Private Placement Variable Annuity


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Managing Your Practice in the New World of Compensation Disclosure Using Private Placement Variable Annuities (PPVA) and Private Placement Variable Universal Life Insurance (PPVUL) to Build Long-Term Recurring Revenue Presented By: Campbell Gerrish and Michael Liebeskind Winged Keel Group, Inc.

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Disclosures Private Placement Variable Annuity and Universal Life are unregistered securities products and are not subject to the same regulatory requirements as registered products. As such, Private Placement Variable Annuities and Private Placement Variable Universal Life should only be presented to accredited investors or qualified purchasers as described by the Securities Act of 1933. This material is intended for informational purposes only and should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney, or tax advisor. Private Placement Variable Annuities are long-term investments. The value of the investment options will fluctuate and, when redeemed, may be worth more or less than the original cost. Withdrawals and other distributions of taxable amounts, including death benefit payments, will be subject to ordinary income tax. If withdrawals and other distributions are taken prior to age 59 ½, a 10% excise tax may apply. Assumes the Private Placement Variable Annuities illustrated herein are not issued in the following states: CA, ME, NV, PR, SD, WV, or WY. These states charge a premium tax, which would add a fee to such illustrations.

Private Placement Variable Universal Life insurance combines the protection and tax advantages of life insurance with the investment potential of a comprehensive selection of variable investment options. The insurance component provides death benefit coverage and the variable investment component gives you the flexibility to potentially increase the policy's surrender and loan value. The tax and legal references attached herein are designed to provide accurate and authoritative information with regard to the subject matter covered and will be provided with the understanding that the presenters are not engaged in rendering tax, legal or actuarial services. If tax, legal or actuarial advice is required, you should consult your accountant, attorney or actuary. The presenters do not replace those advisors. The information and financial data contained in these pages representing forward looking estimates are purely hypothetical and are not an illustration or estimate of future performance. Any forward looking estimate is intended solely for discussion purposes and is not representative of any actual investment results or performance. Actual investment results and performance will vary and are not guaranteed. This information is not intended to constitute any future performance figures and no specific securities are identified. The financial illustrations and other statements within this report, as well as comments made by any individuals, are not guaranteed and do not constitute a contract. Any contract entered into is between the Private Placement Variable Annuity or Universal Life insurance owner and the insurance company, through its Private Placement Variable Annuity or Universal Life policy. You should read the Private Placement Variable Annuity or Universal Life policy, as appropriate. Investors should consider the investment objectives, risks, charges and expenses of any variable product carefully before investing. This and other important information about the product in each product’s offering memorandum, which can be obtained by contacting the insurance company. Please read it carefully before you invest Securities Offered Through M Holdings Securities, Inc. A Registered Broker Dealer Member FINRA/SIPC

Table of Contents 

Compensation Disclosure - An Inexorable Trend



Why Bother with Basis Points?



Technical Discussion: IRC 817, Investor Control Doctrine, and Insurance Fund Structure



PPVA and PPVUL: Key Differences



PPVA Economics



PPVUL Economics



Target Markets



Closing Thoughts

Compensation Disclosure - An Inexorable Trend New York Regulation 194 

Became effective January 1, 2011, intent is to provide compensation transparency and protect the consumer from bias



Applies to all producers doing business in the State of New York, whether resident or non-resident



Initial disclosure must be provided in writing and disclose: • • • •

The role of the producer That the producer will receive compensation on the sale of the policy Compensation may vary based on a number of factors including volume of business Additional information about the producer’s compensation may be obtained from the producer upon request



If the consumer requests additional information about the producer’s compensation, this must be provided in writing within five business days



No particular format is required and the disclosures may be incorporated into other written materials provided to the consumer, as long as the disclosure is prominent



Producers must retain a copy of all disclosures for not less than three (3) years

Compensation Disclosure - An Inexorable Trend Additional Disclosure 

Must be provided in writing within five business days of request



Must include the compensation the producer expects to receive on the product sold and the compensation the producer would have expected to make from the sale of any alternative products quoted to the consumer



Must include disclosure of any material ownership interest held by the producer in the insurer issuing the insurance contract and vice versa



Different methods of providing additional compensation disclosure include: • Total dollar amount • Percentage of annual premium • Percentage of total premiums paid over expected duration of the policy



The latter is the method anticipated to be used by most producers

Why Bother with Basis Points? Annual Revenue Assuming $10 million of New Premium for each of 10 Years and 30 Basis Points of Asset Based Compensation $2,500,000

Annual Revenue

$2,000,000

$1,500,000

$1,000,000

$500,000

$0 1

2

3

4

5

6

7

8

9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Year

* Assumes a net level annual rate of return of 8.00% in the variable policy subaccounts.

