

... 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.

[SoCalActuary]

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.

[GBurns]

In these plans I wonder what is conveyed to the employees in the enrollment material? Is the SPD wording comparable to that in the PD? In other words were the employees given the impression and did the employees have the interpretation that life insurance would (not may) be purchased? Did the employees feel and expect that their benefit was covered by life insurance?

[SoCalActuary]

Initial communications to participants in many small plans are not what I call full & complete disclosure.

But with that tangential note aside, the SPD needs to describe that the death benefit includes insurance if issued. Thus a participant would have to be aware that the insurance policy was written before the death benefit goes into effect.

This is very important to protect the plan from unfunded and premature deaths before the policy can be issued. It also gives the employee more incentive to cooperate in the period while the policy is being underwritten.

[GBurns]

What is an "unfunded" death?

What does it matter if the death is "premature" which I presume to mean death before the policy is issued? The insurance company would still pay the death benefit barring something that would have prevented a policy being issued of which there are very few things.

What does it matter to the plan if death occurs after application but before issue of policy? Why would this situation be different from what happens if it was an individual purchasing the policy? Coverage is bound with the application sometimes even without the initial premium.

What would the employee be cooperating about? Waiting on the completion of underwriting is no different from waiting on the issuing of a medical card or 401(k) account number etc.

[Guest Donkey Kong]

GBurns - good thing you're not in the mob or you would have been wacked for asking too many questions!

[GBurns]

Donkey Kong

Feel free not to answer any.

I would have been the one in charge of whackers, anyhow, especially for knee caps.

[SoCalActuary]

GBurns - think of a small plan where the death benefit is 100 x projected benefit.

A new participant with a projected monthly benefit is $1,000 per month, justifying $100,000 of life insurance.

However, it takes time for a new life policy to make it thru the process of application, underwriting and approval. If death occurs before the policy is approved, where does the new pension plan get $100,000? The insurance company won't pay it because there is too much risk of issuing a "death-bed" policy when the underwriter hasn't approved it.

That is what is meant by unfunded death.

[GBurns]

That is not how insurance policies are issued.

Group insurance should be used for most plans and is available down to 2 lives. Almost all types are available as group insurance. Group insurance comes as guaranteed issue or simplified issue. Declineable conditions are stated on most applications. For guaranteed issue usually only terminal cases can be declined. Simplified issues has medical questions on the application the answers to which determines the level of underwriting. If there are conditions the case is rated. The agent knows in advance what is acceptable and should not submit a case that is already known as subject to decline. For rated cases, if the offer from the initial insurer is not acceptable there are many impaired risk insurers available.

Guaranteed issues can be issued and very often is issued in cases where an individual application would be rated or declined. If the group is large even terminal "death bed" cases have to be issued because in larger groups very little if anything can be declined.

Individual (non group) cases are medically underwritten but then again the agent should select companies that take a particular type of risk or just use an impaired risk insurer from the start.

Whether group or individual insurance, the coverage is bound with the application. The case is either issued as applied for, or rated. The agent should not have submitted a declineable case to such an insurer.

If the applicant dies before the policy is issued, there are very few options that the insurer has to decline paying. The few are material misrepresentation, fraud and undisclosed declineable medical condition. If the case would normally have been rated, the insurer would rate it but would still have to pay the death benefit.

The Plan gets the $100,000 from the insurance company.

[SoCalActuary]

I appreciate your view of best practices. However, my experience is less efficient and sometimes less noble. I see cases where the insurance issues have not taken place timely, and thus I accept the position found in plan documents that show the death benefit based on the policies actually issued.

Just my luck to work with less than perfect insurance agents

[GBurns]

What I gave was standard practice, best practices is still better. To get that I defer to those with more expertise.

If you have been seeing less than the standard "by the book" "as per the application" and the standard new business submission guidelines that I outlined, you have not been getting "less than perfect" you have been getting negligent and possibly incompetent service.

[could be me maybe not]

Mr. Burns, is there something that you are not an expert on?

Had I been SoCal, I would have whacked you rather than conversed. But then again, that is what you wanted so I suppose he wins.

[Effen]

I jumping in late with this long thread, but if the plan says the death benefit is 100X, then the death benefit is 100X, regardless if the plan insured it or not.

Now, if the plan says the death ben is "up to" 100X, but limited to the amount of insurance issued, doesn't that create a fairly significant discrimination in practice issue if the policy is not issued immediately? Seems ripe for a law suit if the HCE is all nicely insured, but the plan just didn't get the NHCE's policy issued before he died.

I know of lots of attorney's who would love this one.

[SoCalActuary]

Effen: the plans I see have the type of language given by the first post.

