Why did I get a 1090-R without a distribution?

Posted: Fri Feb 11, 2011 01:13 am Post Subject:

The policy was really intended more as an investment vehicle than a life insurance policy, and I don't need any additional insurance beyond the face value amount;

Was/is there some other alternative for paying the annual premium that should have been used and that should be used in the future?

Posted: Fri Feb 11, 2011 04:19 am Post Subject:

Hello Max, thanks for the message.

Based on what I've read, this case very closely resembles a number of NY Life cases I've worked in the past. In each case, the agent misrepresented the terms and conditions of the policy and the policy holder was made whole.

If "confused in Cal" would like to contact me, I would be happy to assist them.

Thanks, Mark

Posted: Fri Feb 11, 2011 05:51 pm Post Subject:

Gentlemen: Thank you for the replies and assistance. I am meeting with my agent today to obtain additional information, so that I can hopefully understand and explain the issue better. I believe the situation may not be as serious as I may have first led you to believe by my description, but I will register and follow up with you again after my meeting, and perhaps then you can help me get to the bottom of what has occurred.

Posted: Fri Feb 11, 2011 09:47 pm Post Subject: Updated Information

Max/Mark (and anyone else who cares):

I now have a somewhat better picture of what the issues are. I appreciate that the two of you are concerned that the policy might have been misrepresented to me, and I think that it was, but not necessarily in the way that you might have thought. Rather, my specific concern is with the mistake that led to my receiving the 1099-R, which I'd like to run by you again, if you don't mind. It sounds pretty complicated to me, so settle in:

In a story that is too long to explain here, I originally had a Universal Life policy purchased for me as a benefit by my employer (a firm in which I am a partner) through a 419 Plan, but thereafter ended up buying the policy for myself. The transaction was all cleared by our accountants and a pension attorney, but the result was that I owned the policy with a basis of zero (because I had not paid the initial premium myself with after-tax dollars).

Three years ago, my agent suggested that I convert the Universal Life policy to a Whole Life policy through a like-kind exchange. At that point, the new policy essentially became a single-premium policy with an initial payment of about $100,000 purchasing a face policy of $450,000, with the additional premium being used to purchase paid-up additions for an ALIR that increased the death benefit to over $650,000. (Have I used the correct terminology?) The policy was also set up so that in successive years, I would not be paying the annual premium for the base policy (fixed at about $15,000 per year over the life of the policy to age 100) in cash each year, but that it would be paid for out of a combination of paid-up additions and the dividends earned on the base policy and the ALIR (in a formula too complicated for me to understand). The illustration that I received prior to agreeing to exchange/purchase the Whole Life policy showed that under the non-guaranteed values, the combination of paid-up additions and dividends would be sufficient to pay the annual premiums for each of the first 11 years of the policy, but that in years 12-21 (after the paid-up additions had been exhausted), I would have to borrow from the policy's cash value to pay portions of the annual premium varying from $7,700 to $1,000 for each of those years, but that by year 22, the annual dividends would be sufficient to cover the cost of paying for the entire annual premium each year thereafter. And throughout this time, while the death benefit would reduce back down to approximately the face value of $450,000, my cash value would be increasing substantially from year 10 onward.

What I was not told (because the agent apparently did not know it himself until now) is that for each of the years in which the paid-up additions and dividends were being used to pay the annual premium, the surrender of the paid-up additions and/or dividends would be considered a taxable distribution to me, supposedly because the policy has a basis of zero. In other words, even because the money is being retained and transferred within the policy itself, I am being taxed on the "phantom" distribution of over $15,000 per year. My agent says that this would not be the case if I had any basis in the policy, because the distribution would be used to reduce my basis, but I am thinking that I would still be getting a 1099-R for the distribution from the insurance company (Mass Mutual) and that it would be up to me to calculate how much of that distribution was taxable or not on my income tax return.

My agent advised that the only way to avoid having the payment of the annual premium from within the policy be considered a taxable event is to pay it by taking out a loan each year against my accumulated cash value to pay for the premium. And I would apparently have to do it in perpetuity, so my outstanding loan balance each year will grow higher and higher. This can be done, I suppose, but I suspect that it will result in a much lower net cash value than I was originally planning on having based upon the illustrations originally provided to me; how much lower I don't know yet, since I haven't seen any updated illustrations run with the annual premium being paid each year by a loan, rather than out of the paid-up additions and dividends.

(By the way, the insurer has confirmed that the policy is definitely not a MEC; I don't know why or how, but apparently it passes the tests for it not to be a MEC, perhaps having something to do with how the original single premium payment was actually originally divided into three years' payments and the amount of the ALIR purchased.)

So my question, if anyone is still with me, is does the analysis and explanation I received from my agent make sense and seem correct? He has acknowledged that he "screwed up" by not realizing that the way he had originally set up the policy by using the paid-up additions and dividends to pay the annual premiums would result in a taxable event because my basis in the policy was zero. Is he correct that this result is indeed inevitable; wouldn't a lot of people who use a similar mechanism for paying their whole-life premiums run into a similar problem once their basis was reduced to zero after a few years of using their paid-up additions and dividends to pay the premiums? And is he correct that the only way to avoid the problem in the future is to change to having the annual premiums paid for by loans taken out against the policy's cash value?

Thanks in advance for any advice you might have. This has been quite an education for me.

Posted: Sat Feb 12, 2011 12:22 am Post Subject:

And is he correct that the only way to avoid the problem in the future is to change to having the annual premiums paid for by loans taken out against the policy's cash value?

Posted: Sat Feb 12, 2011 05:37 am Post Subject:

I agree with Max.

