New York State Seal
STATE OF NEW YORK
INSURANCE
DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

.

George E. Pataki
Governor

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Gregory V. Serio
Superintendent

The Office of General Counsel issued the following informal opinion on December 2, 2002, representing the position of the New York State Insurance Department.

Capital Markets Securities Transactions

Questions:

1. Do the Securities described herein constitute insurance contracts under the New York Insurance Law?

2. Does the issuance and sale of the Securities constitute the "doing of an insurance business" by any of the parties described herein under the New York Insurance Law?

3. Would the ownership of the Securities by residents of New York have any consequences for owners thereof under the New York Insurance Law?

4. Would any provision of the New York Insurance Law cause the Securities to be unenforceable under their terms?

Would the underwriters or selling agents of the Securities (or their personnel):

(a) be deemed to be acting as insurance agents, brokers, advisors, consultants, counselors or reinsurance intermediaries under the New York Insurance Law; or

(b) be considered to be aiding or abetting an unauthorized insurer?

Conclusions:

1. The Securities described herein would not constitute insurance contracts under the New York Insurance Law.

2. The issuance and sale of the Securities would not constitute the "doing of an insurance business" by any of the parties described herein under the New York Insurance Law.

3. The ownership of the Securities by residents of New York would not have any consequences for owners thereof under the New York Insurance Law.

4. No provision of the New York Insurance Law would cause the Securities to be unenforceable under their terms.

5. The underwriters or selling agents of the Securities (or their personnel) would not:

(a) be deemed to be acting as insurance agents, brokers, advisors, consultants, counselors or reinsurance intermediaries under the New York Insurance Law; or

(b) be considered to be aiding or abetting an unauthorized insurer.

Facts:

A group of individuals ("Donors") will transfer each of their insurable interests to a charity or charities (the "Charities") and a Delaware business trust (the "Issuer Trust"). The Charities will in turn acquire life insurance policies and supplemental life insurance policies on the lives of the Donors and will deposit specified interests in such policies into the Issuer Trust. In return for their deposits the Charities will receive trust certificates providing for periodic distributions by the Issuer Trust (the "Charity Certificates"). The Issuer Trust will acquire life annuities based on the lives of the Donors.

In order to finance the acquisition of the life annuities, the Issuer Trust will issue trust certificates (the "Investor Certificates" or "Securities"). These sales will occur in transactions exempt from the registration requirements of the Securities Act of 1934.

Each life annuity procured will provide for periodic payments during the life of the respective Donor, and each life policy (together with the related supplemental life policy) will provide for death benefits upon the death of the related Donor. The benefits accruing upon the maturation of these policies will ultimately be used: (i) to pay policy premiums as well as the fees and expenses of the trustee and policy servicing agents, and (ii) to pay distributions of income and returns of capital under the Investor Certificates and Charity Certificates.

You have suggested that the proposed transaction essentially resembles other insurance product securitization transactions, such as when an intermediary Special Purpose Vehicle issues securities and then uses the proceeds from such offering to obtain guaranteed investment contracts. As with such of those transactions that have been opined upon by the Department, the purchasers of the Investor Certificates ("Investors") herein would have no recourse against the issuers of the life policies, supplemental life polices or annuities; their contractual privity (and sole recourse) would be limited to the Issuer Trust.

None of the Donor Insureds will be residents of New York State and all activities involving contact with the Donors regarding the obtaining of the insurance coverage at issue herein will occur outside New York State. Similarly, none of the issuers of the life insurance policies or life annuities will be licensees of New York State. The Securities will, however, be marketed in part to New York Investors by intermediaries located in New York State.

Analysis:

As suggested by the promoters of this transaction and their counsel, the instant transaction is essentially a novel variation upon the securitization of guaranteed investment contracts or funding agreements, each of which has been examined previously by this Office. In this case, however, the economic impetus is not a differential in interest rates but rather the recognition of the arbitrage opportunity presented by the variance of underwriting standards employed by the life insurance industry for life policies and life annuities.

