Independent Financial Adviser

Independent Financial Advisers or IFAs are professionals who offer independent advice on financial matters to their clients and recommend suitable financial products from the whole of the market. The term was developed to reflect a UK regulatory position and has a specific UK meaning, although it has been adopted in other parts of the world, such as Hong Kong.

The term "Independent Financial Adviser" was coined to describe the advisers working independently for their clients rather than representing an insurance company, bank or bancassurer. At the time (1988) the UK government was introducing the polarisation regime which forced advisers to either be tied to a single insurer or product provider or to be an independent practitioner. The term is commonly used in the United Kingdom where IFAs are regulated by the Financial Services Authority (FSA) and must meet strict qualification and competence requirements.

In the UK the industry has been de-polarised since 2005. There are now three main classes of adviser: tied advisers (working for one financial institution), multi-tied advisers (offering products from a selection of the market and usually paid on a commission basis) and independent financial advisers. Independent financial advisers must offer their clients the option to pay for advice by fee as an alternative to commission^[1].

In Europe most advisors are "tied" to a bank or insurance company and these are the main channels of distribution of financial products. However, in places like Spain it is possible to find expat finanancial advice from an independent financial advisor

Typically an Independent Financial Adviser will conduct a detailed survey of their client’s financial position, preferences and objectives; this is sometimes known as a ‘factfind’. They will then advise appropriate action to meet the client's objectives; and if necessary recommend a suitable financial product to match the client’s needs.

Individuals and businesses consult IFAs on many matters including investment, retirement planning, insurance, protection and mortgages (or other loans). IFAs also advise on some tax and legal matters.

Paying for advice

Traditionally IFAs have relied upon commission paid by product providers to pay for their services. In recent years there has been a shift towards fee based advice as this is perceived as fairer toward the client. However, due to under-capitalisation in the advice sector and consumer reluctance to pay for something they perceived as getting for free, the transition to fee based advice has been slow and concentrated in the 'high net worth sector'.

To encourage client's awareness of the cost of advice, and to stimulate a market in advice, the FSA has introduced a new disclosure regime for advisers giving regulated investment advice. Since July 2005 this regime insists that advisers who market themselves as independent must offer the option of paying a fee for advice. The three main remuneration options available are as follows:

• Commission: Traditionally the most common way to pay for advice is for the IFA to receive a commission from the product provider. The amount of commission must be disclosed, and some IFAs will rebate a portion of their commission, particularly in Execution-Only cases. The amount of commission and whether it is deducted from the amount you actually invest or is included in the cost of the investment varies from product to product. The client pays for commission from product charges so it does not represent 'free advice'. As well as the initial commission, the adviser is likely to be also paid an annual "trail" commission by the product provider. Not all products offer the same rate of trail commission and therefore a potential conflict of interest may arise. The products making the highest management charges usually offer the adviser the highest trail commission.

• Fees: Less common than commission, all IFAs must offer the option of working for a fee. Depending on the size and type of the investment, and the complexity of the advice, this can work out cheaper than paying commission. Paying a fee for advice is the best way to ensure that the advice is impartial and there is no incentive for the IFA to recommend a product solution.

• Combination: It is also possible to pay a combination of fees and commission. In this situation the IFA will rebate a proportion of the commission they would have been due in a commission-only scenario.

There are strict requirements for the type and amount of payments to IFAs to be clearly disclosed, so it would normally be quite easy to determine the cheapest option for a particular investment.

[edit] Qualifications

To offer financial advice an individual must represent or be an appointed representative of a firm registered with the Financial Services Authority (FSA). The FSA require that firms ensure that individuals acting for them have appropriate qualifications. The list of appropriate qualifications is determined by the Financial Services Skills Council at the behest of the FSA.

The qualifications for most firms relate to Chartered Insurance Institute (CII) exams past and present.

The entry level is normally the historic 'Financial Planning Certificate' (FPC), or its successor, the 'Certificate in Financial Planning' (CFP) which includes an additional examination focusing on investment advice and risk. For the payment of a fee to the Personal Finance Society members with this level of qualification may use the CertPFS designation. The exams to achieve this are certificate level as designated by the Qualifications and Curriculum Authority (QCA) each exam is approximately equivalent to a GCSE (five for CFP and three for FPC).

