Increase a Foundation’s Endowment

Considering the importance of a healthy charitable Foundation for funding higher education, charities, special programs, activities and academic research, together with the economic volatility that can impact an endowment fund, there is not only a desire to increase and protect a Foundation’s endowment, but also a desire to encourage further contributions. Contributions to a Foundation during volatile economic times are that much more important, as well as that much more difficult, as such economic volatility is likely to also have an impact on those who are the most likely contributors to the Foundation’s endowment. This affects the ability of a charity to accumulate assets necessary for its long-term viability.

Many people would choose to make a sizeable contribution and meaningful impact in regard to their contribution if they were able to do so. In order to make a sizeable contribution, and by virtue of doing so, a meaningful impact to a charitable entity many parties may believe that such a contribution must wait until they have made significant advances in their career having accumulated large sums of money over several decades. To the contrary, the purchase of a life insurance policy today can allow even a less affluent person to make a significant contribution to the long-term viability of their chosen charity.

Let us address this concept in terms of an educational institution. The majority of undergraduate and graduate program graduates are relatively young and of good health. This is ideal as it applies to the purchase of a whole life insurance policy as good health and youth function to keep premiums low while allowing for an increased death benefit at a reduced cost. After purchasing a whole life insurance policy one can decide to gratuitously transfer such policy to their alma mater or its Foundation. (For ease of discussion the institution or its charitable arm receiving the policy will be referred to as the “Foundation”)

The life covered by the life insurance policy is that of an alumnus graduate while the beneficiary and policy owner are the Foundation. Once the Foundation receives the policy it can continue to make premium payments from other funds it raises until the policy reaches a breakeven point, in which case no additional premium payments are required. The Foundation also has the option of continuing to make additional premium payments which generally results in an increased death benefit.

There are various hurdles to overcome before a Foundation becomes an owner or even a beneficiary of a life insurance policy. As this will be a gratuitous transfer the major hurdle to overcome is whether the Foundation has an insurable interest in its alumni. Lacking an insurable interest, the Foundation will be unable to be named the beneficiary or become the policy’s owner.

INSURABLE INTEREST

Grigsby v. Russell, 222 U.S. 149, 156 (U.S. 1911), held that one who purchases a life insurance policy on himself in good faith, and on his own initiative, may freely assign the policy to one who does not have an insurable interest in the purchaser. Grigsby indicated that good faith involves a genuine intent to obtain insurance protection for a family member or business partner rather than gambling on the life of the insured party. Commentators have written that Grigsby stands for the position that “life insurance cannot be purchased with the intent to later sell it to an individual lacking [an] insurable interest” in the original purchaser. Kelly J. Bozanic, An Investment to Die For: From Life Insurance to Death Bonds, the Evolution and Legality of the Life Settlement Industry (113 Penn St. L. Rev. 229, 242), (emphasis applied). The purchase of life insurance with intent to have the policy benefit the Foundation does not involve a sale, but consists of a charitable bequest or transfer, a voluntary act not involving intent to sell the policy. Furthermore, the policy is not purchased at the behest of a third party nor under contract with a third party. In a charitable structure with no intent to sell the policy, nor compensation being paid, nor an agreement having been entered into to later transfer the policy, a gratuitous policy transfer does not appear to violate Grigsby.

Case law has described an insurable interest in property as where someone would profit or gain an advantage by the continued existence of the property or suffer a pecuniary loss or disadvantage by the destruction of the same. Home Insurance Company of New York v. Mendenhall, 164 Ill. 458, 45 N.E. 1078, (1897). In Mendenhall, title to the property is not a required consideration when determining whether an insurable interest exists. Id at 465

An insurable interest as applicable to the current discussion is not of property but is of the life of an alumni with a genuine interest in, and willingness to, donate to their alma mater. The insurable interest exists as a gain to the Foundation by virtue of the donations made by the alumni. A loss is realized upon the alumni passing by virtue of the Foundation receiving no future donations. The present and projected contribution(s) that the alumnus desires to give to the Foundation is the insurable interest.

Where an alumni has an established history of providing for a Foundation, the argument that an insurable interest is present would appear to be significantly stronger. The financial record of contributions from the alumni can be used to prove the Foundation’s potential loss in the context of an insurable interest. Such a history of giving, while functioning to prove an insurable interest, also supports the legitimacy behind the arrangement overall and gives strength to the good faith argument under Grigsby.