Technical Discussion 

Accredited Investor / Qualified Purchaser



IRC Section 817(h): 55 / 70 / 80 / 90



Investor Control Doctrine



Insurance Dedicated Fund

Technical Discussion: IRC Section 817(h) (h) Treatment of certain nondiversified contracts (1) In general For purposes of subchapter L, section 72 (relating to annuities), and section 7702(a) (relating to definition of life insurance contract), a variable contract (other than a pension plan contract) which is otherwise described in this section and which is based on a segregated asset account shall not be treated as an annuity, endowment, or life insurance contract for any period (and any subsequent period) for which the investments made by such account are not, in accordance with regulations prescribed by the Secretary, adequately diversified. (2) Safe harbor for diversification A segregated asset account shall be treated as meeting the requirements of paragraph (1) for any quarter of a taxable year if as of the close of such quarter (A) it meets the requirements of section 851(b)(4), and (B) no more than 55 percent of the value of the total assets of the account are assets described in section 851(b)(4)(A)(i). (3) Special rule for investments in United States obligations

To the extent that any segregated asset account with respect to a variable life insurance contract is invested in securities issued by the United States Treasury, the investments made by such account shall be treated as adequately diversified for purposes of paragraph (1).

Technical Discussion: IRC Section 817(h) (4) Look-through in certain cases For purposes of this subsection, if all of the beneficial interests in a regulated investment company or in a trust are held by 1 or more -

(A) insurance companies (or affiliated companies) in their general account or in segregated asset accounts, or (B) fund managers (or affiliated companies) in connection with the creation or management of the regulated investment company or trust, the diversification requirements of paragraph (1) shall be applied by taking into account the assets held by such regulated investment company or trust. (5) Independent investment advisors permitted Nothing in this subsection shall be construed as prohibiting the use of independent investment advisors. (6) Government securities funds In determining whether a segregated asset account is adequately diversified for purposes of paragraph (1), each United States Government agency or instrumentality shall be treated as a separate issuer.

Technical Discussion: Investor Control Doctrine



No policyowner or their representative has been permitted to select or identify any particular investment



There is not any direct or indirect pre-arrangement plan or agreement between any policyowner (or any representative of a policyowner) and the Manager (or any of its employees)



The actual investments made must be consistent with the investment mandate disclosed

Technical Discussion: Investor Control Doctrine INVESTMENT SUBADVISOR QUARTERLY COMPLIANCE CERTIFICATION ___________________________, as investment manager (“Manager”) of ____________________ (“Series”) hereby certifies that as of the calendar quarter ended ________________, ____:

(i) No policy owner or their representative has been permitted to select or identify any particular investment to be made directly or indirectly with the assets of the Series. The Manager and its employees have not accepted investment recommendations based on information received from any policy owner. (ii) Except for general descriptions of the investment policies of the Series, there is not any direct or indirect pre-arrangement plan or agreement between any policy owner (or any representative of a policy owner) and the Manager (or any of its employees) regarding the investments to be made by the Series. (iii) The actual investments made through the Series have been consistent with the investment mandate disclosed in Section II of the Series Supplement.

I acknowledge that the statements set forth herein are true.

Authorized Signature:__________________________________ Name: Title: Date:

Technical Discussion: Insurance Dedicated Fund Attached is Washington Report 08-90, Account Holders – And Not Insurer - Are Owners of Assets Held In Segregated Asset Account Underlying Variable Life Insurance Contracts. For your convenience, below is a synopsis of this Washington Report: In an Internal Legal Memorandum (ILM 200840043) the Internal Revenue Service's the Office of Chief Counsel has advised a Program Manager of the Large and MidSize Business Division (Financial Institutions & Products) that a taxpayer, an offshore insurance company, has withdrawn – in the face of an adverse determination - requested rulings on the "investor control" doctrine and the qualification of certain insurance contracts as "variable contracts." Specifically, the Chief Counsel's Office notes that it intended to rule adversely on the issue of whether the taxpayer and not the holder of a variable contract is the tax owner of assets held in a segregated asset account where the segregated asset account directly invests in assets available to the general public. The anticipated adverse ruling on this issue made it unnecessary to rule on the taxpayer's second request regarding whether the contemplated contracts meet the definition of variable contract within the meaning of section 817(d) of the Internal Revenue Code.