The next level is the historical 'Advanced Financial Planning Certificate' (AFPC) and newer 'Diploma in Financial Planning' (DFP). Again for a fee members of the Personal Finance Society may use the designation DipPFS.

The next level is 'Advanced Diploma in Financial Planning'.

The highest level is 'Certified Financial Planner' (CFP) issued by the Institute of Financial Planning or Chartered Financial Planner status recently introduced by the CII.

All IFAs also have an obligation to keep up with current developments in the profession, sometimes referred to as Continuous Professional Development. There are many advanced and more specialised qualifications an IFA may take throughout their career, and it can be worth asking about an adviser’s specific areas of expertise.

While the CertPFS qualifications are the minimum requirements, it is likely that an adviser will progress to the more advanced qualifications throughout their career. With the introduction of higher qualifications becoming more important, the level of qualification can therefore be a useful indicator of an adviser's expertise, although a great deal of experienced advisers currently offer a greater deal of practical knowledge than those obtaining qualifications rapidly in a corporate training ground.

[edit] If things go wrong

Financial services are heavily regulated in the United Kingdom. While this may in some cases restrict the market and places a heavy burden on financial services professionals, it also makes for one of the safest consumer markets in the world.

If a client buys a financial product on the advice of an IFA which turns out to be unsuitable, they have the right to complain and, if the complaint is upheld, may receive compensation. All regulated financial services companies, including IFAs must have effective internal complaint handling procedures. If a complaint is not dealt with satisfactorily internally, the client has the option of going to the Financial Ombudsman Service, which will conduct an independent investigation and has the power to award compensation if warranted. It should be noted that in a large majority of cases referred to the Ombudsman, it finds that the firm had treated the customer’s complaint fairly.

This does not mean that a client can claim compensation simply because an investment loses money. With all investments, there is an element of risk, the basis for complaint would only be whether or not that level of risk was unsuitable for a particular client based on the information given to the adviser. This is particularly important (and not well-understood in the public consciousness), and especially in relation to the sale of with profits endowments intended to be used to repay an interest only mortgage. A great many people saw strongly reduced investment returns from their endowments due to lower interest rates (and hence investment returns) and subsequently claimed that they had been mis-sold. While the poor performance is regrettable, it in no way constitutes mis-selling in the legal sense unless it can be shown that the endowment was unsuitable for the client's needs at the time it was advised. It is not possible to use retrospective judgements to assess decisions made in good faith in the past either.

[edit] Execution-only

In some circumstances an IFA will arrange a financial product to a client without providing them advice. This is known as an execution-only service, and is often accompanied by a partial rebate of commission paid by the product provider. This form of sale can be useful when the client does not require advice, as they can often get better value by going through an IFA than if they went directly to the product provider. It can have problems however, since no advice is given, the client has no redress if they subsequently find the product to be unsuitable for them. This has formed the basis of several ‘mis-selling’ claims for certain classes of product.

[edit] Depolarisation

On 1 December 2004 the Financial Services Authority (FSA), the UK financial regulator, changed the rules governing financial advisers. Previously (under a system known as ‘Polarisation’) there were only two types of financial adviser, those who would advise and sell only one company’s products - known as a Tied Agent, and those who would advise and sell the most suitable products from the whole of the market – Independent Financial Advisers (IFA).

With Depolarisation, the FSA has changed this dramatically. A firm may now offer advice on products from just one provider (single tied), more than one provider (multi-tied) or from the entire marketplace (whole-of-market). Generally speaking, to be able to call itself "independent", a firm must offer its clients the option of paying for the advice by a fee and must be a whole of market adviser.

There are a few complications however :

1. A firm may hold themselves out as being whole of market for one class of product such as investments, but be multi-tied on another, for example pensions.
2. An adviser can start a relationship with a client as a single tied adviser, but can then broaden the scope of advice to multi-tie or whole of market advice (he cannot decrease the scope of advice he offers though). If he does this he must re-disclose his status to the client.

The regulations that introduced regulation for mortgages and general insurance (GI) were developed and introduced around the same time as the depolarisation rules (Mortgages 31 Oct 04, GI 14 Jan 05).

