Planned Giving Risk Management

When Financial Advisors Get Creative….

Quick Planned Giving lesson on Commercial Annuities

I couldn’t resist using this cartoon again but this time (to see previous post on commercial annuities – click here), I have a crazy scenario that just played out with a professional advisor who tried to foist a commercial annuity into a CGA on behalf of an unsuspecting intended charity.  See that previous post for more about commercial annuities – this post will just cover one of many disastrous scenarios that could occur.

Here are the facts as presented to me (with small changes to protect the innocent).  A friend (a planned giving director) calls last week with a nervous message, something about a donor giving them a commercial annuity (which I know doesn’t work).   What I find out when I get through to him is that the donor funded a commercial annuity that was somehow placed in the name of the charity but would pay lifetime annuity payments to the donor.  Really strange and my initial reaction was to direct him immediately to competent legal counsel.

After mulling this story over, and hearing a few more details, this is a must read post for planned giving professionals.

What happened here?  The planned giving director had given the professional advisor a CGA illustration on the donor.  Instead of finding out how CGAs work, the advisor decided to ask a really big insurance company (presumably one he is affiliated with) to somehow make the scenario work.  I am guessing that meant to get the donor his lifetime annuity payments and the advisor his commission!  Oh yeah, maybe a second thought about the charity’s remainder – NOT.

What did this multi-trillion dollar insurance company (one that took hefty bailout money just a few years ago for being too big to fail) come up with?  Their solution was to have the donor purchase on behalf of the charity a $100,000 commercial annuity that would pay the donor his CGA rate for his life.  All’s well that ends well, right?  Donor gets annuity and a $100,000 deduction (according to the advisor, at least), advisor gets his commission, charity gets remaining funds in the commercial annuity when donor passes (advisor even told the planned giving director that the remainder was a $100,000 guarantee to the charity – we’ll see about that!)

Your mind should be churning a bit here.  Let’s go through each problem.

  1. Income tax deduction – The donor basically transferred to the charity $100,000 and immediately invested it (on behalf of the charity) into this commercial annuity.  Lot’s of problems here.  #1 donor control of investment is a no-no, meaning no deduction, zero, zilch.  Let’s say the charity had acquiesced retroactively.  Basically, the donor created his own CGA – at best the donor might be entitled to the appropriate CGA deduction.  Advisor’s claim that donor should get $100,000 deduction showed how completely ignorant he is on these matters.
  2. Commission – Let’s say charity said fine, we have a CGA here and the charity agrees that this investment is fine (which it probably is NOT for the NY State Dept. of Insurance – who would probably have forced this entire thing to be reversed if it ever got to their attention).  A big problem is that the advisor basically took a commission on the issuance of a CGA – a violation of the Philanthropy Protection Act (the Act that exempted CGAs, among other vehicles, from SEC regulation).
  3. Remainder – The advisor’s guarantee that the charity was guaranteed a full $100,000 was a complete untruth.  In fact, when the planned giving director inquired of the insurance company about what happens to the remainder, they told him that it basically extinguishes around the end of the life expectancy of the donor.  Nothing, zilch, for charity if donor lives to life expectancy.  Talk about chutzpah!
  4. NY Dept. of Insurance (NY-DOI) – Hate’em, yes, if you have to deal with them but in this case, there is no way they would have let this go (which is a good thing).  I know one scenario where an advisor had a CGA program reinsure all of its CGAs (a NY charity) and didn’t follow NY’s rules (which are particularly strict on reinsurance).  They forced that nonprofit to undo all of the transactions.  Not fun. This one would have been killed sooner or later (probably at the expense of the pg director’s job).

Let’s add it all up. Extremely doubtful deduction, illegal commission, horrific investment choice, NY-DOI will make you pay dearly.  I have probably even missed a few problems.

Why do such disasters happen?  Ironically, the worst planned giving disasters (besides the Huguette Clark estate) almost always involve attempts to  use commercial annuities in planned giving contexts.  Besides the reinsurance disaster mentioned above (that was about purchasing commercial annuities to cover CGA payments), I’ve dealt with disastrous use of commercial annuities as investments in CRTs several times and I just keep asking myself WHY?  Why in the world do advisors do such stupid things like this?

The answer, which my planned giving director friend also agreed with, was the drive to get a commission.  Yes, it comes down to dollars and cents.  Advisors need commissions – preferably cash upfront.  That is their lifeblood, their inspiration.  And, even though commercial annuities don’t pay the great commissions that life insurance policies do (which are insanely huge), they are probably enough for the advisor to sleep well at night.  Of course, if your prime focus is how you can benefit from this gift (you meaning the advisor), you might not pay too much attention to small details like any remainder for the charity.

I had an advisor once defend a case where donor/client put up $25,000 in insurance premiums for the first five years of a policy and by the 6th or 7th year, the policy was already lapsing for nonpayment.  The donor had wanted to give $25,000 to get a $100,000 policy (and leveraged naming gift).  But, the policy needed another 20 years of premiums or more.  Charities almost never pay premiums, certainly not mine at that time.  The advisor skipped that issue when setting up the policy – what should he care?  He got his commissions from the first payments.  I confronted him (and even had pro-boon counsel ready to make his life miserable) and he didn’t show the slightest feelings of guilt. It dawned on me then that singular focus by advisors on their commissions is a dangerous thing.

Back to our story.  Luckily for all involved, there is a 30 day “get out of jail free card” when buying commercial annuities.  The whole thing is being undone.  Somehow the donor isn’t angry, advisor came up with some excuse, and the charity will issue a CGA after all.

Ironically, if this advisor had any clue, he could have advised the donor to set up a CRT and continued to manage the money and continued to get some commissions.  Of course, he probably did better with the immediate commission from the commercial annuity in the short term.  Now, he get’s nothing, which should make us all feel a  little better about this story.