During our telephone conversation, I told Max I had a very simple solution to your dilemma: The illustration you spoke of in the third paragraph of your most recent post?............Have the agent and his manager sign it.
Let's see how confident they really are in the product and their company.

When you have a chance, go to my website and look at Benenson v. Blattmachr on the home page. This is what Mass Mutual's capable of.

Posted: Sat Feb 12, 2011 11:01 am Post Subject:

Dear Investigator, In your previous post you've mentioned about NY life cases that you've worked upon. You've mentioned about terms and conditions being misrepresented by the agent. Can you share some brief instances with us? I'm sure it will help us all who're following this thread.

Posted: Sat Feb 12, 2011 06:51 pm Post Subject:

The New York Life cases involved Premium Misdirection, Vanishing Premium Fraud, and Churning.

Trying to briefly explain any of these would be like explaining the Theory of Relativity in less 100 words.

Premium Misdirection – This is actually another form of twisting but doesn't involve the replacement of an existing policy. Premium Misdirection occurs when the premium for one policy, usually a Universal Life policy with a flexible premium, is lowered so that the excess can be spent on a new policy. For example: A husband purchases a $100,000 Flexible Premium U/L policy and the wife is insured by a $50,000 Spouse Term Rider. Agents sometimes call this type of policy a “Family Insurance Plan.” After just a few years, the agent returns and instructs the husband to lower his monthly premium (as I explained in the Twisting section above). The agent then removes the wife's term rider and sells her another, often larger policy, with all or part of the money that was once applied to the husband's insurance plan.
I'm afraid the number of ways in which agents commit Premium Misdirection are far too numerous to list. I can assure you that these plans seldom work for more than just a few years. At that point, the policy holders usually get a large bill from the insurance company. When/if they are unable to pay the often exorbitant premiums, the policies any cash accumulations are lost.

Vanishing Premiums – This happens when the policy's cash value and earnings are projected to cover the premiums at some point. The common presumption is that such policies are “paid up.” This is very seldom the case. With the real-world rise and fall of interest rates and expenses, premiums that were supposed to have vanished will probably, in future years, suddenly reappear. If this happens, clients who hadn’t counted on their premiums reappearing are in for a big surprise. Some people budget for these premiums annually. If the premium doesn't reappear in a given year, the client can spend his or her “windfall” elsewhere.

Churning – Churning is without question the most common type of life insurance fraud. This occurs when agents sell new policies that are not needed to existing policy holders in order to generate a commission. In some cases, an agent will call a long-time policy owner and claim there is something horribly wrong with their existing policy. After causing the person a great deal of distress, the agent will apologize on company's behalf, and explain how the problem can be easily fixed with the purchase of an "upgraded” policy. Because the company feels so badly about not paying closer attention to one of its long-time policy holders, the agent claims, they are going to allow the equity from the old policy to be applied directly to the new policy. The agent will go on to explain how this money will used to “front-load” or “kick-start” the new, often larger policy. Doing so will completely eliminate, or greatly reduce, any premium payments for the new policy.
Agents with experience in this type of fraud know that when they replace an existing policy, they are required by law to complete a policy replacement form and must also submit information pertaining to that policy on the new application for insurance. Correctly doing so, however, creates a policy replacement paper-trail that can be monitored by both the insurer and certain regulatory agencies.
When questioned about this, agents have explained that they are only required to complete the forms when replacing a policy from Company A with another from Company B. They've claimed they didn’t know they were required to do so if/when they replace a policy issued by their own company. The agents making these claims were wrong and several of them have had their licenses to sell insurance permanently revoked.
In an effort to avoid the aforementioned paper-trail, agents do not surrender the old policy; they just strip it of its cash value and/or dividends. Once this is done, the older policy generally lapses without any value in just a short time. When the money from the old policy is depleted and there isn't any money to pay for the new policy, the policy owner gets a bill from the insurance company for the new policy's premium. If the insured is unable to budget these often very large payments, the new policy lapses as well. In the end, the long-time policyholders are left with nothing to leave their loved ones.
Agents who routinely churned policies usually found this practice to be quite lucrative. They write new policies, pay for them with the equity from existing policies, and reap the commissions for writing new business. Along with this, agents could also make huge bonuses from insurance companies based on the number of polices they write. Churning large numbers of policies brought agents huge amounts of money, recognition, homes, cars, trips, and cruises all over the world.
When money from an existing life insurance policy is taken for any reason, the policy owner is required to sign some type of service request form approving the transaction. In past cases, agents were accused of mixing these forms in with others needing to be signed during the application process. In those cases, the prospective policy owners were not fully informed of the documents they were signing and were led to believe that forms allowing the use of the equity from existing policies to be used to purchase new policies were simply routine forms that had to be signed. In many of my investigations, policy owners told me that their agents, sometimes claiming to be in a big hurry to get to another appointment, asked them to sign blank forms. The agents claimed they would fill in the rest of the information when they got back to their office.
Many of the insurance fraud victims I've spoken with said when they received notices from their insurance company advising them that their old policies were about to lapse, or they needed to increase the premiums on their new policies, they were told there was nothing to worry about and to disregard the notices.

I hope this helps,
Mark

Posted: Sat Feb 12, 2011 07:48 pm Post Subject:

Life insurance, no matter what any other agent or contributor to this forum might say in response to this post, is NOT AN INVESTMENT, even if it is a variable life insurance contract of some kind that allows you to direct your cash accumulation into the insurance company's separate account where it can be invested in subaccounts that resemble mutual funds

Posted: Sat Feb 12, 2011 07:48 pm Post Subject:

OP, I don't understand why a single premium policy has additional premiums.