Look out for the adviser's regulatory documents; the 'Terms of Business Letter' , 'Keyfacts About Our Services' and 'Keyfacts About The Cost of Our Services'. These are very important and will clarify the nature of their status and commercial relationship with you. If you have agreed to remunerate the firm by fees, they will also normally clarify this by issuing a fee agreement letter.

These documents may also compare your adviser's charges (including commission) with those of other firms in the market. The data that the FSA collates to allow firms to create these figures has been subject to criticism. The FSA sources this data from life offices. The process that it uses to do this is new and no doubt will be refined with time.

[edit] Industry

The industry is served by a number of periodicals, including the weekly publication Money Marketing.^[

General insurance

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Non-life insurance premia written in 2005

General insurance or non-life insurance policies, including automobile and homeowners policies, provide payments depending on the loss from a particular financial event. General insurance typically comprises any insurance that is not determined to be life insurance. It is called property and casualty insurance in the U.S. and Non-Life Insurance in Continental Europe.

In the UK, General insurance is broadly divided into three areas; personal lines, commercial lines and London market.

The London market insures large commercial risks, for example insuring supermarkets, football players and other very specific risks. It consists of a number of insurers, reinsurers, [P&I Clubs], brokers and other companies that are typically physically located in the City of London. The Lloyd's of London is a big participant in this market.[1] The London Market also participates in personal lines and commercial lines, domestic and foreign, through reinsurance.

Commercial lines products are usually designed for relatively small legal entities. These would include workers comp (employers liability), public liability, product liability, commercial fleet and other general insurance products sold in a relatively standard fashion to many organisations.

Personal lines products are designed to be sold in large quantities. This would include autos (private car), homeowners (household), pet insurance, creditor insurance and others.

False insurance claims

nsurance fraud or false insurance claims are insurance claims filed with the intent to defraud an insurance provider.

In the United States insurance fraud is estimated to cost US$875 per person per year with The Coalition Against Insurance Fraud estimating the loss to be $80 billion per year and Medicare estimating fraud in its system costs the government $179 billion per year.

Types

[edit] Health insurance fraud

Health insurance fraud is described as an intentional act of deceiving, concealing, or misrepresenting information that results in health care benefits being paid to an individual or group.

Fraud can be committed by both a member and a provider. Member fraud consists of ineligible members and/or dependents, alterations on enrollment forms, concealing pre-existing conditions, failure to report other coverage, prescription drug fraud, and failure to disclose claims that were a result of a work related injury. Provider fraud consists of claims submitted by bogus physicians, billing for services not rendered, billing for higher level of services, diagnosis or treatments that are outside the scope of practice, alterations on claims submissions, and providing services while under suspension or when license have been revoked. Independent medical examinations are used to debunk false insurance claims and allow the insurance company or claimant to seek a non-partial medical view for injury related cases.

In response to the increased amount of health care fraud in the United States, Congress, through the Health Insurance Portability and Accountability Act of 1996 (HIPAA), has specifically established health care fraud as a federal criminal offense with punishment of up to ten years of prison in addition to significant financial penalties.

[edit] Auto (or Motor) insurance fraud

Globally, one of the largest categories of insurance claims fraud revolves around the insurance of vehicles. There are a number of modus operandi:

[edit] Staged collisions

This rapidly growing category involves staging a collision where the fraudsters will use a vehicle to stage an accident with the innocent party. Typically, there would be 4 or 5 fraudsters in the vehicle which makes an unexpected manoeuvre causing the innocent party to collide with the fraudsters vehicle. Each of the fraudsters then claim for injuries sustained in the vehicle. Working with a “recruited” doctor, the injuries are typically whiplash or other soft tissue injuries which are hard to dispute later.

[edit] Exaggerated claims

A real accident may occur, but the dishonest owner may take the opportunity to incorporate a whole range of previous minor damage to the vehicle into the garage bill associated with the real accident.

