Life Insurance Shenanigans

What are shenanigans? The Merriam-Webster dictionary defines them as “tricky or questionable practices or conduct.”

A prime example of such a shenanigan is an employee benefit that was recently proposed for the teachers of the Pasco County, Florida public school system. A small group of private investors offered to create an organization that would provide free life insurance to the teachers, as well as an equally free death benefit for the school district.

Why would these private investors offer free life insurance to the teachers and the school district of Pasco County? By basing the insurance company in Bermuda and passing death benefits through an off-shore trust in the Cayman Islands, the investors planned to avoid all federal, state, and local income taxes in the United States. In addition, by basing the company and trust in a pair of off shore regulatory and tax havens, the group planned to avoid many governmental oversight functions as well.

But the most important factor involved the youthful ages of most of the 9,769 teachers. Because the investors were forecasting that only thirteen teachers would die annually during the early years of the insurance program, they were free to dedicate the lion’s share of any early tax free profits to other purposes. The investors could, for instance, use the funds to pay dividends to themselves, or to allow the profits to accumulate in their tax-free off shore investment accounts.

Last week, when questions arose about the personal and professional backgrounds of the investors, the school district walked away from the plan. Nevertheless, for a time, they did actively consider entrusting their employees’ life insurance benefits to a “tricky or questionable” proposal that promised free coverage for all.

Insurance companies, of course, have been engaging in “tricky or questionable” practices for years. In 1991, for instance, Executive Life of California and Mutual Benefit Life of New Jersey both went bankrupt because of excessively risky investments in junk bonds and other securities. For the first time, policy holders with Guaranteed Investment Contracts (GICs) learned that there was nothing “guaranteed” about the GICs that were issued by their life insurers.

And more recently, in 2008/09, the government of the United States bailed out AIG because of concerns that its failure would destroy the global economy. Although AIG did indeed sell insurance policies, its insolvency was attributable to its transactions involving the creation of credit default swaps on collateralized debt obligations. Such transactions, by and large, fell outside of the regulatory umbrellas of the federal authorities and state insurance commissioners.

Thus, we should give the school district of Pasco County full credit for learning from these prior experiences and declining the offer of free life insurance. When insurers propose risk-free returns at little or no cost, the only prudent response is “thanks, but no thanks.” After all, any such proposal is most likely a shenanigan.