In the case presented, the Securities are not insurance contracts 1 because there is no obligation on the part of the Issuer Trust to "confer benefit of pecuniary value" upon the Investors upon the happening of a fortuitous event in which the Investor has, or is expected to have, a pecuniary interest which will be adversely effected by the event. The Securities are unlike insurance contracts because the purchasers of Securities commit their resources in order to achieve investment returns. The investment transaction is complete upon purchase, payment by the Security holder, and delivery of the Security to the Investor by the Issuer Trust. An insurance contract, on the other hand, involves an ongoing undertaking to deliver a benefit of some kind in the future upon the happening of an event, which may or may not happen. Since the Securities do not meet the definition of an insurance contract under the New York Insurance Law, the underwriters or dealers in the Securities do not have to be licensed by this Department to sell the Securities in New York and would not be considered to be engaging in an insurance business in New York State.

The Department has often opined on the permissibility of securitizations of funding agreement/guaranteed investment contracts. As noted, these transactions are similar to the type described in the instant inquiry.

In an analysis of the securitization of a funding agreement or guaranteed investment contract transaction, the following factors are relevant in determining the applicability of the New York Insurance Law. First, the purchasers of the Securities issued by the Issuer Trust must have no privity of contract with the insurance company issuing the funding agreement. Second, there must be no guarantee of the Issuer Trust’s Securities by the insurer or any other entity, i.e., the Issuer Trust must be the sole source of payment on the Securities. Finally, the Securities of the Issuer Trust must not be represented to prospective investors as a type of insurance contract or product. Each of these elements is satisfied in the proposed transaction.

As indicated above, based upon the descriptions of the proposed offering, the activities do not constitute the doing of an insurance business. Similarly, no entities are acting in the state of New York as an agent for any unauthorized insurer.

In the proposed transaction, the Issuer Trust will not be conducting an insurance business and the Securities will not be marketed as an insurance product. Thus, the activities of any of the parties in New York would not violate the prohibition on aiding unlicensed insurers contained in N.Y. Ins. Law § 2117(a) (McKinney 2000). 2

 For further information you may contact Supervising Attorney Michael Campanelli at the New York City Office.


1 N.Y. Ins. Law Section 1101(a)(1)(McKinney 2000) defines an insurance contract as, "(a)ny agreement or other transaction whereby one party, the "insurer", is obligated to confer benefit of pecuniary value upon another party, the "insured" or "beneficiary", dependent upon the happening of a fortuitous event in which the insured or beneficiary has, or is expected to have at the time of such happening, a material interest which will be adversely affected by the happening of such event."

2   That Section provides, in pertinent part, as follows:

(a) No person, firm, association or corporation shall in this state act as agent for any insurer or health maintenance organization which is not licensed or authorized to do an insurance or health maintenance organization business in this state, in the doing of any insurance or health maintenance organization business in this state or in soliciting, negotiating or effectuating any insurance, health maintenance organization or annuity contract or shall in this state act as insurance broker in soliciting, negotiating or in any way effectuating any insurance, health maintenance organization or annuity contract of, or in placing risks with, any such insurer or health maintenance organization, or shall in this state in any way or manner aid any such insurer or health maintenance organization in effecting any insurance, health maintenance organization or annuity contract.

Individuals in their 70’s and 80’s, who have spent decades accumulating assets typically have two types of goals.

1.    Sustaining, and if possible, enhancing their own cash flow to ensure that they can maintain their standard of living.

2.    Mitigating the effects of taxation from tax deferred assets, qualified assets, and other holdings thereby distributing greater wealth to their heirs.

While assisting one’s heirs is important, my practical experience has shown that providing for one’s self and immediate family takes precedence over providing for ones heirs.

Even if well intentioned individuals in their 70’s and 80’s desire to reduce taxes (including Estate Taxes), they all too often cannot or will not take advantage of life- insurance as part of their estate planning. Quite often, their rationale for not moving forward stems from the large premiums that are inherent with purchasing policies at these ages, and the natural aversion to mortality that life insurance suggests.
While there are a number of methods to mitigate these premiums, invariably successful employment of arbitrage has proven to be the most palatable and successful.

Intuitively, one would think that a “zero sum game” exists whereby enhancing one’s own standard of living would invariably reduce funds available for ones heirs. This is not universally the case. There exists a simple and very effective way for individuals to simultaneously enhance both their own cash flow and funds available for their heirs. This is accomplished by coupling the purchase of life insurance with an immediate annuity.

