A universal life policyowner must receive a notice of cash surrender value at least every

Life Bureau Filing Guidance Note

Guidance Date: 07/29/2013

Over Loan Protection Benefit Guidance (For use with Individual Universal Life Insurance or Variable Life Insurance Policies)

Scope: These standards apply to over loan protection benefits that are built into individual universal life insurance or variable life insurance policies or added to such policies by rider. An over loan protection benefit is designed to prevent a heavily loaned policy from lapsing and triggering a taxable event under the I.R.C. If specified requirements are met, the benefit converts the policy to a paid-up policy, potentially preventing the adverse tax consequences that typically result from a policy lapsing with outstanding loans (i.e. the entire loan amount less basis is taxed as income received in the year the policy lapses.)

The benefit is typically free of charge until exercised at which time a one-time charge may be applied. Any other charge proposal may not be submitted under the certified process unless the Department has given permission and will be reviewed on a case by case basis.

I. SUBMISSION REQUIREMENTS

1. ACTUARIAL MEMORANDUM

   Include an actuarial memorandum, prepared, dated and signed by a member of the American Academy of Actuaries that provides a numerical demonstration of how the over loan protection benefit functions, and of how any minimum benefit requirements applicable under the benefit are met.

2. SUBMISSION LETTER/SERFF FILING DESCRIPTION

   For riders, specify by form number and approval date all policies with which it will be issued.

3. MEMORANDUM OF VARIABLE MATERIAL

   The company may identify as variable product specifications that may be changed without prior approval as long as a Memorandum of Variable Material is submitted. Permissible variable items may include the benefit charge, the minimum loan indebtedness percentage, the guaranteed minimum loan indebtedness percentage, the maximum loan indebtedness percentage, and the minimum age/duration the policy must be in force before exercising the benefit. The Memorandum of Variable Material must present reasonable and realistic ranges for all variable items as well as a full explanation of any interactions between variable items.

II.

1. DISCLOSURE FORM REQUIREMENTS

   (1) A brief description shall appear on the cover page of the policy or rider; for example, Over Loan Protection Rider.

   (2) A prominent disclosure, in bold print, must appear in the rider or the policy form if the benefit provision is built into the policy, using the same or similar language:

   Neither the IRS nor the courts have ruled on the tax consequences of exercising the overloan protection rider. It is possible that the IRS or a court could assert that the policy has been effectively terminated and that the outstanding loan balance should be treated as a distribution, all or a portion of which could be taxable when the rider is exercised. In addition, this overloan protection rider may not be appropriate for your particular circumstances. Consult with a tax advisor regarding the risks associated with exercising this rider.

2. SPECIFICATIONS PAGE

   (1) The policy specifications page must disclose, to the extent applicable, the benefit charge, the minimum loan indebtedness percentage, the guaranteed minimum loan indebtedness percentage, the maximum loan indebtedness percentage, and the minimum age/duration the policy must be in force before exercising the benefit, and all other data pertaining to the benefit as applicable.

III. BENEFIT PROVISIONS

1. BENEFIT

   (1) The benefit shall state that if the benefit is exercised, the policy will not lapse when there is insufficient value to cover the monthly deduction charges of the policy, and that the policy will automatically become paid up life insurance.

   (2) The benefit form shall describe the conditions that must be met in order for the benefit to be exercised.

   (3) The form must be clear on whether the benefit is to be exercised automatically or if the owner must elect to exercise the benefit.

   (4) If the benefit is exercised automatically then the insurer:

   (a) shall notify the policyowner at least 31 days prior to the benefit being exercised to allow the policyowner to opt out of the benefit; or

   (b) shall notify the policyowner, within 31 days after the benefit is exercised, to allow the policyowner to decline the benefit and reverse the transaction.

   (5) The benefit should operate so that the policy continues to qualify as life insurance under the IRC.

