Nonprofits Take Out Life Insurance On Donors; Broker May Be Winner

By THEO FRANCIS and ELLEN E. SCHULTZ
Staff Reporters of THE WALL STREET JOURNAL

Why have a bake sale when you can have a "dead pool"?

Charities with diverse agendas -- from raising money for Catholic schools and animal shelters, to
opposing abortion and gay-rights ballot initiatives -- are taking out life-insurance policies on
donors as part of a growing money-making program.

Charity-owned life insurance, familiarly called CHOLI, is the newer cousin of corporate-owned
life insurance (COLI), which also goes by the name of "janitors insurance" and "managers
insurance." These are policies that employers take out on employees, often without employees'
knowledge, with the company as the beneficiary. Companies use the policies as tax-sheltered
investment pools, and the deaths of workers and former employees generate tax-free cash for the
companies, which often say they use the money for employee benefits.

Corporate-owned life insurance recently has come under fire by lawmakers. But charity-owned life
insurance, which works much the same way, has remained largely off regulators' radar screen.

 RELATED NEWS

Some Companies Insure Lives of Current, Former Directors

It's impossible to say how widespread CHOLI is, because in many cases neither buyer nor seller is
required to disclose anything about the purchase to state insurance regulators. But state insurance
records show that by the end of the 1990s, almost all 50 states had amended their insurance codes
to allow charities to take out life insurance on donors and "well-wishers." Insurance consultants
say they are getting dozens of inquiries from nonprofits asking if CHOLI is really a surefire way to
make money, with no money down.

Consultants' advice to charities: Beware.

The big difference between corporations buying life insurance on workers and charities buying life
insurance on donors is that corporations can make substantial sums of money doing it, thanks to tax
breaks. But since charities don't pay income taxes, they don't benefit from the tax breaks that attract
employers. In fact, charity-owned life insurance appears to provide its biggest benefits to brokers,
life insurers and, in some cases, outside investors who have no connection at all to those being
insured.

Here's how it works: A broker approaches a charity and encourages it to borrow money from the
life insurer or an outside lender, and use the money to buy life insurance on consenting donors or
other interested parties, who constitute what is sometimes called a dead pool. Donors do nothing
but sign a form and in many cases are rewarded with a modest no-cost policy for themselves. When
donors die, the insurance payout pays off the loan and the donors' heirs. Whatever is left over -- if
anything -- goes to the charity.

In the case of Bob Sandifer, the broker approached him before the charity came into being. Mr.
Sandifer, a 66-year-old semiretired landscaper who runs a dog-catching business in Palm Desert,
Calif., heard about CHOLI from a jogging buddy in the life-insurance business. Interested in
befriending animals, Mr. Sandifer decided he could further his cause by using the potential
money-making features of CHOLI (sometimes called FOLI or ROLI, for foundation- or
religious-owned life insurance). So he founded the Coachella Valley Society for the Prevention of
Cruelty to Animals. "The charity itself was really housed to form a home for this program," Mr.
Sandifer acknowledges.

"My first thought was, what have I got to lose? I don't have to put any money into it, and I could get
$60 million for the charity," Mr. Sandifer says. With this happy thought, in 1999, Coachella Valley
SPCA arranged to borrow about $5 million at 6.5% interest from the Insurance Co. of North
America, then a unit of Cigna Corp., to pay the premiums, and Mr. Sandifer set out to find 1,000
animal lovers willing to give the SPCA permission to buy policies of $275,000 on their lives, for a
net benefit over time of about $60 million for the charity.

Mr. Sandifer says his wife asked him where he'd find the people. "I said, 'For $60 million, I can
find a thousand people,"' he recalls. An incentive: The volunteers were promised that their
beneficiaries would receive a $25,000 death benefit.

He placed newspaper ads and networked his friends. One business acquaintance signed up
members of the local Lutheran Church. "We got...everyone from motorcycle clubs to -- you name it.
At the Ford dealership, I think we got 28 people signed up," he says. "You get $25,000 of life
insurance and somebody else pays for it."

From the first, Mr. Sandifer was a little hazy on how the deal was going to make money. "The first
thing I tried to understand is how the insurance company makes money, and I never did figure that
out," he says. "But they must be making money, because they're willing to do it. All I have to worry
about is, are the people going to die as scheduled?"

