The real heart of the STOLI scandal.
Strikingly, the second schematic displays, in graphic form, the illegal commission rebate which was forced on most legitimate market participants by unlicensed entities that entered into this business and treated it as if it was simply another structured finance matter. When uninformed or unconcerned finance professionals, aided and abetted by their legal advisors (who knew or certainly should have known better), learned of the front loaded insurance commissions (which are supposed to cover the insurance costs and infrastructure investment) they immediately grasped that the diversion of these funds would allow them to manufacture a much wider array of "insurance trades" than was formerly the case. The fact that it was unlawful, the fact that it caused enormous tax liabilities, and the fact that it created extraordinary market distortions were of no concern to the financiers who took only a short term look at the insurance marketplace before moving along to their next target. It is now up to the industry associations, private litigants, insurance carriers, and most important, state insurance departments and attorneys general to let it be known that violations of state insurance laws will not be tolerated.
Focusing on Table 2 (page 38), one will note the undisclosed commission split between the agent and the SOLI promoter, and the further transfer of the commission revenue to the client. Although the chart and the use of the chart in the article are sub-optimal, the point is made. In virtually every case of STOLI, IOLI, SOLI and their progeny, the illicit use of insurance commissions is the glue that holds these deals together. Nevertheless, with the exception of the articles that have appeared in the Insurance Advocate there has been very little written about the market abuses that have permitted tens of billions of dollars of life insurance to be issued illegally pursuant to massive fraudulent schemes that have left in their wake tremendous toxic waste that will require enormous amounts of clean-up during the next few years. It is interesting to note that in a correspondence between two experts in the field focused upon the subject of the problems of STOLI, not one word is mentioned about the most egregious component of the entire disastrous adventure.
It needs to be understood that the financing for the STOLI enterprise emanated from finance professionals rarely being checked by insurance professionals. Even the actual legal professionals involved in these transactions were, for the most part, finance law specialists and not lawyers with years of experience in the insurance field. As a result, there were three areas of concern to these individuals, (1) premium finance laws, (2) usury constraints and (3) insurable interest. Completely absent from their analysis is the use of commission dollars in a patently illegal manner. As the chart demonstrates, the commissions (up to an arbitrary limit of 2% of death benefit-roughly equivalent to 20%-40% of the actual commissions paid) the insurance commission is manufactured from the payment of the insurance premium and then unlawfully diverted from the insurance professionals who are licensed, appointed, and not involved in the taking of credit risk with respect to the premium loan. It is this financial transfer which creates terrific market distortions and potentially disastrous tax consequences and which needs to be addressed for the state regulatory regime to receive the respect to which it is entitled and for state law to be properly enforced.
It is a core principle of law and regulation that one cannot do indirectly that which one cannot do directly. We would all instantly agree that a commission based payment to induce a purchaser of insurance to transact with a given carrier or agent is illegal. However, many seem to miss the obvious point that when these commissions are recycled in the form of payments, excess loans, or off market loans, the rebate is every bit as real as if paid with cash. The primary difference between the two is that, when paid in cash, the recipient probably recognized the tax consequences and has the cash reserves included in the rebate itself. When the payment is in another form it is more difficult, or even impossible, to recognize. In this way, a trap of unmitigated proportions has been set against the seniors who do not even recognize that they have received the taxable and unlawful rebate.
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As I have pointed out in previous articles, the probable tax consequences of this arrangement is the full taxability to the senior recipient (unshielded, we believe, by the promoted use of non-grantor trusts) and the loss of deductibility to those who are improperly sharing their commissions with unlicensed entities or with those who are furthering illicit rebates. Although this schematic depicts an actual purchase of the policy after misleading the carrier with respect to the purpose of the transaction, it is the loan versions that present the greatest volume and the most disguised rebates. This variation in the form in which the rebate is delivered makes no difference in the value or the factual context of the rebate itself.
Recently, the New York State Insurance Department issued Circular Letter No. 9 (2009) dated March 3, 2009 to provide advice and guidance to licensees regarding the kinds of services can be provided without violating the anti-rebate laws of the state of New York. However, there is no reading of permissible services that would allow severely discounted financial services in the form of off-market loans without being in violation of any states' anti rebate laws.
This letter clearly portrays the execution and function of illegal rebates. Hopefully, this, along with our ongoing efforts, will compel authorities to investigate this matter and commence an enforcement campaign against both insurance professionals and outside financiers who corrupted this marketplace and have savaged thousands of seniors and their finances and who desperately need help to manage the tax consequences of the illegal and horrifyingly common practice of illegal rebating.
By Mark Ross, Paladin Resolution Complex, Inc.