U.S. Treasury Department Support

The U.S. Treasury Department, pursuant to § 1211(c) of the Pension Protection Act of 2006, has completed a study and provided a report on Charitable Owned Life Insurance Polices, “CHOLI”. The report states that “it is not uncommon for a charity to own or otherwise be in a position to benefit from life insurance on the lives of its donors” and provides examples of situations which are similar to those involving Foundations discussed supra. (Report at 9). An example of one such uncommon activity cited by the Treasury report is where a donor purchases a life insurance contract on his or her own life and subsequently donates the policy to a charity. In relation to such acts, the report states, “These traditional uses of life insurance by a charity generally do not raise public policy, insurance regulatory, or tax policy concerns.”

The example of donating a life insurance policy to a charitable entity provided by the Treasury Department’s Congressional report is the exact act explained above. The Treasury’s Congressional report makes it clear that such acts are permitted in that they “do not raise public policy, insurance regulatory, or tax policy concerns.” Such support provided by the Treasury Department strengthens the conclusion that not only are these arrangements a great way to add significant funds to a charitable entity, but that such actions are also legal and do not risk the charitable status of an entity receiving a life insurance policy in this manner.

SAMPLE NUMERICS

Under a worst-case scenario (comparatively speaking), upon the death of the insured and subsequent receipt of the death benefit, a Foundation can receive an amount in excess of the premium payments made to the policy. In a best-case scenario (financially speaking considering the trigger), the Foundation will receive a sizeable gain significantly in excess of the premium payments made upon passing of the insured. This is demonstrated by the information presented from sample policy ledgers below.  

Male, Non-Smoker, Age 30, Guaranteed Death Benefit of $100,000

A 30-year-old non-smoking male can receive a death benefit of $100,000 for an annual premium of $1,270. In year 11 the cash value is approximately equal to the premiums paid. If the premium were no longer paid, $50,065 of death benefit would be paid when the person passes on, or $108,261 would be paid if the premium is current. At year 20 the death benefit would be $133,964 if payments continue or $102,589 if no further payments are made. At year 20 a total of $25,400 of payments have been made. The cash value, if one wished to simply remove the cash, would be $35,881. If the Foundation chooses to continue paying premiums, the death benefit increases to $154,234 after 25 years. As we all unfortunately do perish, the Foundation will at some point in time receive the death benefit, which is a multiple of the premiums paid in.

Female, Non-Smoker, Age 30, Guaranteed Death Benefit of $100,000

A 30-year-old non-smoking female can receive a death benefit of $100,000 for an annual premium of $1,038. In year 10 the cash value is approximately equal to the premiums paid. If the premium were no longer paid, $41,936 of death benefit would be paid when the person passes on, or $103,470 would be paid if the premium is current. At year 22 the death benefit would be $128,991 if payments continue or $102,873 if no further payments are made. At year 22 a total of $22,836 of payments have been made. The cash value, if one wished to simply remove the cash, would be $34,157. If the Foundation chooses to continue paying premiums the death benefit increases to $140,146 after 25 years. As we all unfortunately do perish, the Foundation will at some point in time receive the death benefit, which is a multiple of the premiums paid in.

Male, Non-Smoker, Age 40, Guaranteed Death Benefit of $100,000

A 40-year-old non-smoking male can receive a death benefit of $100,000 for an annual premium of $2,051. In year 11 the cash value is approximately equal to the premiums paid. If the premium were no longer paid, $59,513 of death benefit would be paid when the person passes on, or $109.103 would be paid if the premium is current. At year 18 the death benefit would be $129,129 if payments continue or $106,277 if no further payments are made. At year 18 a total of $36,918 of payments have been made. The cash value, if one wished to simply remove the cash, would be $47,692. If the Foundation chooses to continue paying premiums the death benefit increases to $162,254 after 25 years. As we all unfortunately do perish, the Foundation will at some point in time receive the death benefit, which is a multiple of the premiums paid in.