Premier analysis of federal legislative and regulatory developments for the nation’s 2,000 most advanced life insurance planners, focusing on business, estate, qualified and nonqualified retirement planning. Counsel

AALU David J. Stertzer, Chief Executive Officer Tom Korb, Vice President of Policy & Public Affairs Marc R. Cadin, Vice President of Legislative Affairs Sarah Spear, Director of Policy & Public Affairs Erik Ruselowski, Assist. Dir. of Policy & Public Affairs

Buchanan Ingersoll & Rooney PC Gerald H. Sherman Stuart M. Lewis Deborah M. Beers Keith A. Mong

PricewaterhouseCoopers William Archer Donald Carlson

Federal Policy Group Ken Kies Matthew Dolan

Sutherland Asbill & Brennan LLP 2901 Telestar Court, Falls Church, Virginia 22042 Toll Free: 1-888-275-0092 Fax: 703-641-8119 Stephen E. Roth www.aalu.org Eric A. Arnold

Ricchetti, Inc. Steve Ricchetti Jeff Ricchetti

AALU Bulletin No: 08-90

October 8, 2008

Subject: Account Holders – And Not Insurer - Are Owners of Assets Held In

Segregated Asset Account Underlying Variable Life Insurance Contracts Major References: ILM 200840043 Prior AALU Washington Reports: 06-11; 05-31; 03-78; 03-75; 03-74 MDRT Information Retrieval Index Nos.:

4400.05; 7400.023

SEE THE CIRCULAR 230 DISCLAIMERS APPENDED TO THE CONCLUSION OF THIS WASHINGTON REPORT. In an Internal Legal Memorandum (ILM 200840043) the Internal Revenue Service's the Office of Chief Counsel has advised a Program Manager of the Large and Mid-Size Business Division (Financial Institutions & Products) that a taxpayer, an offshore insurance company, has withdrawn – in the face of an adverse determination - requested rulings on the “investor control” doctrine and the qualification of certain insurance contracts as “variable contracts.” Specifically, the Chief Counsel’s Office notes that it intended to rule adversely on the issue of whether the taxpayer and not the holder of a variable contract is the tax owner of assets held in a segregated asset account where the segregated asset account directly invests in assets available to the general public. The anticipated adverse ruling on this issue made it unnecessary to rule on the taxpayer’s second request regarding whether the contemplated contracts meet the definition of variable contract within the meaning of section 817(d) of the Internal Revenue Code. Under that section, a variable contract based on a segregated asset account is not treated as an annuity, endowment, or life insurance contract unless the segregated asset account is adequately diversified.

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For purposes of testing diversification, applicable Treasury regulations provide a “look-through” rule for assets held by certain investment companies, partnerships, or trusts. Look-through treatment is available with respect to any investment company, partnership, or trust only if (i) all the beneficial interests in the investment company, partnership, or trust are held by one or more segregated asset accounts of one or more insurance companies, and (ii) public access to such investment company, partnership, or trust is available exclusively (except as otherwise permitted by section 1.817-5(f)(3)) through the purchase of a variable contract. On July 23, 2003, the Treasury and Internal Revenue Service issued two revenue rulings (Rev. Ruls. 2003-91 and 2003-92, considered in our Bulletins Nos. 03-74 and 03-75), which were followed, on July 30, 2003, by proposed regulations issued under the authority of section 817. Those proposed regulations were intended to conform the regulations to the position adopted in the rulings (see our Bulletin No. 03-78) and were finalized with little change on March 1, 2005. (See T.D. 9185, discussed in our Bulletin No. 05-31.) In essence, these pronouncements, taken together, hold that the owner of a variable life insurance or annuity contract, that is invested (via sub-accounts) in certain nonregistered partnerships which are open to investors other than variable contract holders, will be treated as owning the assets in the sub-accounts directly , thus undercutting the insurance policy status of the variable contract and the favorable tax treatment that would otherwise follow for the contract holder. While ostensibly breaking new ground, the rulings collectively affirmed the Internal Revenue Service’s long-standing interpretation of the “investor control” doctrine as applied to these products. See, e.g., Rev. Rul. 81-225, 1981-2 C.B. 12, which held that the insurance company in Situation 5 of the ruling would be considered to be the owner of mutual fund shares in a situation in which the investments in the mutual fund shares are controlled by the insurance company and the mutual fund shares only are available through the purchase of an annuity from the insurance company. See also Christofferson v. U.S., 749 F.2d 513 (8th Cir. 1984), in which the contract holders retained, among other rights, the right to direct that their premium payments be invested in any of six publicly traded mutual funds. The Court in Christofferson concluded that, for federal income tax purposes, the contract holders, not the issuing insurance company, owned the mutual fund shares that funded the variable annuity. In ILM 200840043, “Taxpayer” is a life insurance company incorporated in “Country 1.” Taxpayer meets the definition of a life insurance company as defined in section 816(a), and has filed an election to be treated as a U.S. corporation for Federal tax purposes. Taxpayer proposed to create a segregated asset account for each policy it issues and represented that all such contracts will be designed to comply with all of the statutory and regulatory requirements of Sections 72, 817, 817A, 7702 and 7702A of the Code. [Note: It is unclear when Taxpayer originally filed its ruling request – i.e., whether the request was filed after the above noted Revenue Rulings and final regulations were published in, respectively, 2003 and 2005.] Each segregated asset account would be managed by an investment advisor retained by the Taxpayer. The holder of the policy linked to the segregated asset account would be able to nominate the investment advisor for the segregated asset account link to their policy (the nominated investment advisor cannot be related or subordinate to such policyholder) and the Taxpayer would generally accept such nomination. The investment decisions within the segregated asset account would be made by such investment advisor at its sole and unfettered discretion; however, the policyholder would be permitted to submit a questionnaire regarding investment horizons, investment goals, risk tolerance, risk profile, comfort with investments in different regions (i.e. Latin America, Eastern Europe, Far East; Western Europe, Australia), and comfort level with different types of investment vehicles (e.g. real estate, ADR's, partnerships, etc.). There would be no agreements, understandings or communications between the policy