They haven't. Just one of the 1,003 volunteers died while the program was operating, and none of
the $275,000 death benefit went to save puppies or to neuter tomcats. That's because the Insurance
Co. of North America was acquired by Bermuda-based ACE Ltd. in 1999. Because the insurance
policies had been pledged as collateral for the SPCA's loan, the lender could surrender them at any
time -- and did, soon after the acquisition, Mr. Sandifer says. He remains optimistic, however. He
met with insurers two weeks ago to see if they would lend him money to restart his SPCA charity.

There are those who would advise him against that: For charities, buying life insurance with debt is
usually a bad idea, says Vaughn Henry, a Springfield, Ill., estate planner who holds insurance
licenses in several states. Particularly because charities don't receive additional tax benefits from
the policies, they are usually better off with other investment vehicles. "There is a time when life
insurance will do better -- but that's only if people are willing to die early," Mr. Henry says. "You
can't count on that."

Still, charities are perennially short of cash, so the attraction is that for no money down, they can
later enjoy a stream of cash from the death benefits. The Osteopathic Health Foundation in Fort
Worth, Texas, borrowed money to buy life-insurance policies on 1,239 supporters in 1995. So far,
four people have died, one fewer than expected, Executive Director Joe Flowers says. Mr. Flowers
says, the program "has not made the return yet that is going to make it work out financially, but it
will." He adds that if the foundation had been able to invest without borrowing, "we might be ahead
of where we are, but we didn't have the money."

Dick Johnson, chairman and chief executive officer of FOLI Inc., Fort Worth, which sold the
arrangement to the osteopathic foundation, says that with the right policies and lending terms,
charities can make money, over time, from the death benefits, but he declines to provide further
details.

Carmelite priests in San Antonio were more cautious than the osteopaths. Several years ago, they
got more than 1,000 members of their predominantly Hispanic Catholic parish, the Basilica of the
National Shrine of the Little Flower, to allow the church to insure their lives. But the Carmelites
called the deal off, because the insurer, John Hancock Financial Services Inc., couldn't explain to
their satisfaction how the church would make money, says Father Ralph Reyes, who was superior
of the Carmelite house in San Antonio at the time. John Hancock declined to comment.

While CHOLI has grown without much scrutiny from regulators, some states are starting to take
notice. The Christian Medical and Dental Associations, a Bristol, Tenn., nonprofit, for example,
has yet to implement its program, marketed by Capital Partners Funding Group Inc., Chico, Calif.,
because Tennessee insurance regulators have raised questions about it.

Capital Partners markets a "L.I.F.E. Heritage Program" that calls for a charity to establish a trust as
a "special-purpose entity" that would be funded with millions of dollars from outside investors. A
spreadsheet included in the firm's marketing material shows that a charity that signed up 5,000
volunteers would receive $30 million over three decades, while corporate investors receive more
than $2.5 billion from their initial investment of $208 million.

The Christian group, which campaigns against euthanasia and abortion and sends medical teams to
developing countries, began signing up well-wishers under the plan about five years ago and has
paid $100,000 in fees to Capital Partners. But regulators say neither the charity nor Capital
Partners has provided requested materials, and the arrangement so far has benefited only Capital
Partners.

Allin Karls, head of Capital Partners, says he is working hard to get the programs up and running in
several places but hasn't succeeded yet, which he blames on recent accounting-rule changes. David
Stevens, executive director of the Christian group, isn't deterred. "It has tremendous potential," he
says of the program. "We still have hopes it's going to work."

As more regulators study CHOLI, one subject bound to surface frequently is the role that outside
investors play in some programs. The gray area: States generally allow charities to insure
supporters because the nonprofits ostensibly have an "insurable interest" in donors or supporters,
and outside investors have no such interest. What's more, the practice raises a major question: Are
charities that use such programs essentially, if unwittingly, renting out their insurable interest in
donors to the benefit of outside investors?

That question has come up in Michigan, where Catholic schools in and around Grand Traverse
established a program to take out life insurance on 10,000 "members." Unnamed outside investors,
holding notes issued by the trust, would receive an internal rate of return between 8% and 10%,
according to the application filed by the foundation.

Forget it, said Michigan regulators. The investors "do not have an insurable interest but an
investment interest," a regulator wrote the foundation in May 2002.