[edit] Examples

Some memorable examples of insurance fraud include the following:

• Former British Government minister John Stonehouse went missing in 1974 from a beach in Miami. He was discovered living under an assumed name in Australia, extradited to Britain and jailed for seven years for fraud, theft and forgery.
• Derek Nicholson and Jottie Nagle were accused of attempting to defraud a life insurance company for $1 million after Mr Nicholson apparently went missing in New Jersey in July 2003 and Ms Nagle reported him missing and made a claim on the policy.
• Gaylan Sweet of San Diego, California, who was a claims adjuster for Allstate Insurance set up a scheme in 2002 that included non-existent children who were killed in hit-and-run auto accidents at non-existent intersections by phantom drunk drivers. Sweet and two others (who posed as the parents of the non-existent children) pocketed $710,000 before being caught by Allstate and later jailed for five years.
• John Magno, a Toronto businessman, allegedly hired accomplices to set fire to his Woodbine building supply hardware store so he could collect insurance money. This was one of the biggest fires in the city's history as more than 170 firefighters were required to bring the six-alarm blaze under control. One accomplice was burned to death, and another was in a coma for several months. Not only did investigators immediately suspect arson, Magno and his accomplices were later charged with second-degree murder.

Estate planning

Wills, trusts and estates

Part of the common law series

Wills

Legal history of wills Joint wills and mutual wills Will contract · Codicil Holographic will · Oral will

Sections Attestation clause Residuary clause Incorporation by reference

Contest Testamentary capacity Undue influence Insane delusion · Fraud

Property disposition Lapse and anti-lapse Ademption · Abatement Satisfaction of legacies Acts of independent significance Elective share · Pretermitted heir Wills and conflict of laws

Trusts

Express · Resulting Constructive

Common types Bare · Discretionary Accumulation and Maintenance Interest in possession Charitable · Purpose · Incentive

Other types Protective · Spendthrift Life insurance · Remainder Life interest Reversionary interest Testamentary Honorary · Asset-protection Special needs (Supplemental Needs)

Governing doctrines Pour-over will Cy-près doctrine Trusts and conflict of laws

Estate administration

Intestacy · Testator · Probate Power of appointment Simultaneous death · Slayer rule Laughing heir · Advancement Disclaimer of interest · Inheritance tax

Related topics

Advance directive (Living will) Totten trust

Other common law areas

Contract · Tort · Property Criminal law · Evidence

v • d • e

The examples and perspective in this article may not represent a worldwide view of the subject. Please improve this article and discuss the issue on the talk page.

Estate planning is the process of disposing of an estate. Estate planning typically attempts to eliminate uncertainties over the administration of a probate and maximize the value of the estate by reducing taxes and other expenses. Guardians are often designated for minor children and beneficiaries in incapacity.

Contents [hide] 1 Estate planning devices 2 Remainder 3 Tax 4 Mediation 5 References 6 External links 7 See also

[edit] Estate planning devices

Estate planning involves the will, trusts, beneficiary designations, powers of appointment, property ownership (joint tenancy with rights of survivorship, tenancy in common, tenancy by the entirety), gift, and powers of attorney, specifically the durable financial power of attorney and the durable medical power of attorney. After widespread litigation and media coverage surrounding the Terri Schiavo case, virtually all estate planning attorneys now advise clients to also create a living will. Specific final arrangements, such as whether to be buried or cremated, are also often part of the documents. And more sophisticated estate plans may even cover deferring or decreasing estate taxes or winding up a business.

Many people (and even some attorneys) confuse a living will with a durable medical power of attorney. A living will sets out directives concerning end of life decisions, whereas a durable power of attorney gives all medical decision making authority to an appointed individual upon incapacity, including end of life decisions. Some people have both a living will and a health care power of attorney. Some, who wish to give complete discretion to a loved one, including end of life decision, have only a health care power of attorney.

[edit] Remainder

The tax code allows wealthy people to set up charitable remainder trusts and set up qualified personal residence trusts to own their personal residence yet leave it to their children without estate tax.

[edit] Tax

Because the United States tax code does not tax life insurance proceeds as income, a life insurance trust could be used to pay estate taxes. However, if the decedent holds any incidents of ownership like the ability to remove or change beneficiary, the proceeds will remain in his estate. For this reason, the trust vehicle is used to own the life insurance policy and it must be irrevocable to avoid inclusion in the estate.

[edit] Mediation

Mediation serves as an alternative to a full-scale litigation to settle disputes. At a mediation, family members and beneficiaries discuss plans on transfer of assets. Because of the potential conflicts associated with blended families, step siblings, and multiple marriages, creating an estate plan through mediation allows people to confront the issues head-on and design a plan that will minimize the chance of future family conflict and meet their financial goals.