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holder and the Taxpayer or the investment advisor regarding the investments in the segregated asset account other than the guidance provided in the questionnaire. The ruling states that it was anticipated that the segregated asset accounts will directly invest in assets available to the general public. It is not surprising that the Revenue Service concluded that it would issue an adverse ruling on the investor control doctrine in the above circumstances. What is surprising is that the Taxpayer asked for such a ruling given the existing authorities. In PLR 200601007, discussed in our Bulletin No. 06-14, the taxpayer, a non-U.S. insurer, appears deliberately to have structured its contracts to violate various Federal income tax rules that would have classified those contracts as “variable contracts,” thus potentially subjecting distributions to foreign contract holders on those contracts to 30% withholding at the source. This factual oddity does not appear to be the case in ILM 200840043, however. Any AALU member who wishes to obtain a copy of ILM 200840043 may do so through the following means: (1) use hyperlink above next to “Major References,” (2) log onto the AALU website at www.aalu.org and enter the Member Portal with your social security number and select Current Washington Report for linkage to source material or (3) email Erik Ruselowski at [email protected] and include a reference to this Washington Report. In order to comply with requirements imposed by the IRS which may apply to the Washington Report as distributed or as re-circulated by our members, please be advised of the following: THE ABOVE ADVICE WAS NOT INTENDED OR WRITTEN TO BE USED, AND IT CANNOT BE USED, BY YOU FOR THE PURPOSES OF AVOIDING ANY PENALTY THAT MAY BE IMPOSED BY THE INTERNAL REVENUE SERVICE. In the event that this Washington Report is also considered to be a “marketed opinion” within the meaning of the IRS guidance, then, as required by the IRS, please be further advised of the following: THE ABOVE ADVICE WAS NOT WRITTEN TO SUPPORT THE PROMOTIONS OR MARKETING OF THE TRANSACTIONS OR MATTERS ADDRESSED BY THE WRITTEN ADVICE, AND, BASED ON THE PARTICULAR CIRCUMSTANCES, YOU SHOULD SEEK ADVICE FROM AN INDEPENDENT TAX ADVISOR.

The mission of AALU is to promote, preserve and protect advanced life insurance planning for the benefit of our members, their clients, the industry and the general public. For more information about how AALU’s advocacy efforts help protect your business and the advanced life insurance marketplace, visit our website at www.aalu.org, or call toll free 1-(888)-275-0092.

Doc 2008-21298 (6 pgs)

Office of Chief Counsel Internal Revenue Service

Memorandum Number: 200840043 Release Date: 10/3/2008 CC:FIP:4:CLieu POSTN-131993-07 UILC: date:

Third Party Communication: None Date of Communication: Not Applicable

817.00-00 June 10, 2008

to:

Stuart Mann Program Manager (Financial Institutions & Products) LMSB:FS from: Donald J. Drees, Jr. Senior Technician Reviewer, Branch 4 (Financial Institutions & Products) CC:FIP:4 subject:

Notification of Withdrawn Letter Ruling Request LEGEND Taxpayer = ----------------------------------------------------------------------------Country 1 = -----------ISSUES Pursuant to § 7.07(2)(a) of Rev. Proc. 2007-1, 2007-1 I.R.B. 1, 27, this is to notify you that Taxpayer has withdrawn a letter ruling request regarding the “investor control doctrine” and §§ 61 and 817 of the Internal revenue Code (the “Code”) after we reached a conclusion adverse to that requested and to provide you our view on issues raised in the request. Taxpayer requested a ruling that (1) the Taxpayer and not the holder of a variable contract is the tax owner of assets held in a segregated asset account where the segregated asset account directly invests in assets available to the general public and