Write to Theo Francis at theo.francis@wsj.com and Ellen E. Schultz at ellen.schultz@wsj.com
 

Updated February 6, 2003
 

~~~~~~~

Some Companies Insure Lives Of Current, Former Directors

Charity-Owned Life Insurance Has Kept Relatively Low Key

By THEO FRANCIS and ELLEN E. SCHULTZ
Staff Reporters of THE WALL STREET JOURNAL

Sometime after Vice President Dick Cheney dies, Procter & Gamble Co. will collect at least $1
million, tax free, in death benefits and will donate $1 million in his name to charities of his choice.
The same scenario will unfold after the death of former Mexican president Ernesto Zedillo and
other current and former directors of P&G.

Dozens of other large companies have instituted similar programs, often called "directors'
charitable gift plans," including MetLife Inc., ConAgra Foods Inc., and General Mills Inc. The
companies, understandably, focus on the programs' benefits for charity. But the corporate benefits
are also considerable: Like other forms of corporate-owned life insurance -- often taken out on
broad swaths of a company's work force -- directors-insurance plans allow companies to shelter
millions of dollars in life-insurance policies.

(Mr. Zedillo referred questions to P&G, but said he had named Yale University to receive the
company's donation on his death. A spokeswoman for Mr. Cheney, a former P&G director,
declined to comment.)

Under these arrangements, a company buys cash-value life-insurance policies on its directors and
receives the death benefits tax free when the directors, or often their surviving spouses, die. The
company then makes a donation to the deceased's chosen charities. Often, the policies carry no
explicit connection to the charitable gift, insurance experts say. But thanks to the tax breaks of the
life insurance, the companies can not only deduct the charitable contributions but also get additional
financial benefits that can help pay for -- or potentially exceed -- the value of the charitable gift.
P&G, for example, says its program "should result in little or no long-term cost."

 RELATED NEWS

Dying to Donate: Charities Invest in Death Benefits

The difference between life insurance bought on workers and that bought on directors is largely in
the justification. When companies buy insurance on executives and middle managers, they often say
it is used to finance retiree health-care coverage or the executives' own deferred-compensation
accounts. But in both cases, companies have essentially built tax-free investment pools.

Lawmakers and other critics of corporate-owned life insurance, often called COLI, say companies
are using it as a tax shelter, not to protect themselves from financial loss, which is the intended use
of insurance. The directors-insurance program hasn't attracted criticism because it has been little
noticed. Indeed, it is impossible to say how much money companies have sunk into policies on their
directors. While a corporation typically acknowledges in its filings with the Securities and
Exchange Commission that the directors program is in place, it needn't disclose how much
insurance is involved, what the earnings from it are, or where the donations will go.

The benefit to the company and the insured executive or officer is sometimes explicit. AIG Hawaii,
a unit of financial conglomerate American International Group Inc., has bought $200,000 insurance
policies on each of 11 officers. When they die, Aloha United Way will receive $100,000; a charity
chosen by the executive will receive $50,000; and the rest is split between AIG Hawaii and a
beneficiary picked by the employee.

Until then, the growth of the cash value in the policy adds to AIG Hawaii's bottom line, says Robin
Campaniano, president and CEO of AIG Hawaii. "It helps the community, it helps the business," he
adds. Mr. Campaniano, who sits on Aloha United Way's board, is insured not only under AIG's
program but also as a director of First Hawaiian Bank, which bought policies on its directors under
a similar arrangement with Aloha United Way.

Write to Theo Francis at theo.francis@wsj.com and Ellen E. Schultz at ellen.schultz@wsj.com

Updated February 6, 2003

Money & Investing
What's a CLAT?

Ashlea Ebeling, 01.20.03
Forbes

With interest rates low, an old trust turns new tricks.

Charitable lead annuity trusts have been around since the 1970s. The late Jacqueline Kennedy
Onassis had one in her will. But these trusts haven't been used much by run-of-the-mill
millionaires. Now that is changing, thanks to low interest rates and creative planners.

A CLAT pays to charity a set amount for a set number of years. What's left at the end goes to you or
your heirs. A charitable remainder annuity trust, a much more widely used device,
does the reverse: You or your heirs get annual payments and what's left goes to charity.

Recently CLATs have become much more useful, CRATs less so. The reason is the decline in
interest rates.

The Internal Revenue Service uses current interest rates to determine how much of a CLAT or