[edit] References

[edit] External links

• National Committee On Planned Giving website organization for estate planners

[edit] See also

Economic capital

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In finance, mainly for financial services firms, economic capital is the amount of risk capital, assessed on a realistic basis, which a firm requires to cover the risks that it is running or collecting as a going concern, such as market risk, credit risk, and operational risk. It is the amount of money which is needed to secure survival in a worst case scenario. Firms and financial services regulators should then aim to hold risk capital of an amount equal at least to economic capital.

Typically, economic capital is calculated by determining the amount of capital that the firm needs to ensure that its realistic balance sheet stays solvent over a certain time period with a pre-specified probability. Therefore, economic capital is often calculated as value at risk.

The concept of economic capital differs from regulatory capital in the sense that regulatory capital is the mandatory capital the regulators require to be maintained while economic capital is the best estimate of required capital that financial institutions use internally to manage their own risk and to allocate the cost of maintaining regulatory capital among different units within the organization.

Other uses

The term economic capitol (note the different spelling) can also be used as a description of a city in a country or region that is the centre of that country or region's economy, even if it is not the governmental capitol. For example, Toronto is considered the economic capitol of Canada, while in the United States, New York City is considered the economic capitol.

Critical illness insurance

ritical illness insurance or critical illness cover is an insurance product, where the insurer is contracted to typically make a lump sum cash payment if the policyholder is diagnosed with one of the critical illnesses listed in the insurance policy.

The policy may also be structured to pay out regular income and the payout may also be on the policyholder undergoing a surgical procedure, for example, having a heart bypass operation.

The policy may require the policyholder to survive a minimum number of days (the survival period) from when the illness was first diagnosed. The survival period used varies from company to company, however, 28 days and 30 days are the most common survival periods used.

The contract terms contain specific rules that define when a diagnosis of a critical illness is considered valid. It may state that the diagnosis need be made by a physician who specialises in that illness or condition, or it may name specific tests, e.g. EKG changes of a myocardial infarction, that confirm the diagnosis.

In some markets, however, the definition of a claim for many of the diseases and conditions have become standardised, thus all insurers would use the same claims definition. The standardisation of the claims definitions may serve many purposes including increased clarity of cover for policyholders and greater comparability of policies from different life offices. For example, in the UK the Association of British Insurers (ABI) has issued a Statement of Best Practise which includes a number of standard definitions for common critical illnesses.

he First Critical Illness product

Critical illness insurance was founded by Dr Marius Barnard^[1], with the first critical illness product being launched on the 6th of October 1983 in South Africa, under the name dread disease insurance.

Since 1983, the cover has been accepted into many insurance markets around the world. Other names of the insurance cover include: serious illness insurance, crisis cash and living assurance.

[edit] Conditions covered

The schedule of insured illnesses varies between insurance companies. In 1983, four conditions was covered by the policy, i.e. heart attack, cancer, stroke and coronary artery by-pass surgery. Since then various conditions were added and now the most comprehensive coverage is offered by PruProtect with 154 illnesses covered. The next nearest is Bupa who offer 38 while Norwich Union offer the least with 26 illness covered. ^[2]

Examples of other conditions that might be covered include:

• Alzheimer's disease
• blindness
• deafness
• kidney failure
• A major organ transplant
• multiple sclerosis
• HIV/AIDS contracted by blood transfusion or during an operation
• Parkinson's disease
• paralysis of limb
• terminal illness

Due the fact that the incidence of a condition may decrease over time and both the diagnosis and treatment may improve over time, the financial need to cover some illnesses deemed critical a decade ago are no longer deemed necessary today. Likewise, some of the conditions covered today may no longer be needed a decade or so in the future.

The actual conditions covered depend on the market need for the cover, competition amongst insurers, as well as the policyholder's perceived value of the benefits offered. For these reasons conditions such as diabetes and rheumatoid arthritis, among others, may become the norm cover provided in the future.

[edit] Need for Critical Illness cover

Critical illness cover was originally sold with the intention of providing financial protection to individuals following the diagnosis or treatment of an illness deemed critical.

The finances received could be used to:

• pay for the costs of the care and treatment;
• pay for recuperation aids;
• to pay debts off;
• replace any lost income due to a decreasing ability to earn; or even
• fund for a change in lifestyle.

