Update on Previous Post about Barry Kaye Article

In all fairness to Mr. Kaye and my readers, I have some new information that clarifies that story. When I met with Mr. Kaye a few years ago, he gave me the impression that he would put prospective "insurees" on the board of his private foundation and then the private foundation would borrow money to take out a life insurance policy on its new board member. This scenario raises a bunch of legal issues which I was stilling wondering about all this time.

Today, I had a conversation with the writer of the story in the Palm Beach Post and finally I have a better understanding about what Mr. Kaye was doing. Mr. Kaye did say he put our board member his foundation board, he just didn't say which foundation. It just happens that Mr. Kaye also owned/controlled the Wealth Creation Foundation. Not a foundation in the sense we normally think because it was a for-profit company (mentioned in the Palm Beach Post article that it closed).

Now I got it. Mr. Kaye put the prospective insuree on his for profit "foundation" board, it borrowed money and took out a policy our board member's life, sold the policy after two years for a significant profit (in this case because the insuree almost didn't make it), and then donated the net profits from the deal to his private foundation (to be granted out to charities of Mr. Kaye's and the insuree's choice).

This answers a big question for me since from my own conversation with Mr. Kaye. I was under the impression that everything was done through his private foundation. I was taking notes during our meeting and I think I would have picked up on the for-profit entity if he revealed it or maybe he was spinning a confusing web which I just didn't get.

So, I have to give Mr. Kaye credit, his plan was more legal than I thought even though his glossing over facts definitely gave me some false impressions.

Story About Gift Annuities in Chron. of Philanthropy

I spoke to the author of this article extensively and provided lots of documentation in hopes of getting my name in the article.

Well, I didn't get into the article but she did do a very good job on a very sensitive topic. I wouldn't have been so sensitive if I had written it.

To see the article:

http://philanthropy.com/premium/articles/v21/i18/18001701.htm

(you might need to be a subscriber to get to it)

Article Touting Some New and Not So New Techniques

I try to keep up with new options in the planned giving/fundraising world by glancing at the titles, scanning through interesting ones, and eventually reading closely important stories. This most recent article on the Planned Giving Design Center would have just remained in my "scanned" category but for discussion of a new approach to lead trusts. Any interest? Here is the story: http://www.pgdc.com/pgdc/shark-fin-clats-vs-bears-charitable-giving-down-times

As an aside, the article struck me as not being in touch with reality. The author quotes someone as saying that lead trusts are "poised to explode in popularity." What a load of you know what. Check out my primer on lead trusts that you can click through on the right column. There is no way lead trusts will become the popular vehicle like the author says. Unfortunately, if lead trusts really do increase in popularity, the only explosions will the law suits of unhappy families sold on false promises by either charities or advisers - most of whom are typically inadequately knowledgeable about the multitude of pitfalls that come with these trusts.

Update on Previous Post About Insurance Schemes

Finally, someone read my previous post and wondered what I was saying (Thank you to Josh Wilk!).

As I said in my previous post, I only spent a few minutes looking at the overview of the Ohio case on insurance fraud. One key thing I learned early on as a lawyer is to read the case and not rely on summaries (summaries are helpful for locating an issue but you need to see the case itself to determine if there is something useful or not in the case).

So, here is my summary of the Ohio case previously posted for those in the charitable world (and if it interests you, read the case). The case has nothing directly to do with charities. It is about a convoluted, viatical scheme whereby the promoter would find elderly (possibly dying) individuals to buy life insurance on themselves to immediately transfer the policies to the promoters who lined up investors on the policies. Ironically, there were multiple frauds going on - fraudsters against fraudsters - and of course the whole thing went under. Too complex to even attempt to describe.

The short of it: the receiver in bankruptcy of the principal fraudster wanted to get back premiums on three "fraudulently" obtained policies from an issuing insurance company (mind you - as much as you might hate insurance companies, this one was not a part of the fraud). Court says: you (the plaintiff) perpetrated a plan to obtain insurance policies fraudulently and now you want the money back because the policies were fraudulently obtained (by you!)? No way, end of case (for now).

What should we in the charitable world learn from this? Number one: insurance policies purchased "with the intent to resell...constituted insurance fraud because the viators (the elderly persons buying the policies) never intended to insure their own lives." In other words, anyone promoting a plan that rests on the reselling of policies after two years to "investors" is treading on a very thin ice. And, most charitable insurance schemes that I have seen in the past few years relied exactly on that idea.

