Confusion Surrounding Life Insurance Policy Valuation

The valuation of life insurance policies can be challenging, and fights between vendors of qualified and non-qualified plans and the IRS over valuation are widespread. Springing cash values tend to be an operative issue in these debates between plan vendors and the IRS. Springing cash values refer to life insurance funded welfare benefit trusts, qualified defined-benefit plans, and Volunteer Employee Benefit Association plans that distribute the policy at a very low cash value that later increases substantially over a few years’ time.  

Springing Cash values cause major debates over whether the insured should report a policy’s value or cash surrender value as income when he is transferred the policy. Not surprisingly, buyers, administrators, and sellers argue that the cash surrender value (typically $0) is the correct amount, while the IRS argues that a much higher account value is appropriate.

Highlighting the confusion surrounding the correct valuation for these policies is the case of Schwab v. Commissioner (136 T.C. No. 6) in which the insured claimed zero income by using the cash surrender value for two VUL life insurance policies he received from a multi-employer welfare benefit plan. One of the policies continued after its distribution and the other terminated shortly after its distribution. The IRS asserted that the correct valuation was $80,000.

The issue at hand was whether the accumulation account could be used to pay future insurance costs—if so, the value would be $80,000, and if not, the value would be $0. The court held that the correct values should be based on the guaranteed cost of insurance from the date the first policy terminated to the date the second policy’s premium was paid. The court further held that the evidence presented did not convince the court that options were available for the insured to use the accumulated cash value to pay costs relating to maintaining the policies in force.   

For more on valuing life insurance policies, see Peter C. Katt, Convoluted Valuing of Life Insurance Policies, The Journal of Financial Planning (March 2012).

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.