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(2) the contemplated contracts meet the definition of variable contract within the meaning of 817(d) of the Code. CONCLUSION Where a segregated asset account directly invests in assets available to the general public, the policyholder and not the taxpayer is the owner of the assets in the segregated asset account. When the Taxpayer received notice of our adverse determination regarding the first ruling request, the taxpayer withdrew their letter ruling, which made it unnecessary to address the second issue. FACTS Taxpayer is a life insurance company incorporated in Country 1 using the accrual method of accounting. Taxpayer meets the definition of a life insurance company as defined in § 816(a) of the internal Revenue Code (the “Code”). Taxpayer has filed an election to be treated as a United States corporation for all purposes under § 953(d). Taxpayer proposes to create a segregated asset account for each policy it issues. The Taxpayer represents that all such contracts will be designed to comply with §§ 72, 817, 817A, 7702 and 7702A of the Code and the applicable regulations thereunder. Each segregated asset account would be managed by an investment advisor retained by the Taxpayer. The holder of the policy linked to the segregated asset account would be able to nominate the investment advisor for the segregated asset account link to their policy (the nominated investment advisor cannot be related or subordinate to such policyholder) and the Taxpayer would generally accept such nomination. The investment decisions within the segregated asset account would be made by such investment advisor at their sole and unfettered discretion, however, the policyholder would be permitted to submit a questionnaire regarding investment horizons, investment goals, risk tolerance, risk profile, comfort with investments in different regions (i.e. Latin America, Eastern Europe, Far East; Western Europe, Australia), and comfort level with different types of investment vehicles (e.g. real estate, ADR’s, partnerships, etc.). There would be no agreements, understandings or communications between the policy holder and the Taxpayer or the investment advisor regarding the investments in the segregated asset account other than the guidance provided in the questionnaire. It is anticipated that the segregated asset accounts will directly invest in assets available to the general public. LAW AND ANALYSIS Section 61(a) provides that the term "gross income" means all income from whatever source derived, including gains derived from dealings in property, interest and dividends.

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A long standing doctrine of taxation provides that "taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed--the actual benefit for which the tax is paid." Corliss v. Bowers, 281 U.S. 376 (1930). The incidence of taxation attributable to ownership of property is not shifted if the transferor continues to retain significant control over the property transferred, Frank Lyon Company v. United States, 435 U.S. 561 (1978); Commissioner v. Sunnen, 333 U.S. 591 (1948); Helvering v. Clifford, 309 U.S. 331 (1940), without regard to whether such control is exercised through specific retention of legal title, the creation of a new equitable but controlled interest, or the maintenance of effective benefit through the interposition of a subservient agency. Christoffersen v. United States, 749 F.2d 513 (8th Cir. 1984), rev’g 578 F. Supp. 398 (N.D. Iowa 1984). Rev. Rul. 77-85, 1977-1 C.B. 12, considers a situation in which the individual purchaser of a variable annuity contract retained the right to direct the custodian of the account supporting that variable annuity to sell, purchase, and exchange securities or other assets held in the custodial account. The purchaser also was able to exercise an owner's right to vote account securities either through the custodian or individually. The Service concluded that the purchaser possessed "significant incidents of ownership" over the assets held in the custodial account. The Service reasoned that if a purchaser of an "investment annuity" contract may select and control the investment assets in the separate account of the life insurance company issuing the contract, then the purchaser is treated as the owner of those assets for federal income tax purposes. Thus, any interest, dividends, or other income derived from the investment assets are included in the purchaser's gross income. In Rev. Rul. 80-274, 1980-2 C.B. 27, depositors in certain savings and loan associations could transfer cash, existing passbook accounts, or certificates of deposit to an insurance company in exchange for annuity contracts. The insurance company deducted expenses and premium taxes, and then deposited the net amounts received into a separate account at each contract holder's savings and loan association. These amounts were then invested in the association's certificates of deposit for a term designated by the contract holder. Except for the ability to withdraw the deposit from a failing savings and loan, the insurance company could not dispose of the deposit or convert the deposit into a different asset. In the event of a withdrawal from a failing savings and loan association, the insurance company was required to deposit the withdrawn amounts in another federally insured savings and loan association. When the certificate of deposit expired, the insurance company was required to reinvest the proceeds in a certificate of deposit for the same duration if the duration would not extend beyond the annuity starting date. If reinvestment for the same duration would extend beyond the annuity starting date, then the insurance company was required to purchase a certificate of deposit with a duration not extending beyond the annuity starting date. If no such certificate of deposit was available, the insurance company was required to reinvest the proceeds in a passbook savings account. The ruling concludes that if a purchaser of an annuity contract can select and control the