See my earlier post about the possibility of Barry Kaye's big pledge to FAU not coming to fruition because of his inability to resell insurance policies for nice profits after two years. http://www.palmbeachpost.com/localnews/content/local_news/epaper/2009/06/12/0612kayepledge.html

I am going to save my thoughts on why even legally legitimate insurance schemes are not productive for charities to get involved with for another post.

My apologies to Choli, Stoli, and Stromboli and whatever else you might call yourself for lumping you in with this case.

More on Life Insurance Deals Going Down

I lost track of these newfangled charitable insurance "too good to be true" schemes a few years ago. CHOLI stood for Charitable Owned Life Insurance, which was a version of STOLI (Stranger Owned Life Insurance).

Anyway, thanks to an anonymous friend who provided me with these links, if you want some enjoyable vacation reading on the topic, check out this summary piece posted by a law firm: http://www.bricker.com/publications/articles/1470.pdf.

If you are really a glutton for punishment, check out the full decision: http://www.bricker.com/legalservices/industry/insurance/09a0187.pdf.

I have to admit that I haven't read either carefully but I really plan to do so soon.

So who is going to "The CHIEF Plan Luncheon" on June 24, 2009 in NYC? They sent me a package and invitation by overnight mail. (CHIEF stands for Charitable Insured Endowment Fund plan)

Real Estate for Life Income All Over Again

With the still down market, proposed Planned Gifts funded with real estate keep coming up more and more. And, if you are familiar with these situations, the idea of using gift annuities sounds all too enticing. FLIP CRUTs are really the "real estate" ready vehicles but what if there is a mortgage on the property? what if the donor demands an annuity and not a unitrust income?

I am going to put out the collective wisdom of many who have tried and learned their lessons: forget about gift annuities for real estate (at least for the start of the conversation). If I had my druthers, I wouldn't allow them like NY law used to.

Why am I so negative? Because they are disasters waiting to happen.

What if you have buyer ready and waiting? What if the buyer walks?

What if the property isn't sold during the year of the gift? NY and other states require you to put cash into the require reserves. What if the property doesn't sell for a really long time - you might not be employed by the time it gets sold.

What if the property sells for a lot less than everyone anticipated? Does your donor still get income based on "appraised" donation value?

These are just the start of complications. I actually love trying to figure out how these will work but no charity in their right mind should offer them in most cases.

Just my thoughts after working on a few of these potential gifts this week. Comments? Any successful real estate funded CGAs out there?

Charitable Insurance Schemes Falling? Surprise, Surprise!

I can't even tell you how many charitable planned giving insurance schemes I have reviewed. In almost every case, I was convinced throughout the presentation. Then after the insurance salesmen leave, doubts start to sink in and finally, I know it is just too good to be true.

Bottom line: charities do not gain by leveraging the insurability of their donors, and/or by borrowing to buy insurance, or any other cockamamie plan (I had to look up the spelling of that one). I don't care who you are and how many tax-planning patents you have (a tell tale sign that the scheme is particularly insidious)or how many non-disclosure agreements you have me sign (another tell tale sign that the plan is bogus) or that you have a prominent law firm's "tax-letter" testifying to your plan (probably the worst of all the signs that you are dealing with crooks - try running your plan by the IRS lawyers and see what they say!).

For the non-planned giving professional, I am referring to "get rich quick" schemes for charities involving insurance - they are all the same in my mind: not worth your time and resources and worse.

Finally, if you have ever heard of Barry Kaye, the real King of Insurance, you shouldn't be surprised that his insurance/charitable empire may be starting to tumble. Here is the story:

http://www.palmbeachpost.com/localnews/content/local_news/epaper/2009/06/12/0612kayepledge.html

I met with Barry a few years ago just after he made his $16 million dollar pledge to FAU. In fact, he seemed to be very proud of his charitable giving but also seemed to be using it as leverage to get his foot in our door (just my sense, of course). He had a new "can't miss" twist on the whole charitable insurance scheme industry. Yes, he wanted to have insurance policies issued on our donors. His new program was that he would put insurable donors (with significant insurability of course) on the board of his own private foundation. The foundation would then borrow money (he was talking about borrowing hundreds of millions of dollars for this new deal) to buy insurance on its "new board members" (a neat way around insurable interest questions). Then, after two years of holding the policy - if the donor survived that period of course - the foundation would sell the policy, pay some taxes, pay itself back for the funds expended on the premiums, and then let the board member direct half of the net profits from the deal to his/her charities of choice. It was a no risk transaction for us - right?

