Major Marketer of ‘Split-Dollar’ Insurance Amends Several of Its Plan’s Provisions

A California company is making changes in its approach to a controversial giving technique in which charities and wealthy donors divide the proceeds of life-insurance policies purchased with tax-deductible dollars.

InsMark, a San Ramon, Cal., company that is among the nation’s most aggressive marketers of so-called charitable split-dollar plans, will require new policy holders of its Charitable Legacy Plan to pay charities a lump sum of cash if an insurance agreement is terminated prematurely.

The change, one of several made by InsMark, comes amid growing scrutiny of split-dollar arrangements by government regulators and estate-planning experts.

A top official at the Internal Revenue Service said the service recently denied an application for tax exemption to a would-be charity that planned to finance its operations through split-dollar arrangements.

Marc Owens, director of the I.R.S.’s Exempt Organizations Division, declined to identify the group that sought tax-exempt status. He said the service was concerned that people setting up the plans would reap an undue “private benefit” from the arrangements.

The I.R.S. has been investigating split-dollar insurance for months (The Chronicle, August 13, 1998), and Congress also is looking into the issue.

Robert B. Ritter, Jr., InsMark’s chief executive, said that his company’s changes are not a reaction to government scrutiny. Rather, he said, they are “incremental enhancements” aimed at improving InsMark’s brand of split-dollar plan and countering false or misleading claims by his company’s critics, some of whom have attacked InsMark’s approach in professional journals and other venues.

“We’ve got the current law dead center,” Mr. Ritter said, declaring that the Charitable Legacy Plan, even without the changes, “will take the bright light of federal review.”

Still, Mr. Ritter said he is “strongly recommending” to the people who sell InsMark’s plan that the changes be applied retroactively to the company’s approximately 1,500 existing split-dollar arrangements. InsMark’s plans are marketed by an independent sales force of about 456 insurance agents, financial planners, lawyers, and others who are licensed by the company.

In a typical split-dollar deal, a donor seeks to minimize federal income and estate taxes by setting up a life-insurance trust, naming a family member as beneficiary. Separately, the donor makes an annual tax-deductible gift to a charity, stipulating that the charity can use the gift any way it wishes.

The insurance trust buys a cash-value life-insurance policy on the donor, and the trust arranges to pay a small part of the policy’s annual premium. The charity pays most of the premium. The charity’s premium payment matches — or nearly matches — the amount of the donor’s gift.

The donor or donor’s trust has tax-free access to money in the policy’s cash-value portion, which is a reserve that grows over time. When the donor dies, part of the death benefit goes to the charity. The rest goes to the donor’s heirs, who commonly use the money to pay estate taxes.

Critics say split-dollar arrangements provide a disproportionate benefit to donors and put a charitable organization’s tax-exempt status at risk.

Douglas K. Freeman, a California tax lawyer and vocal critic of charitable split-dollar plans, said that in a typical split-dollar arrangement, a charity pays about $4 in insurance-premium costs for every $1 the donor pays, and “when the benefits come out, the charity gets $1 for every $4 the individual gets.”

InsMark’s actions focus on a series of specific criticisms of its plan. One is that a charity could end up with little or no insurance coverage at or near the time the policy owner dies. Some insurance policies lapse if the policy owner lives longer than mortality tables predict.

InsMark maintains in promotional material that its existing policies prevent that from happening. Nonetheless, Mr. Ritter said the plan’s language has been “beefed up” so that what InsMark calls an “extended death benefit” continues throughout the policy holder’s life at the highest amount of coverage held in any previous year of the plan.

Another amendment is meant to short-circuit critics’ concerns that a policy owner could terminate a split-dollar arrangement and leave the charity with no death benefit. Mr. Ritter denies that was ever the case. The amendment, however, does give policy owners the right to unilaterally end a split-dollar agreement, but at a steep price: The policy owner has to pay the charity its death-benefit interest in cash at the highest level of coverage the charity would have received in any year of the agreement.

To deal with charges that a policy owner could surrender a policy and leave a charity with nothing, a third amendment stipulates that the charity will be entitled to a share of the proceeds equal to the highest level of death-benefit coverage it would have gotten had the policy remained in place. If an owner’s loans or withdrawals of money from the policy causes the surrender value to be less than the amount due the charity, the policy owner must pay the difference.

Such changes have done little to satisfy critics of InsMark and its split-dollar arrangement.

“The changes are intended to enhance the economic interests passing to a charity, but they don’t reach the fundamental issue” of whether charitable split-dollar arrangements are legal, Mr. Freeman said. “The fact that a charity makes money in this deal is not relevant. It’s engaged in an activity it is not permitted to do.”

Frank Minton, a planned-giving consultant in Seattle and the ethics chairman of the National Committee on Planned Giving, an organization that represents fund raisers and estate planners, said InsMark’s amendments “are an improvement in that they give somewhat more protection to the charity.” But, Mr. Minton added, the changes “don’t necessarily address the fundamental problem” with split-dollar plans: whether “deductible dollars” are used “to generate a private benefit for individuals.”

Last year, the National Committee on Planned Giving said the split-dollar strategy raises “unacceptable risks” for donors and “may endanger the tax-exempt status of charities.”

Mr. Owens said the I.R.S. continues to be concerned that some plans may afford donors the ability to manipulate a policy for their own financial benefit. But he declined to comment on the InsMark plan, and he acknowledged that his office has not “exhaustively reviewed” all the forms that split-dollar plans have taken.