The insured death benefit is only available if issued.

As to discrimination in practice, your example is right on. If I find the insurance is not issued uniformly while doing the actuarial review, including the type of contracts used, then I advise of probable discrimination, risk of disqualification, and the need to correct the situation.

Having said this, small plans rarely find attorneys who actually are willing to help participants who face discrimination in practice. But that's another subject for a different thread.

[GBurns]

could be me maybe not

What purpose does the Board serve for you?

If you do not want to use the Boards to converse Why are you here any at all?

And Yes, however it should be "knowledgeable on", since I am far from being expert in my few areas of coverage. I think I am just getting to the "competent and experienced" level.

[mwyatt]

Maybe we should get a little back on track here.

AC, your original post stated that this was a takeover DB plan. The 2003 contribution consisted of a sidefund contribution amount and a mortality (presumably the insurance premiums) charge.

To clarify:

Was this plan established in 2003? If so, do you mean that the original design and valuation contemplated the purchase of life insurance policies, but that NO policies ended up being purchased, but that your client just ran with the original valuation and paid the total of the side fund contribution and contemplated premiums to the trust?

If this is the case, and NO policies were ever purchased, I'd have a hard time staying with the original valuation results. I'd rerun the numbers. Presumably the revised normal costs would come out between your original side fund normal cost and the cost of insurance.

Who signed the 2003 Schedule B (or has this come due yet if not a calendar year plan?)

[Guest Hans Moleman]

Mr. Burns,

Your modesty is truly genuine and touching. For what it's worth, I consider you an expert, well, either that or a maniacal doddling rambler one step short of senility. I haven't decided.

[GBurns]

Hans (Mr Moleman?)

Thank you for the kind words, but I have to warn you that as a result you might now have been classified by some as being questionable and subject to a whack.

I have heard that it is a very fine line between insanity and genius. I walk with a slight limp so that concerns me greatly so I just try not to wobble but I will doddle. Enough of my rambling before you really decide.

[Blinky the 3-eyed Fish]

The effective date of the plan was 1/1/03.

Mwyatt, here's an answer to 2 of your questions.

If this is the case, and NO policies were ever purchased, I'd have a hard time staying with the original valuation results.

As indicated in prior posts, I disagree with this statement, but I was curious to your reasoning. Do you feel the purchase of insurance is not an assumption?

[Effen]

Having said this, small plans rarely find attorneys who actually are willing to help participants who face discrimination in practice.

Maybe I should forward this to John Grisham. Seems like the kind of sorted conspiracy that he could turn into another best seller. Good insurance guys, bad insurance guys, corrupt actuaries and attorneys, greedy plan administrators and the poor secretaries mother who just wants to bury her daughter...I'm getting all tingly just thinking about it

[mwyatt]

Hey Blink:

Just wanted a clarification on the effective date (was buried in too many posts jumping over poor old GBurns ).

Let's look at it another way. Let's assume you did your original valuation contemplating the issuance of (obviously) new policies for all (let's not confuse this with the other problem of selective policies for only the HCEs being issued) and that you used the expectation of insurance policies through Gigantor Corp Life Insurance and your estimates of what the premiums would end up being, given proposed policies from the agent. However, the agent decides to go with Fred's Bait, Tackle, and Insurance company, so the actual premiums (and projected cash surrender values) differ from what you originally estimated. Would you show on the Schedule B the estimated or actual premiums paid? And would you possibly revise your normal cost numbers to reflect the revised CSV numbers? I know which way I would lean in this case.

Now you have a situation where your original proposal/valuation contemplated insurance but the plan sponsor for whatever reason didn't go ahead and issue any insurance policies. I would be curious to know whether the sponsor decided to bag the purchase of insurance entirely or whether they just didn't get their act together for 2003 issuance but went forward in 2004.

[SoCalActuary]

How was this sorted? By the sordid details or by the value of the proposed contingency fees?

[SoCalActuary]

In addition, you could use reasonable mortality tables for death benefit claims as used by insurance companies.

You could also anticipate some policy expense charges in the current year.

It seems reasonable that the expenses you would see in a UL policy ledger statement are plan expenses for providing the death benefit.

[Effen]

SoCalActuary, as an actuary I'm just more familiar with "sorted" details than "sordid" ones. Funny typo... if you’re an actuary.

GBurns - I like your perspectives - don't let those school yard bullies kick you around. You don't need to apologize to anyone.

[Blinky the 3-eyed Fish]

George, I deleted it. I was just coming up with a random reason for the limp. My apologies.

[could be me maybe not]

done likewise. no offense intended.

[GBurns]

So what do we discuss/argue about now?