Message to UBS (and Other Swiss Banks)

A.  Overview

Over the course of the last twelve years that I have been active in the recommendation of private placement insurance solutions, I have had the opportunity to meet and solicit business with a number of private banks and specifically the private client groups within those banks. The U.S. Government announced on September 11, 2012 that it would pay UBS “Whistleblower” Brad Birkenfeld $104 million. Unfortunately, Mr. Birkenfeld will have to wait a few months until he gets released from house arrest in order to enjoy his  $104 million for his role in disclosing to the U.S. Government the name of 5, 000 accounts held by Americans within the private client group of UBS.

The story of UBS goes something like this. Brad Birkenfeld was a fifteen year veteran of UBS. Over the course of his career, he helped over 5,000 wealthy American taxpayers hide over $20 billion in Swiss bank accounts. After “blowing the whistle” on UBS, he ended up getting convicted himself for not being forthcoming enough initially. He got apparently pleaded to a lesser charge in exchange for his cooperation.

In my view, the story did not have to end this way. A number of legitimate planning techniques with lots of  statutory authority in the Internal Revenue Code exist that would have provided similar results to the illegal strategy of hiding the money under a rock and hoping that nobody finds out.

B.  Background

 Private placement life and annuity contracts are institutionally priced products designed for the same type of clients that private banks have – accredited investors and qualified purchasers, aka rich folks. These products allow for  investment customization that would allow the UBSs of the world to provide a complete platform of customized investment options for private bank clients on a tax-advantaged basis . The investment menu could have complete open architecture to include bank-managed funds and discretionary accounts as well funds managed by third party managers approved by the bank.

The tax treatment of life insurance and annuities are bullet-proof from a statutory point of view. The tax law definition of life insurance is defined in IRC Sec 7702. The tax law definition of an annuity is defined in IRC Sec 72. Life insurance policy loans and withdrawals are also covered in IRC Sec 72. The tax law requirements for variable insurance requirements are defined in IRC Sec 817 and Treasury Regulations.

The tax treatment of a life insurance death benefit is covered in IRC Sec 101. The estate tax treatment of the death benefit is covered in IRC Sec 2042. The tax treatment of insurance companies is covered in Sub-chapter L of the Internal Revenue Code (IRC Sec 801-IRC Sec 818). Each state or offshore jurisdiction has a statute dealing with the treatment and legal requirements of insurance company separate accounts.

Private placement life insurance policies (PPLI) enjoy significant tax-advantages. The investment income within the policy is tax-free. The policyholder also has the ability to access the policy cash value during lifetime on a tax-free basis though low cost policy loans (0-50 basis points per year). Life insurance also allows the policyholder to recover his basis in the contract first on a tax-free basis as well.

The death benefit of a life insurance contract is income tax-free. The policy’s ownership can also be arranged so that the policy proceeds avoid estate taxation for multiple generations. In otherwards, IRS rules allow a policyholder to enjoy the tax-free build up of investment income within the PPLI contract; enjoy tax-free income during lifetime; and at death enjoy income and estate-free tax treatment of those investment gains. The cost of the structure is approximately one percent per year.

 Isn’t that what UBS and its clients were trying to accomplish?

What other investment vehicle offers similar tax benefits on a statutory basis?

Private placement variable annuities (PPVA) contracts also provide significant tax advantages albeit but not like PPLI. The investment income within the policy enjoys tax deferral. In the event deferred income is converted into a stream of payments (annuitization), part of each payment is treated as a tax-free return of capital and part of each payment is treated as income taxed at ordinary rates. At death, deferred income can be continued to enjoy further deferral for at least another five years, or paid out over the lifetime of a beneficiary extending the deferred benefits.

C.  Private Banks and Private Placement insurance Products

Over the course of the last twelve years, a number of life insurers in the private placement insurance business called on these banks. However, the level of business never approached any meaningful level for a few important reasons:

(1)Product Complexity and Sophistication – Most banks previously had no experience selling insurance products; however since the repeal of Glass-Steagal, banks have been the largest seller of annuities by large margin. Investment brokerage firms would probably be a close second particularly in the area variable annuities.

On the life insurance front, banks have been less successful in selling life insurance products. In my view it does take more sales ability to sell life insurance and the estate planning considerations for wealthy clients can be complex. Nevertheless, this should not have been difficult for private banks with  trust companies. 

In the final analysis, private banks and investment brokerage firms sell complex investment product and strategies that are more far-flung in my opinion than life insurance and annuities.

(2) Bureaucracy

A number of life insurers got tangled up in long reviews with compliance departments while at the same time, other departments within the banks were involved in “crimes and misdemeanors” that resulted in far greater negative publicity than the sale of life insurance and annuities. I suppose profits “trump” compliance.

(3) Marketing and Distribution

Most private placement life insurers do not have marketing resources internally. High end life insurance salesmen have avoided selling private placement insurance products not because of the absence of competitiveness  because of the absence of high commissions. Private placement insurance contracts compensate the distributor in a manner similar to investment products with asset-based compensation.

(4) Professional Arrogance

Another reason is professional arrogance. Traditional banks and investment firms quite frankly look down their nose at life insurance companies and agents. To put it another way, it was beneath the banks to sell products benefits of the benefits for clients.

Offshore Accounts

The domestic private placement life insurance industry is represented by two life insurers. The offshore industry has a few options. These carriers are fully compliant with U.S. law. These carriers remind their carriers of their compliance obligations regarding FBAR and other IRS filings – Form 3520; Form 3520A and Form 8938 among others. The carriers have generally made an election under IRC Sec 953(d) to be treated as U.S. taxpayers and are subject to review by the IRS. Nobody is hiding!  Recent event should not serve as a deterrent at considering offshore options. Generally, the jurisdictions have greater regulatory flexibility and stronger asset protection benefits.


The entire situation was more than unfortunate for UBS and the participants. The bank enjoyed centuries of excellent reputation and service for customers. My commentary is focused on the missed opportunity to use tax-advantaged products with strong statutory authority. The current tax landscape is changing quickly. PPLI for high net worth individuals should not draw the wrath of Congress as not much as ever been sold versus what could have been sold (if only they had not hidden money under a stone).

The American Council of Life Insurers is the national association and lobby organization of the life insurance industry. Obviously, it is very well funded and politically connected. The so-called inside buildup of life insurance is the industry’s sacred cow”. The industry goes to the mat on that one. Life insurance agents are also politically active and well represented in Washington, D.C. For the moment, private placement insurance is in great shape. It may not last! Carpe diem! These products are one of the few remaining investment vehicles with clear statutory authority

About gerrynowotny

I am a tax and estate planning attorney with a JD and LL.M in estate planning from the Univesity of Miami School of Law. I have worked in the life insurance industry for twenty three years and the last eleven in private placement life insurance.
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