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certificates of deposit supporting the contract, then the purchaser is considered the owner of the certificates of deposit for federal income tax purposes. Rev. Rul. 81-225, 1981-2 C.B. 12, describes four situations in which investments in mutual funds pursuant to annuity contracts are considered to be owned by the contract holder rather than by the insurance company issuing the annuity contracts, and one situation in which the insurance company is considered the owner of the mutual fund shares. In situation 1, the investment assets in the segregated asset account underlying the annuity contracts consist solely of shares in a single, publicly available mutual fund managed by an independent investment advisor. Situation 2 is similar to situation 1 except that the mutual fund is managed by the insurance company or one of its affiliates. Situation 3 also is similar to situation 1 except that the segregated asset account underlying the annuity contracts consists of five sub-accounts on which the performance of the annuity contract would depend. The contract holder retains the right to allocate or reallocate funds among the five sub-accounts during the life of the annuity contract. Situation 4 is similar to situation 2 except that the shares of the mutual fund are not sold directly to the public, but are available only through the purchase of an annuity contract or by participation in an investment plan account of the type described in Rev. Rul. 70-525, 1970-2 C.B. 144. Situation 5 also is similar to situation 2, except that the shares in the mutual fund are available only through the purchase of an annuity contract. The ruling concludes that the contract holders in Situations 1-4 have sufficient control and other incidents of ownership to be considered the owners of the mutual fund shares for federal income tax purposes. In Situations 1, 2, 3 and 4 the policyholder has investment control over the mutual fund shares and possesses sufficient other incidents of ownership to be considered the owner of the mutual fund shares for federal income tax purposes. In each of these situations, the mutual fund shares are available for purchase not only by the prospective purchaser of the deferred variable annuity, but also by other members of the general public either directly (as in Situations 1, 2, and 3) or indirectly (as in Situation 4). The policyholder's position in each of these situations is substantially identical to what his or her position would have been had the mutual fund shares been purchased directly (or indirectly, as in Situation 4). Although a mutual fund's diversified portfolio of securities is controlled by the manager of the mutual fund and not by the policyholder, this does not distinguish these situations from Rev. Ruls. 77-85 and 80-274 because the mutual fund themselves are securities the incidents of ownership of which may be attributed to the policyholder in these situations. Prior to the annuity starting date IC is, in such circumstances, little more than a conduit between the policyholders and their mutual fund shares. Rev. Rul. 81-225. In Rev. Rul. 82-54, 1982-1 C.B. 11, the purchasers of certain annuity contracts retained the right to direct the issuing insurance company to invest in the shares of any or all of

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three mutual funds that were not available to the public. One mutual fund invests primarily in common stocks, another in bonds, and a third in money market investments. Contract holders are free to allocate their purchase payments among the three funds and allocations made with respect to previous purchase payments may be changed by a policyholder at any time prior to the maturity date of the annuity contract. The ruling concludes that the contract holders' ability to choose among general investment strategies (for example, between stock, bonds, or money market instruments) either at the time of the initial purchase or subsequent thereto, does not constitute sufficient control so as to cause the contract holders to be treated as the owners of the mutual fund shares. In Rev. Rul. 2003-92, 2003-2 C.B. 350, a life insurance company issues variable life insurance and annuity contracts that are funded by a segregated asset account. The segregated asset account is divided into 10 sub-accounts. Each sub-account invests in a partnership, none of which are publicly traded partnerships (as defined under section 7704). Each partnership has an investment manager that selects such partnership’s specific investments. In addition, contract holders will not have any voting rights with respect to any partnership interests held by any of the sub-accounts. Each sub-account will meet the asset diversification test of section 1.817-5(b)(1) of the Income Tax Regulations at all times. In example 1, variable annuity contracts are funded by subaccounts that invest in partnerships that are available to qualified purchasers and accredited investors in private placement offerings. In example 2, life insurance contracts are funded by sub-accounts that invest in partnerships that are available to qualified purchasers and accredited investors in private placement offerings. In example 3, both life insurance contracts and an annuity contracts are funded by subaccounts that invest in partnerships that are only available through the purchase of an annuity contract, life insurance contract or other variable contracts from insurance companies. The ruling holds that the holder of a variable annuity or life insurance contract will be considered the owner, for federal income tax purposes, of the partnership interests that fund the variable contracts if interests in the partnerships are available for purchase by the general public. The ruling further holds that if the holder of a variable annuity is considered to be the owner of the partnership interests that fund the variable contracts, the contract holder must include interest, dividend or other income derived from the partnership interests in gross income in the year in which the income is earned. Rev. Rul. 81-225 is amplified and clarified. In Christoffersen, the United States Court of Appeals for the Eighth Circuit considered the federal income tax consequences of the ownership of the assets supporting a segregated asset account. The taxpayers in Christoffersen purchased a variable annuity contract that reflected the investment return and market value of assets held in a separate account that was segregated from the general asset account of the issuing insurance company. The taxpayers had the right to direct that their premium payments be invested in any of six publicly traded mutual funds. Taxpayers could reallocate their investment among the funds at any time. Taxpayers also had the right upon seven