The actual risks covered by some of the products sold can be significant. For example, in America, about 1.3 million new cancer cases are diagnosed each year, every 29 seconds someone suffers a coronary event and every 45 seconds someone suffers a stroke.^[3][4] In Canada, more people will experience a critical illness before they reach 75, than will die before that age.^[5] In the United Kingdom, 1 in 5 men and 1 in 6 women will experience a critical illness before their normal retirement age.^[6]

However, some conditions covered may be purchased to give the policyholder a 'peace of mind' rather than actually meet any need or cover any major risks. An example of this is the coverage of Creutzfeldt Jakob Disease (CJD) in the UK, which generally has a very low incidence rate, but generally is valued by people due to the potential high media coverage of the cases. Thus, the fear of contracting such a disease may be disproportionate to the actual risk, which means the cover does not meet the policyholder's needs appropriately.

Critical illness may be purchased by individuals in conjunction with a life insurance or term assurance policy at the time of a residential purchase, known as a 'bolt-on' benefit. The reason for this is to provide financial protection to the policyholder or their dependants on the repayment of a mortgage due to the policyholder contracting a critical illness condition or on the death of the policyholder. In this type of product design, some insurers may choose to structure the product to repay a portion of the outstanding mortgage debt on the contracting of a critical illness, whilst the full outstanding mortgage debt would be repaid on the death of the policyholder. Alternatively, the full sum assured may be paid on diagnosis of the critical illness, but then no further payment is made on death, effectively making the critical illness payment an 'accelerated death payment'.

Some employers may also take out critical illness insurance for their employees. This contract would be in the form of a group contract and has become an essential strategy used by employers around the world to both protect their employees financially as well as attract more employees to consider working for the company.

[edit] World Markets

In South Africa, the UK, Ireland, Australia and New Zealand, critical illness insurance has become a well established form of insurance.

Critical illness insurance continues to grow in popularity and has recently been accepted into other territories including the far east and the United States.

In markets, where the product is newer, many insurers choose to use the expertise of reinsurers with worldwide exposure as well as overseas insurers whom have sold the product for a number of years. The expertise may come in the form of data provided as well as assistance with the product design features of the product.

Critical illness insurance seems to have developed into an essential insurance policy, which many individuals around the world consider to be a worthwhile purchase.

Corporate-owned life insurance

Corporate-owned life insurance (COLI) is life insurance on employees' lives that is owned by the employer corporation, with benefits payable to the corporation. COLI was originally purchased on the lives of key employees and executives by a company to hedge against the financial cost of losing key employees to unexpected death, the risk of recruiting and training replacements of necessary or highly-trained personnel, or to fund corporate obligations to redeem stock upon the death of an owner. This use is commonly known as "key man" or "key person" insurance. Once, COLI was used for masses of non-key employees in order to get tax benefits, a practice known as "janitor insurance" or "dead peasant insurance". Congress set limits on the practice in 2004, and today COLI is limited to the more senior executives of a firm.

Tax Law History

Under the Internal Revenue Code ("IRC") dealing with life insurance benefits paid due to the death of the insured, the benefits are usually excluded from the taxable income of the beneficiary.

Because of the tax-free nature of death benefits, the IRC prohibits the deduction of the premiums paid for life insurance when the premium payor is also the owner of the insurance. In addition, loans from insurers secured by policy values are not income and earnings credited to an owner's policy values (known as "inside buildup") by the insurance company are not currently taxed (and may escape taxation altogether if such earnings are not distributed other than as part of the death benefits paid upon the death of the insured).

[edit] 1950s: Leveraged Insurance

Interest incurred on indebtedness has historically been deductible, (although the deduction of "personal" interest was largely eliminated in 1986), and in the 1950s a type of "leveraged insurance" transaction began being marketed that permitted an insurance owner to in effect deduct the cost of paying for insurance by (1) paying large premiums to create cash values, (2) "borrowing" against the cash value to in effect strip out the large premiums, and (3) paying deductible "interest" back to the insurer, which was in turn credited to the policy's cash value as tax-deferred earnings on the policy that could fund the insurer's legitimate charges against policy value for cost of insurance, etc.

The advantage of being able to deduct interest, on the one hand, and yet not include in income the interest credited to the policy's cash value is a form of "tax arbitrage."