Female, Non-Smoker, Age 40, Guaranteed Death Benefit of $100,000

A 40-year-old non-smoking female can receive a death benefit of $100,000 for an annual premium of $1,657. In year 8 the cash value is approximately equal to the premiums paid. If the premium were no longer paid, $38,283 of death benefit would be paid when the person passes on, or $101,848 would be paid if the premium is current. At year 19 the death benefit would be $120,730 if payments continue or $101,452 if no further payments are made. At year 19 a total of $31,483 of payments have been made. The cash value, if one wished to simply remove the cash, would be $41,702. If the Foundation chooses to continue paying premiums the death benefit increases to $145,726 after 25 years. As we all unfortunately do perish, the Foundation will at some point in time receive the death benefit, which is a multiple of the premiums paid in.  

Additional Considerations

Upon the Foundation’s receipt of the life insurance policy, the Foundation will continue making premium payments until the life insurance policy has cash reserves sufficient to allow the policy to pay for itself, or self-fund. In the above scenarios, this should occur after approximately 10 or 11 years of premium payments. The Foundation can choose to continue making premium payments to increase the death benefit and cash value or it may discontinue making payments and ultimately receive the paid-up death benefit. Upon the alumni’s death the Foundation will receive the policy’s death benefit. Presumably, once a policy has been transferred to the Foundation, the Foundation will have other alumni or interested parties that will contribute sums sufficient to pay the policy premiums. Once even one insured passes on the financial increase to the Foundation, the Foundation’s Endowments will begin to substantially increase. A large pool of life insurance policies can result in a long-range Endowment that perpetuates the Foundation and expands opportunities for the institution.

Distinguished from Viatical Settlements

A viatical settlement contract essentially involves the sale of a life insurance policy where the sale price is based on the face value of the policy, the life expectancy of the insured individual, and the amount of the policy’s cash value. The resulting contract allows the original policyholder immediate access to the sales proceeds of their policy.  

A viatical settlement is a taxable transaction as discussed in PLR 9443020 (I.R.S. 1994). PLR 9443020 reflects the IRS position that “an assignment of a life insurance contract for consideration constitutes a sale of property” under IRC §1001(b) requiring that the amount realized be the amount of money and the fair market value of any property received upon the sale.

The assignment proposed as a charitable transfer is not a viatical settlement as there is no exchange of money. The assignment to the Foundation is a gratuitous transfer and not a transfer for monetary consideration.  

Distinguished from Stranger Originated Life Insurance Policies (STOLI)

Stranger originated life insurance (STOLI) involves an unrelated third party providing someone with a loan to purchase a life insurance policy and pay for premiums for two years. This initial policy purchaser is typically someone with a relatively short life expectancy, generally a senior citizen. After the two-year contestability period lapses, the policy will be transferred to the party that provided the loan to make the premium payments, as well as providing additional cash or payments to the insured. If the policy is not transferred the policy owner must re-pay the loan and may retain the life insurance policy or permit it to lapse. If the policy is transferred, the unrelated third-party purchaser will continue making premium payments while waiting for the original policy owner to pass. The unrelated third-party policy purchaser is gambling that they will have paid less in premium payments and purchase price when compared against the death benefit, they will receive upon the passing of the original policy owner. The intention is to profit from the difference between the amount originally paid to the purchaser and the death benefit received upon the passing of the party covered by the policy.

STOLIs have been frowned upon as a “wager on the life of the person insured” and therefore “void as against public policy”. See, 2004 Stuart Moldaw Trust v. XE L.I.F.E., LLC, 642 F. Supp. 2d 226, 233 (D.N.Y. 2009). Many states prohibit stranger originated life insurance arrangements.

The assignment proposed here is significantly different from a STOLI. At the time of policy issuance, there is neither a third-party investor nor are there any resources or guarantees from a third party in relation to the initiation of the life insurance policy. Therefore, the Policy transfer should not be deemed to be a STOLI.

Benefits to the Educational Institution Foundations

Chief among the benefits to the Foundation receiving life insurance policies are the long-range financial benefit. The intention behind transfer of these policies is one of charitable intent, not policy purchase. Because the policies are life insurance policies, provided the institution remains current on premium payments, the Foundation, at some point in time, will receive the policy’s death benefit. Because of the sizeable value of a policy’s death benefit, the Foundation will always increase its net worth at the time of the insured’s passing. Generally, the increase to its net worth will be substantial in relationship to the premiums paid. Furthermore, provided the insurance carrier is an A+ rated carrier, the risk of loss to the Foundation is minimal and the benefit, particularly if a pool of life polices are maintained, is substantial. This technique in coordination with other fund-raising techniques can assist our beloved alma mater in securing its long-range future and provide for its sustained growth and financial stability.