   (a) To achieve this, the following provisions may be included:

   1. Limiting availability of the benefit to a specified death benefit option or requiring a change in death benefit option upon exercise. Typically, the Option 1 Death Benefit is required to be selected either at issue or upon election of the benefit. “Option 1 Death Benefit” means the greater of (i) the face amount of the policy or (ii) a percentage (as set forth in the policy) of the policy’s cash value at least equal to the minimum necessary for the policy to qualify as life insurance under Section 7702 of the Internal Revenue Code, as amended.
   2. That the policy is in effect for a specified number of years. This is usually 15 years (See IRC Section 7702(f)(7)(B)
   3. That the insured (or which insured, if this is a joint last to die survivorship policy) is a specified minimum age.
   4. That the amounts that may be withdrawn from the policy without the imposition of federal income tax have been taken as partial surrenders prior to exercise of the benefit.
   5. That the loan or the loan plus accrued interest exceeds the face amount of the policy in effect at the time the benefit is exercised.
   6. That the loan or the loan plus accrued interest is no more than the maximum loan indebtedness percentage of the policy’s cash surrender value or policy account value after deduction of the benefit charge.
   7. That the loan or loan plus accrued interest is greater than or equal to a specified percentage of the policy’s cash surrender value or policy account value before or after the deductions of the surrender charge and the benefit charge.
   8. That there must be sufficient cash surrender value or policy account value in the policy to cover the benefit charge.
   9. Other conditions approved by the Superintendent.

   (b) The following provisions must be included:

   1. That no current or future distribution will be required to maintain qualification as life insurance under Section 7702 of the Internal Revenue Code, as amended.
   2. That the policy was not a Modified Endowment Contract under Section 7702A of the Internal Revenue Code, as amended, on the issue date of the policy.

      Note: The Department would not object to the exercise of the benefit causing the policy to become a Modified Endowment Contract, nor would we object to a provision that the benefit is not available if exercise would cause the policy to become a MEC.

   3. Disclose how any benefit charge is calculated, and that there is no charge if the benefit is never exercised.
   4. Describe any changes that will be made to the policy if the benefit is exercised (for example, any change in face amount or death benefit), and any restrictions on contractual provisions that will be imposed if the benefit is exercised.
   5. If the conditions specified in the form for the benefit are met, the insurer will provide notice to the owner that the benefit may be elected. Further, if the benefit may only be elected for a limited period of time, such notice must be given at least 31 days prior to the end of such period. Alternatively, the benefit may be exercised automatically once the conditions specified in the form are met. If the benefit is exercised automatically, the owner must be given written notice that the benefit is to be exercised and an opportunity to decline the benefit.

      (I) The owner must be given notice by the insurer, at least 31 days prior to the automatic exercise of the benefit, to allow the owner to opt out of the benefit; or

      (II) The owner must be given notice by the insurer, within 31 days after the automatic exercise of the benefit, to allow the owner to decline the benefit and reverse the transaction.

   6. After the benefit is exercised, loans and loan repayments may not be prohibited. Sections 3203(a)(8) and 4222.
   7. Once the benefit is exercised, the policy may not lapse due to indebtedness that exceeds the cash surrender value.

2. REINSTATEMENT

   If issued by rider, disclose whether the rider may be reinstated and under what conditions.

3. TERMINATION

(1) Include the following termination conditions:

(a) The benefit terminates upon termination of the policy; and

(b) The benefit terminates upon written request if the benefit is provided by rider.

(2) The policy or rider may provide that, if the benefit is not exercised, the benefit will terminate upon the date the insured reaches the age when monthly deductions end and no further premium can be paid or the date the younger insured reaches the age when monthly deductions end and no further premiums can be paid under a last to die survivorship policy.

(3) The benefit may provide that if further loans are taken after the benefit is exercised the benefit will terminate which may result in the policy lapsing immediately or at some future point in time. If the benefit provides for this termination provision it must also address how the death benefit, the policy values and loan values are affected.