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days notice to make withdrawals or to surrender the contract, or to apply the accumulated value under the contract to provide annuity payments. The Eighth Circuit held that, for federal income tax purposes, the taxpayers, not the issuing insurance company, owned the mutual fund shares that funded the variable annuity. The court concluded that the taxpayers "surrendered few of the rights of ownership or control over the assets of the sub-account," that supported the annuity contract. Christoffersen, 749 F.2d at 515. According to the court, "the payment of annuity premiums, management fees and the limitation of withdrawals to cash [did] not reflect a lack of ownership or control as the same requirements could be placed on traditional brokerage or management accounts." Id. At 515-516. Thus, the taxpayers were required to include in gross income any gains, dividends, or other income derived from the mutual fund shares. Under Rev. Rul. 81-225, assets held directly by a segregated asset account that are available to the general public are owned by the policyholder for federal tax purposes. For this reason, we believe that the policyholder in the ruling request and not the Taxpayer would own the assets in the proposed segregated asset accounts for federal tax purposes. This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views. Please call (202) 622-3970 if you have any further questions.

/S/ By: _____________________________ Donald J. Drees, Jr. Senior Technician Reviewer, Branch 4 Financial Institutions & Products

Technical Discussion: Insurance Dedicated Fund The graphic image below shows the difference between the type of insurance dedicated fund structures (on the left) that the IRS and the tax courts have repeatedly affirmed (Rev. Ruling 81-225; Christofferson v. U.S. 1984; Rev. Ruls. 2003-91 and 2003-92; etc.) as acceptable and the type of segregated asset account structures (on the right) that the IRS deems to be a violation of the investor control doctrine.

t Account Structure

Insurance Dedicated Fund Structure

Policy Owner

Policy Owner

Insurance Company

urance mpany

Commercial Lender

mercial nder

Segregated Asset Account

ated Asset count

et ble to neral lic

Asset Available to the General Public

Asset Available to the General Public

Asset Available to the General Public

Independent Investment Manager Insurance Dedicated Fund

(not available to General Public) Asset Available to the General Public Asset Available to the General Public

Asset Available to the General Public

Asset Available to the General Public

Asset Available to the General Public

Asset Available to the General Public

Asset Available to the General Public

PPVA and PPVUL: Key Differences Private Placement Variable Annuity (PPVA)

Private Placement Variable Universal Life Insurance (PPVUL)

Requires medical exam?

No

Yes

Includes death benefit?

No

Yes

Deferred

Deferred

LIFO Taxation

Tax-free withdrawals (up to cost basis) and loans

IRD

Tax-free

10% Excise Tax

No

Taxation of investment gains? Taxation of distributions? Taxation at death? Penalty on distributions prior to age 59 ½?

PPVA Economics: $5 Million Deposit Notes:

After-Tax Annual Distributions (Level over 20 Years)

Distributions:

1. Assumes an 8.00% return on a $5 million $3,500,000

PPVA Accountinvestment in a Taxable Account and a PPVA

Taxable Account

Taxable Account (after-tax)

$3,000,000

Account, 100% of realized gains are taxed at ordinary income rates, and no withdrawals are made before age 59 ½.

PPVA Account (after-tax)

$2,500,000

$1,994,030

$2,000,000 $1,500,000

$1,024,624

$1,000,000 $500,000

$555,665

$481,283

$0 10

Asset Values:

20

3. The cost of the tax-deferral is an annual PPVA fee of 70 basis points, charged monthly on the Net Asset Value (NAV).

30

$45,000,000

$41,073,465

Taxable Account (after-tax)

Asset Values (Assuming No Distributions)

$947,311

$675,222

PPVA Account (after-tax)

$37,000,000

PPVA Account (pre-tax or net to charity)

$29,000,000

$23,902,495 $21,000,000

$13,998,277 $13,000,000

$5,000,000 Year 10

Year 20

2. The PPVA Account enables all fund fees and expenses to become effectively tax deductible (i.e. not subject to 2% of AGI floor), which might not be possible in the Taxable Account due to the 2% of AGI floor and the limitations on deductions of such fees for alternative minimum tax purposes.

