The Prohibition Against Investor Control Doctrine

October, 2023
The Diversification Rule

The Private Placement Life Insurance (PPLI) Investor Control Doctrine is a legal concept that defines the level of control a policyholder has over the investments held within a PPLI policy. The doctrine establishes that for a PPLI policy to qualify for favorable tax treatment, the policyholder must not have "investor control" over the policy's underlying assets.

The doctrine was established through a series of court cases and IRS rulings that established certain requirements for PPLI policies to qualify for tax-deferred treatment. Under the doctrine, the policyholder must not have control over the investment decisions made within the policy so as to not be considered the "real" owner of the underlying assets.

The investor control doctrine is designed to prevent PPLI policies from being used solely as a tax-avoidance strategy. By requiring the policyholder to not have control over the investments held within the policy, the Doctrine ensures that PPLI policies are used primarily for their intended purpose of long-term planning and not as an actively traded investment account.

Thirty years of Private Letter Rulings (PLRs) issued by the IRS clarified what a policyholder could and could not do with respect to making policy investment decisions.  A historical hide-and-seek game between the IRS and policyholders culminated in the U.S. Tax Court weighing in on the specifics of the Prohibition Against Investor Control Doctrine in Webber v. Commissioner (2015).1  

In this case, the policyholder used premiums to purchase investments in start-up companies that the policyholder was closely aligned either via direct investments in the companies or through private equity funds that were managed by the policyholder.  The Tax Court found the policyholder exercised his control over the policy’s separate account through a not too elaborate “protocol” in which the policyholder’s “investment advisor”, accountant and lawyer acted as his intermediaries in the selection, purchase and sale of the investments held in the policy account.  As part of the evidence in the case, the IRS offered 70,000 emails to or from the taxpayer’s investment manager, lawyer, accountant and insurance carrier containing his investment “recommendations”, all of which were followed.

The Court in Webber highlighted three principles in determining whether a policyholder rather than the insurance company is the owner of the investment assets (and taxed as such):

  1. Who has the power to select investment assets by directing the purchase, sale and exchange of particular securities?
  2. Who has the power to vote the securities or exercise rights pertaining to the securities?
  3. Who has the power to extract money from the account by a withdrawal or by other means?

Specifically, the owner of a variable policy, including a PPLI policy, cannot have an arrangement, contract, plan or agreement with the investment advisor to select or direct investments.  The investment advisor must be permitted to make independent investment decisions, though, these decisions may be based upon the knowledge of a policyholder’s general investment philosophy and risk tolerances.  

For instance, a policyowner may request a specific Insurance Dedicated Fund (IDF) or Separately Managed Account (SMA) but a policy’s owner, insured or beneficiaries may not play a role in the selection of the IDF’s investment positions nor the SMA’s individual investments.  Similarly, a policyowner may request a particular Registered Investment Advisor (RIA) and asset custodian, but the ultimate selection and ongoing retention of the RIA and custodian is fully discretionary for the carrier.

An investor control violation can result in the retroactive assessment of taxation at ordinary rates, plus fees and interest, on any investment growth in the segregated account.

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  1. 1 Webber v. Commissioner (T.C., No. 14336‐11, 144T.C. No. 17, 6/30/15)

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