Although annuities are not appropriate for everyone, they have the potential to work remarkably well for individuals in their 70’s and 80’s in generating significantly higher returns than comparable investments. When annuities are coupled with life insurance, a “win-win” scenario can be created, with individuals and their heirs both receiving more money than they would have otherwise realized. The advantages of a life insurance-annuity tandem include:

  • Generating additional current cash flow for individuals and their families to enjoy
  • Enhancing the future value of assets left to heirs
  • Mitigating taxes (including Estate, and Income taxes)

Structuring an effective life insurance-annuity tandem is a very straight forward process. The major hurdle involves underwriting. As individuals who have obtained life insurance can attest, there exists a wide variety in pricing and underwriting classes between different insurance carriers offering the same type of product. Today, many carriers are offering table shaving programs that will allow many formerly out of reach premiums to be priced in the more favorable standard rate classifications.

Given this wide range of pricing and underwriting options it follows that certain companies offer more attractively priced or underwritten life insurance policies, while other companies offer more attractively priced or underwritten annuities. It further follows that if life insurance policies and annuities are obtained in tandem, there may well exist pricing differentials that can be realized to one’s advantage. Hence the concept of Arbitrage which is defined as follows: noun; “the nearly simultaneous sale and purchase of products within different markets in order to profit from pricing differentials” By taking advantage of arbitrage opportunities that exist between different companies and coupling the purchase of life insurance with an annuity, individuals can realize significant economic upside.

To illustrate the power of this in -tandem technique, consider the following example;

  • Healthy 79 year old male
  • Three married children and six grandchildren
  • Significant assets placing him within the higher Income and Estate tax brackets
  • $1,000,000 in CD’s and or comparable instruments generating a 4% pre-tax return and a 3% after tax return, with the proceeds subsequently spent.
  • Other liquid investments generating an 8% after tax return
  • Interested in obtaining enhanced yields on investments without taking on additional risk
  • Has an interest in providing for heirs, but unwilling to do so to the detriment of his own cash flow/standard of living
  •  

Status Quo. If no changes are made, this individuals CD’s would generate an after tax return of $30,000 per year, with ultimately $550,000 passing to his heirs.

Life Insurance- Annuity Tandem. As an alternative, rather than investing $1,000,000 in CD’s generating an after tax return of $30,000 this individual could:

  • Invest in an immediate annuity, generating annual, guaranteed pre-taxed proceeds of $157,590 and after tax proceeds of $140,225 based on a 66.7% exclusion ratio and a 33% income tax rate.
  • Purchase a $1,000,000 life insurance policy requiring an annual guaranteed premium of $55,270

Utilizing the technique of Arbitrage, he would more than double his annual after tax return during his lifetime from $30,000 to $84,985 ($140,225 less $55,270). Moreover, if he did not need the additional $44,985, he could re-invest these proceeds and ultimately provide additional funds for his heirs. If the excess funds were re-invested annually through life expectancy-12 years- and generated an after tax return of 8%, and additional $856,686 could be created. With the addition of one extra step, this individual could utilize part of his annual gifting allowance to eliminate transfer taxes and direct that the policy be owned by a trust to keep the proceeds from inclusion in his Estate. As a result, his initial $1,000,000 would grow to $1,853,686 thus nearly tripling the amount to his heirs.

Please note that this is an example of but one of several ways that life insurance and annuities can work in tandem.

Other examples can utilize second-to-die policies where couples are involved. The bottom line is that there are several ways for individuals in their 70’s and 80’s to structure a “win-win” scenario to benefit both themselves, and their heirs by taking advantage of insurance arbitrage opportunities.

In addition to the above mentioned uses for arbitrage based planning there are two other very active an important arenas that clients may wish to look into. These areas are IRA Wealth Transfer (how to pass your IRA to your heirs with tax free dollars), and Charitable Giving (creating current income for your charity now while you are living, and leaving an endowment at your death).

Winston P. Stevenson is the Principle of W. P. Stevenson and Companies. W. P. Stevenson and Companies is an independent firm aiding clients with insurance, wealth accumulation, and wealth transfer strategies.

Special Thanks are extended to all those that have contributed to the practical content of this article and the day to day implementation of the strategies described herein.