Estimated reading time: 3 minutes
Private placement life insurance (PPLI) is a life insurance policy wrapped around an investment. It is similar to a variable universal life insurance policy, but the investments owned by the policy are privately offered and meet very specific tax code requirements. The investments of many high net worth clients can be very tax-inefficient (mainly hedge funds and similar investments).
PPLI presents an opportunity to investors for otherwise tax-inefficient investments to be owned inside an insurance policy where investment earnings are not subject to income tax as earned or as realized and are similarly not subject to income tax upon the death of the insured when the proceeds of the policy are paid out to the beneficiary of the policy.
What are the requirements of PPLI?
Several requirements must be satisfied to ensure the tax-free treatment of PPLI. First, the investments must be held in a separate account which must be segregated from the general account of the insurance carrier. This is beneficial for the investor because the assets in the segregated account are not subject to the claims of creditors of the insurance carrier.
Second, several investment restrictions apply. Specifically, purchasers of PPLI, whether an individual or a trust, must generally qualify as both an “accredited investor” who falls under section 501(a) of Regulation D of the Securities Act of 1933 and a “qualified purchaser” under section 2(a)(51) of the Investment Company Act of 1951.
There are limits on the amount of control that the owner of the PPLI policy may exercise. The owner may not engage in conduct that would qualify as investor control. Investor control may occur when the contract owner directs investment strategy or makes investment decisions for the segregated account, including:
- Determining the specific allocation of the assets of the segregated account.
- Requiring the manager of the account to acquire or dispose of any particular asset.
- Requiring the account manager to incur or pay any specific liability of the account.
Any Rules or Restrictions?
To avoid investor control, there must be no prearranged plan or agreement between the separate account manager and the policy owner to invest any amount in any particular asset or subject to a specific arrangement. Concerning the management of the account assets, the manager may not consult with or rely on the advice of any person who the manager knows is a policy owner, policy beneficiary, the beneficial owner of any entity that is a policy owner, or a fiduciary or beneficiary of a trust, the trustee of which is a policy owner.
Finally, there are diversification requirements that must be met in the separate account. No more than 55% of the value of the total assets of the account may be represented by any one investment, no more than 70% by any two investments, no more than 80% by any three investments, and no more than 90% by any four investments.
Investment in an investment company, partnership, or trust (such as a mutual fund or hedge fund) will not violate the diversification requirement as long as the fund meets the requirement of an insurance-dedicated fund. To be an insurance dedicated fund, (1) all of the beneficial interests in the fund must be held by insurance company separate accounts, and (2) public access to the fund must be available exclusively through the purchase or acquisition of a variable insurance contract.