|
|
 |
|
| Risk & Reward |
A Hybrid Haven
Eileen Gunn
10/01/2004
|
Michael Book, a managing partner at the New York financial advisory firm
Lenox Advisors, recently sought to devise an investment plan that would shelter
assets from taxes for one of his clients, a newly retired Wall Street executive
in his mid-40s. The client has a tax-deferred retirement account that will
continue to grow for several years before he starts drawing on it, and a
portfolio of municipal bonds that generate a few hundred thousand dollars in
mostly tax-free income each year to cover his living expenses. He also has about
$4 million set aside to invest in alternative assets such as hedge funds.
TOP VIEW
Private-placement life insurance can offer us an attractive vehicle for
investing in alternative asset classes, while securing a death benefit for our
heirs. We must cede asset selection decisions to the insurance company in most
cases. Costs and access to strongly performing funds vary significantly among
insurance carriers, so it pays to research them carefully, and to negotiate the
fees. |
“As a Wall Street person, he loves hedge funds,” Book explains. He also
knows that the funds’ active trading strategies generate an unfortunate amount
of short-term capital gains, which are taxable as ordinary income, rather than
at the lower, long-term capital gains rate. To avoid this cost, Book advised his
client to purchase a private-placement life insurance contract and use it as a
vehicle for investing in various hedge funds.
Private-placement insurance
policies are tailored to fit the needs of affluent investors, and, as their name
indicates, are unavailable to the public at large. They are, essentially,
variable insurance policies. Clients have some degree of choice over the assets
they hold—at least when setting up these policies—and how well those investments
perform determines the size of the death benefit. For example, the policy that
Book arranged for his client starts out with a $19 million death benefit. “But,”
Book notes, “we’re hoping the investments will grow to $30 million to $40
million.”
Private-placement life insurance is therefore a hybrid: half
insurance policy, half asset-management tool. It is a valuable financial
planning strategy for those of us who have enough liquidity to meet day-to-day
expenses, and who want to invest a portion of our capital for long-term
appreciation. For example, Anne Melissa Dowling, a senior vice president at
MassMutual Financial Group in Springfield, Mass., recommends private placements
for people who have recently had liquidity events, either inheritances or
windfalls from selling a business or investment.
Many major financial
companies, including New York Life, Massachusetts Mutual Life Insurance and
Citigroup, offer these products. They have become more widespread as hedge funds
have grown in popularity, primarily because of tax advantages. Any assets used
to fund an insurance policy grow tax-free inside the policy, and the death
benefit paid out to beneficiaries is also tax-free. Private placements are more
flexible and less expensive than other types of insurance policies, making them
attractive as investment vehicles.
 “Still, people shouldn’t lose sight of
the fact that it is an insurance policy, and there are complications,” cautions
Douglas Moore, national director of estate and charitable planning at Citigroup
Private Bank in New York. For example, rather than investing directly in a hedge
fund, we pay a premium to an insurance company, which then invests the capital
for us. Private-placement policies typically have higher premiums than other
kinds of life insurance. This can work to our advantage, because it allows us to
put capital to work quickly. The premiums typically start at around $2.5
million, are spread over four or five years and can total as much as $10 million
to $20 million (there are limits on the extent to which we can insure
ourselves). The premium represents the initial cash value of the policy, and the
insurance company invests it in the hedge funds or other assets we choose. The
growth in its value partially funds the death benefit.
| “Some insurers have a wide selection of well-performing funds; others
don’t have as good a selection in terms of number or quality. I was
surprised by the discrepancy when I started looking into them for
our clients.” |
Circuitous Route
There are other costs we will not bear if we invest in a
hedge fund directly. The federal and state governments levy taxes on insurance
policies. The insurance company itself will charge a commission and
administrative fees, and a management fee if the policy is big enough to require
its own asset manager. Advisors recommend factoring in all taxes and fees for
private-placement insurance when weighing it against direct investments. “We
assume a rate of return and run the numbers with all these fees, and with the
taxes we’d pay on the gains without the insurance policy. Then we see what the
consequences will be,” says Mark Watson, vice president of financial capital
services in the Orlando office of Asset Management Advisors. “Usually the
insurance product looks better.”
|
|
|
|
|
|
|