CRAT is really going to charity. Low rates increase the tax breaks for CLATs and decrease
them for CRATs. The IRS' November 2002 "charitable midterm rate," used to calculate the tax
break for CLATs set up through January, was just 3.6%, down from 8% in July 2000.

There are three main types of CLATs:

CLAT for Heirs: This is the most common type of CLAT and is used to transfer assets to the next
generation with little or no estate/gift tax. Charles Collier, a philanthropic adviser at
Harvard, is setting one up for an alumnus right now. The $2 million trust will pay $175,000 a year
for 15 years to charity, splitting the payouts 50-50 between Harvard and other
beneficiaries (Harvard manages and administers the trust for free). Using the IRS' 3.6% discount
rate, the present value of the charitable payout equals $2 million. (Put another way: If
the trust earns a steady 3.6% return, it will run out of money after the last payment owed to charity
is made.) In the IRS' somewhat narrow view, that means there's no gift to the children,
and therefore no gift tax must be paid, even if the trust in fact does a lot better than 3.6%. If it
manages to earn 7% a year, $1.12 million will go to the kids--free of gift tax.

Rates are crucial. If the discount rate were still 8%, the $175,000 annuity would be valued at just
$1.5 million, leaving a $500,000 taxable gift.

What if a CLAT's investments tank? Ramsay Slugg, a wealth strategist with Bank of America (nyse:
BAC - news - people )'s private bank, has a client who put a $1 million portfolio of
mostly tech stocks in a CLAT for his heirs in 2000. The trust is now worth only $600,000 and still
has to pay out $80,000 a year to charity for 29 more years. Still, if the trust does run out of
cash, he doesn't owe the charity anything.

Note: The official jargon for this beast is "nongrantor trust." Don't try to parse the phrase; the words
are meaningless.

CLAT for Yourself: With one of these (official jargon: "grantor trust"), what's left in the trust goes
back to you and not to your heirs. The carrot is a break on income tax, not gift tax. At
current interest rates, says Springfield, Ill. charitable planner Vaughn W. Henry, grantor CLATs
work for a surprising variety of donors. He offers two recent clients as examples.

A 54-year-old drug company executive received an unexpected $1 million bonus last year. He
wanted to help charity and didn't need the bonus money now--but thought he might in
retirement. So he put the $1 million in a CLAT that will pay $50,000 a year, for eight years, to
charity. At the end of the eight years, he'll get what's left back. The trustgenerated an
immediate tax deduction of $342,000--that being $400,000 discounted back to the present. (If the
discount rate were still 8%, the deduction would be only $287,000). If tax rates drop,
taking the whole deduction now through the CLAT looks all the better.

If the executive had been younger and richer, he might have had the CLAT pay a charity $50,000 a
year for 36 years, in which case the deduction would be $1 million, potentially offsetting
taxes on his whole bonus. At the end of 36 years, if the trust earned 7% a year, there'd be $4 million
left in it.

Drawback: Any income earned by one of these CLATs is taxable to the donor. Solution: Invest it in
tax-free bonds and nondividend-paying stocks. To be sure, with intermediate-term
munis earning 4% and Cisco (nasdaq: CSCO - news - people ) not doing so well, the 7% return
may be a pipe dream.

At the other extreme, Henry recently set up a CLAT for a retiree who was giving $5,000 a year to
her church but had so few other deductions that it didn't pay her to itemize. Using the trust,
she front-loaded years of charitable deductions into one year and itemized that year.

Super CLAT: This is a newer invention, designed to provide both income and estate tax benefits.
"Clients want the best of both worlds," says Christopher Colombo of Merrill Lynch's
private wealth management group. The jargon: "defective grantor trust."

The children are the end beneficiaries of this trust and little or no gift tax is paid. But the donor
retains enough power over the CLAT--this requires careful drafting--that for income tax
purposes, it's still considered his money. That means the CLAT's earnings are taxable to the donor
and he gets an upfront charitable income tax deduction. The catch is, if the donor
dies before payments to the charity end, the assets may be thrown back into his estate, and the estate
may have to pay back some income tax breaks.

Does the IRS really allow the Super CLAT? It's not specifically authorized in the tax law, as the
more conventional CLATs are. But Memphis tax lawyer Robert F. Sharpe Jr. notes the IRS
has issued at least six private letter rulings to individual taxpayers okaying this newer type of
CLAT. "Congress might not have intended for it to be possible to achieve both the income
and gift and estate tax benefits,'' says Sharpe, "but for now it appears to be a sweet spot for tax
planning."