The Internal Revenue Service ("IRS"), via the Supreme Court case Knetsch v. U.S. (1947), had early success in challenging the bona fides of these types of arrangements as creating legitimate debt and interest eligible to be deducted. However, subsequent court losses and IRC amendments weakened their position, appearing to permit tax-deductible borrowing to provide funds to pay insurance premiums, so long as such borrowing did not account for more than three of the first seven annual premiums on the policy (the "4 out of 7" test).

[edit] 1980s: Tax Shelters

Another IRC amendment limited to $50,000 the amount that could be borrowed (and yet yield deductible interest payments) with respect to any one insured. Although the 4 out of 7 test was exploited in the 1980s by businesses seeking to in effect pay for insurance on employees/shareholders, e.g., on a deductible basis, the introduction of the $50,000 cap/insured in 1986 in turn led to the creation of broad-based leveraged COLI transactions, i.e., those in which the employer would purchase life insurance on hundreds or thousands of (usually low-level) employees, that would produce tax savings on interest deductions in excess of the actual cost to the employer of engaging in the transaction. These transactions were deemed by the IRS to be "tax shelters."

In a typical broad-based leveraged COLI transaction, a corporate employer would purchase policies on masses of lower-level employees, sometimes without the employees' knowledge or consent. When an insured employee died, the company received the death benefits, and the employee's family typically received either a small portion of the proceeds or nothing. These policies could remain in place even after the employee quits or retires. This practice of taking out life insurance policies on large numbers of rank-and-file employees, with or without their knowledge or consent, with the corporation making itself the beneficiary became known derisively as "janitor insurance" or "dead peasant insurance." Often the real purpose of the transaction was to obtain the benefits of the tax arbitrage and not to acquire insurance.

[edit] 1990s to Present: Limited Reform

Ultimately, the IRS won court cases against several leveraged COLI investors, including Camelot Music, Winn-Dixie, American Electric Power, and Dow Chemical. Other similar investors settled their tax cases with the IRS on a basis mostly favorable to the IRS. Meanwhile, Congress amended the IRC several times again to both ensure that the prohibition on borrowing (on a deductible basis) to fund insurance acquisitions was clear and to deny the tax-free nature of death benefits to corporate employer in some situations (e.g., if the insured was not provided with adequate advance notice and an opportunity to block the insurance acquisition or if the insured was not an employee of the corporation within a year of his or her death).

So long as the employer complies with the new rules (adopted in 2006 and characterized as the "COLI Best Practices Act"), however, the tax free nature of the death benefits and the tax deferral on earnings credited to policy value remain (although the opportunity for tax arbitrage no longer exists).

The COLI Best Practices Provision, within The Pension Protection Act of 2006, was signed into law on August 17, 2006. This provision is designed to codify industry "best practices" regarding employer owned life insurance and amend the Internal Revenue Code of 1986 to exclude from gross income the proceeds from certain company-owned life insurance. The Act amends Section 101 of the Internal Revenue Code by adding subsection (j), “treatment of Certain Employer Owned Life insurance Contracts,” and adds Section 60391, “Returns and Records with respect to Employer-Owned Life Insurance Contracts.”

Under Section 101(j)^[1], the employer owned death benefit proceeds will be considered eligible for exclusion from the employer's income provided all the following Notice and Consent Requirements and one of the Specified Exceptions are met prior to the issuance of the insurance contract.

Notice and Consent Requirements
The Employee must :

1. Be notified in writing that the employer intends to insure the employee’s life and the maximum face amount for which the employee could be insured at the time the contract is issued. 2. Provide written consent to be insured under the contract during and after active employment. 3. Be informed in writing that the employer will be the beneficiary of any death benefits.

Specified Exception : Directors and Highly Compensated Employees: At time of contract issue, the insured employee was a director, or a 5% or greater owner of the business at any time during the preceding year, or received compensation in excess of $95,000, adjusted for future inflation, in the preceding year, or was one of the five highest-paid officers, or was among the highest-paid 35% of all employees.

(Executive COLI is sometimes humorously and derisively referred to as "E. COLI", a reference to the disease-causing bacteria, e. coli.)

Accordingly, corporate-owned life insurance is still a viable and useful financial product for many businesses. According to one source, Hartford Life Insurance estimated that one-quarter of all Fortune 500 companies have COLI policies, which cover the lives of about 5 million employees.