Year 30

4. The Asset Values are net of all fund fees and annuity charges, as applicable. 5. Tax Rates assume no additional tax legislation is enacted. Ordinary Income Tax Rate Year 1, 2, 3, and 4 +: 40.80%, 39.50%, 47.60%, 47.60%. Lower tax rates on capital gains would make the investment return for the taxable investment more favorable, thereby reducing the difference in performance between the accounts shown.

PPVUL Economics: $5 Million Deposit (non-MEC) Distributions:

Notes:

After-Tax Annual Distributions (Level over 20 Years)

$3,500,000

Taxable Account

$3,256,964

Taxable Account (after-tax)

$3,000,000

Taxable Account and a PPVUL Account, and 100% of realized gains are taxed at ordinary income rates.

PPVUL Account (after-tax)

$2,500,000

2. The PPVUL Account enables all fund fees and expenses to become effectively tax deductible (i.e. not subject to 2% of AGI floor), which might not be possible in the Taxable Account due to the 2% of AGI floor and the limitations on deductions of such fees for alternative minimum tax purposes.

$2,000,000

$1,550,229 $1,500,000

$947,311

$1,000,000 $500,000

$675,222

$691,989

$481,283

$0 10

Asset Values:

20

30

Asset Values (Assuming No Distributions)

$45,000,000 Taxable Account (after-tax) PPVUL Account (after-tax)

$37,000,000

PPVA Account an 8.00% return on a $5 million investment in a 1. Assumes

$36,589,560

PPVUL Account (pre-tax or net to charity)

3. Assumes insured is a male age 50 who does not smoke and is classified as a Preferred insurance risk. The policy performance is comparable for a female age 55 who does not smoke and is classified as a Preferred insurance risk. Assumes the policy is issued in the state of Connecticut and is structured to qualify as a Non-Modified Endowment Contract (Non-MEC). Assumes the amount not invested in PPVUL grows in the Non-Insurance Fund until it is invested in the PPVUL account. 4. The Asset Values are net of all fund fees and insurance charges, as applicable.

$29,000,000

$21,603,712 $21,000,000

$13,998,277 $13,000,000

5. The Taxable Account excludes the cost of term insurance. An additional annual cost of approximately $49,455 for years 1-10 is required to cover the cost of a level term premium for $44,068,400 of insurance benefit. 6. Tax Rates assume no additional tax legislation is enacted. Ordinary Income Tax Rate Year 1, 2, 3, and 4 +: 40.80%, 39.50%, 47.60%, 47.60%.

$5,000,000 Year 10

Year 20

Year 30

PPVUL: Optimal But Complex  Medical underwriting  Capacity  MEC vs. non-MEC  DAC and premium taxes  Jurisdiction management  Net amount at risk charges

 Distribution management (withdrawals and loans, limitations on distributions, forceouts)  Varying IRRs by year

 Estate planning issues

Target Markets Private Placement Variable Annuity • • • • •

Tax-deferred investing in alternative asset class funds Retirement income Executives who work in financial institutions U.S. Expats: FATCA, FBAR, PFIC reporting requirements Testamentary bequests to charity

Private Placement Variable Universal Life • • • • • •

Tax-free investing in alternative asset class funds Retirement income Dynasty Trust funding Executives who work in financial institutions U.S. Expats: FATCA, FBAR, PFIC reporting requirements People who need large blocks of life insurance

Target Markets PPVA Investment Account Summary Since Inception 06/02/2010 - 02/28/2011 Beginning Contract Account Value

$0.00

Premium Deposits

17,500,000.00

Premium Charges

0.00

Withdrawals

0.00

Carrier M&E

(62,816.05)

Investment Gains/(Losses)

2,652,414.86

Ending Contract Account Value

$20,089,598.81

Target Markets PPVUL Investment Account Summary Since Inception Beginning Contract Account Value

06/01/2009 - 02/28/2011 $0.00

Premium Deposits

9,616,968.00

Premium Charges

(141,626.00)

Withdrawals Cost of Insurance Carrier M&E Other Carrier Charges Investment Gains/(Losses)

0.00 (46,822.00) (113,677.00) (35.70) 3,483,089.00

Ending Policy Account Value

$12,797,896.30

Insurance Benefit

$80,649,536.00

What Does it Take to Develop a Practice Like This?



Design capabilities to select an appropriate product and create the most efficient design for the client



Infrastructure to administer and service contracts through the lifetime of the annuitant or insured



Reporting platform to provide accurate, transparent, and timely periodic statements to the client

Closing Thoughts