And, sadly, this story confirms how insurance companies are utterly ignorant of this stuff.  How could a room full of guys (who all drive BMGs and Porches) be so stupid? I would love to train advisors but they will have to learn to change their outlook to get a clue on planned giving.  It can’t be about your silly $2 commission.  It has to be about finding the best options for your clients!  And, they might have to actually use their brains a bit.

Anyway, the bottom line with commercial annuities in a planned giving context is this: They never work (except for simple beneficiary designations) and are actually very dangerous from a tax standpoint (to the donor and the charity).  In other words, stay away from them if an advisor is trying to slip one into a planned giving situation.

Assessing the risk – a key to planned giving success

When it comes down to precautions in planning giving (i.e. cover yourself letters, seeking your own counsel, etc…), there is one good rule of thumb:

The bigger the gift, the bigger the stakes, the more ethical and legal precautions you take!!

What spawned this post?  Check out this charitable bequest nightmare story:

The point is this: as a potential bequest or other planned gift unfolds, you as a fundraiser have to make a decision how much fire power (i.e. legal help and other outside experts) you need.  At certain dollar amounts, let’s say $100k range, you might want to review the gift with a consultant. Get to the $1 million range, you might want paid legal counsel to be involved. It could also start with hostile family members.  It could be an unusual arrangement.

You will have to judge for yourself when a gift requires more protective action.  The linked story is an extreme example of how badly a good intent can go (the only solution there might have been  for the donor to create and fund his foundation while he was alive and in a sound mental/physical state).

In any case, as a fundraiser involved with donors and their estate plans, you need to develop a workable gauge.  If you bring it all out for every gift, your costs and/or efforts will be out of control. On the other hand, a few thousand dollars of expert guidance might save your institution millions of dollars later on.

Commercial annuity as investment option for a Charitable Remainder Trust?

I worked on the issue of a commerical annuity in a CRT last year – the aftermath of a CRT investing its principal in a commercial annuity and the disaster that followed.

Now, thanks to the planned giving design center and an IRS letter ruling, use of a commercial annuity in a CRT might become more prevalent.  Click through to see the short letter ruling:

The question though is why would a trustee want to do this?

Let’s start with why not.  The story I worked on was a classic example of why not.  Unwitting donors created a CRT with a few hundred thousand dollars of hard earned money, to create an income steam for themselves and a remainder for great charitable works.

Sadly for them, everyone involved with the process of creating this CRT were absolutely clueless – from the drafting attorney to the third party planned giving specialty company to the investment manager.  The investment adviser saw that this trust needed to produce an annuity for the donors for their lives.  So, the investment adviser suggested to put the entire principal in a commercial annuity paying exactly what they are supposed to receive yearly. 

Problem: the principal was not guaranteed.  Second problem: the annuity wasn’t guaranteed either.  Third problem: stock market crashes and eats up the value of the principal.

This was an incredibly poor piece of advice given to these CRT donors. 

I actually devised a bailout plan for this disaster which entailed the donors relinquishing their interest in the CRT in favor of a charity, and that charity issuing a CGA on their lives.  The new income stream would have been about half of what the CRAT was paying but it would have at least salvaged a remainder and guaranteed a fixed income for life.

What they really should have done is sue all of the offending advisers involved – they were all sitting ducks for their so-called professional advice.

In the end, they decided to let the CRT languish.  Having been burned very badly once, I don’t think they were up for any more complexities and just hoped for the best.  Maybe the annuity recovered.  Maybe not.

There was a serious legal issue in that case that is not addressed in the letter ruling that just came out.  The question is whether a trustee should make such an investment, especially if it is not in the best interests of the remainder charities.  Prior rulings, I recall, required an independent trustee to help make this risky decision.

Bottom line, and why I wrote this piece, is that regardless of this new letter ruling, CRT trustees should be very cautious before ever investing in a commercial annuity.  It has to make sense for both income and remainder beneficiaries or the trustee deserves to be sued.

I did promise a discussion of why it would make sense for a CRT to invest in a commercial annuity.  Well, if it can guarantee a remainder, then it might make sense.  Something like reinsurance within a CRT.  The key is guaranteed principal for the charities while guaranteeing the income stream.  In the end, you might be giving up half or more of the principal to accomplish this but that isn’t so bad considering the cases where there is nothing left for the charity.

I have discussed before that I actually believe that reinsurance in the CGA arena is very useful and sometimes a better long term option for a charity.  Could work similarly here for CRTs.

The main thing is to have advisors who knows CRTs and who know commercial annuities – real knowledge, not just faking it.

Remembering the Spring of 2009 – Let’s not forget the risks involved in Planned Giving

I know I promised a NY Times/WSJ style article to my blogosphere readership – that will take a few days.  In the meantime, I came across an interesting presentation that is worth sharing.

While looking at my cluttered computer desktop last night, I opened a presentation that I gave to the Philanthropic Planning Group of Greater New York in May of 2009 with a colleague and some reinsurance people from The Hartford.  A really interesting presentation and still relevant today.

Here is it: Planned Giving Day presentation on crashing stock market and CGAs

This was done at the height of the crashing stock market, CGA programs were buckling under unheard of market losses, and we really had to wonder if the field of planned giving would ever be the same.

Anyway, why should all of the work we put into this presentation disappear into the annals of computer memory.  Check it out and post questions on it here!

And, believe it or not, under the right circumstances, I believe that reinsurance of CGAs (and possibly CRTs) actually works better than “self-insuring” (keeping and investing) for most CGAs/planned giving programs.  Just don’t ignore my “under the right circumstances” caveat.