Funky Demutualization Question - Life Insurance Held by a 401(k) Plan

[Scott]

A company maintains a 401(k)/profit sharing plan. Beginning in the '70's the plan allowed participants to purchase whole life insurance through the plan. If a participant elected to do so, 25% of his employer contributions each year were paid into a group life insurance contract through Principal, the owner of which was the plan's trust. In the late '80s, the plan stopped allowing new participants to participate in the life insurance, but participants who were already participating could continue to do so.

When a participant who is participating in the life insurance leaves employment, the cash value of his insurance is converted into paid-up insurance, meaning that he no longer pays premiums, but his death benefit is fixed. His benefit is still considered part of the group policy owned by the plan's trust, and when he dies, it is paid to his beneficiary by Principal. Currently, there are about 20 active employees paying premiums toward the life insurance, and about 100 former employees with paid-up insurance. The plan has about 1,000 total participants.

In 2001, Principal demutualized. The plan sponsor elected to receive Principal stock, but for reasons unknown to me did not allocate it. The stock has been held by the plan, and dividends have been paid on the stock, but neither the stock nor the dividends have ever been allocated under the plan. The stock has appreciated, and now the company wants to direct the plan to sell the stock and is wondering what it can do with the proceeds.

The company would like to take the proceeds of the sale of stock and use it to offset future employer contributions. Based on what I know of demutualization, I don't think this is a good idea. I believe that the stock is plan assets and should be allocated to the participants and not used to benefit the employer, which an offset would do. Further, I believe that it should be allocated only to those participants who have participated in the life insurance.

My questions are: Am I right that the proceeds should be allocated, and only to those participants who have an interest in the life insurance? If so, exactly who are those participants? Is it only the 20 or so actives, or the actives plus the 100 former employees? If the former employees should share in it, would the plan simply make a distribution to them of their share and report it as taxable income? How should the allocation be made--on a prorata basis based on cash surrender value, a per capita basis, or some other method?

Any thoughts would be appreciated. Thanks!

[Bird]

I think you have to figure out how the stock should have been allocated back when it was received in 1981 (pro rata based on cash values at the time?) and track it from there.

It's definitely an asset of the plan and should not be used to offset contributions.

[Everett Moreland]

The demutualization proceeds (the stock) are plan investment earnings when received and should have been allocated as such. Your question about which accounts receive the allocation it is beyond me on a Friday afternoon, and requires lots of analysis. One thing to consider is that the allocation needs to be under an earnings allocation provision in the plan document. This could include an earnings allocation provision that applies only to the stock. In connection with the demutualization Principal published guides for qualified plans. I have them if you can't obtain them from Principal's website (which is where I got them). At about the same time Prudential published a comparable set of guides for qualified plans in connection with its demualization. One of these sets of guides (Principal's or Prudential's) is extraordinarily good and worth reading front to back in connection with your analysis of which accounts receive the allocation. I have Prudential's guides, if you can't get them from Prudential's website.

[Jim Chad]

I have been involved in a few demutualizations and I always received a list of how many shares and partial shares were from each policy. I would think the insurance company would still have these records. Then, it will be necesary to follow the dividends and interest earned from 2001 to now and allocate it to each Participant based on their shares.

I don't think it is completely accurate to say the Premiums were paid into a group policy. They were Paid to the insurance company and if they know the cash value for each Participant enough to calculate a Paid-up Policy, they should know this information on per Participant basis.

Good luck.

[401 Chaos]

My experience with demutualization situations is limited and mostly involves welfare plans. I second the comment that the Principal and Prudential guides are very good and about the best guidance I was able to find on these issues. For what its worth, I have found the DOL to be pretty flexible in terms of allowing allocation of relatively small demutualization proceeds across all current participants when that makes sense from an administrative standpoint as compared to trying to locate former participants directly connected to the demutualization proceeds. I think to some degree this depends upon the amounts involved but there may be some support in not having to track down the 100 or so separated participants.

[Scott]

Thanks for all the good comments, and if there are more out there, keep 'em coming! I'm considering calling the DOL and seeing what kind of informal guidance I get, but I don't know exactly whom to call. Anyone have a good contact or an idea of how to direct my inquiry?

[david rigby]

You migt try this: http://www.dol.gov/ebsa/

Search using the word demutualization.