Well, we weren't biting. We had no interest in inviting Barry to meet with our trustees and in fact, the ones that knew him personally absolutely refused to discuss any meetings (we needed to show that we made some effort). If our trustees found him on their own and did it, fine. But, we were not going to be a "party" whatsoever to this new deal.

Also, my general concern at the time was about legislative efforts to put the viatical settlement business out of business. I didn't have the foresight to see an economic collapse.

The main point to understand is that insurance contracts are subject to multitudes of unknown or unexpected factors that makes the iron clad guarantees of the salesmen very flimsy. In Barry's case, he couldn't see (or wouldn't admit) that the market for insurance policies on the lives of strangers might dry up. Apparently it has and it could take down his empire.

Interestingly, only once in my career have I ever seen any of the insurance schemes pitched actually benefit a charity. I would love to be proven wrong by hearing good stories. That case: it was a policy that Barry Kaye's foundation bought on a trustee of an entity I worked for! The trustee survived the 2 year non-contestability and they did sell the policy for a profit! A very large pledge was made and at least a very significant payment was on it by the Kaye Foundation. After that, I moved on in my career don't know if the institution ever received everything promised.

That was the exception to the rule. Most of the promoters of these schemes won't admit that no one (but themselves) has benefited. Ask for names and phone numbers of charities which have seen monetary benefit from being involved in one of these things. I invite the world to report back on all of the great get rich quick charitable insurance schemes that have worked marvelously for your institutions (miraculously if you ask me).

Underwater endowments in New York and other places

Anyone following a really important issue for non-profits with permanent endowments, particularly in New York? Assuming you have "underwater" permanent endowment funds - which are effectively frozen - haven't you been wondering if there will be a change in the law to open up distributions?

Well, over 30 states have already enacted UPMIFA, the updated version of UMIFA (the law that originally let you use a spending rate irrespective of principal for permanent "income only" funds as long as your fund principal was over its original gift amount). This was the "modern" approach started in the 1970s but that last caveat reared is ugly head this past year in a big way. Currently, only three states have not even proposed UPMIFA - so with more than 30 on board, and up to 47 states potentially enacting, this new law should be the standard (see below for more about it).

What about New York? Well, not yet! It was proposed for the first time this past April but passing laws in NY is not that simple. Bottom line, these things usually take a few goes around and anything effecting charities needs the AG to support it. And, they break by July 4th weekend for the year! Not looking good for this year.

The new law though adds the letter P - for Prudent to UMIFA. In other words, underwater/frozen endowments will be a thing of the past - Prudent decisions will reign and let's hope charities learn how to be prudent.

Here is a short summary of UPMIFA. Annual distributions from permanent funds should be based a series of “prudent” factors: 1. the duration and preservation of the endowment fund; 2. the purposes of the institution and the endowment fund; 3. general economic conditions; 4. the possible effect of inflation or deflation; 5. the expected total returns of investments; 6. other resources of the institution; and 7. the investment policy of the institution.

For more information or to confirm if your state has enacted this important law, go to: http://www.upmifa.org/DesktopDefault.aspx.

Gift Annuity Risk

Gift Annuity Risk

I was wondering if I am crazy or not. Was I the only one in the planned giving world ringing the alarm, calling out to whoever would listen, that many gift annuity programs might be in big trouble? When you are an alone alarmist, you have to start wondering.

At Planned Giving Day in New York a few weeks ago, I presented on a panel various “doomsday” projections about exhausting CGAs but the response was quiet – too quiet, like maybe people didn’t want to hear the message or maybe I was wrong. There was of course the misleading article in the Wall Street Journal, hardly backup for my theory that CGA programs in general could be in trouble.

Finally, Frank Minton on PGCalc’s latest webinar on Advanced Gift Annuities dedicated the first 20 minutes of his presentation, billed as a discussion on advanced and new gift annuity techniques, to “risk control.” And, listening to Frank’s presentation and seeing that he used similar projection models to what I use, mostly “what ifs” using assumed constant rates of return, I know I am not crazy.

Here is the bottom line in what I found with the NEW (February 2009) ACGA rate tables. If your program returns 4% a year constant returns, I feel comfortable saying that your program will never experience (or very rarely) exhausting CGAs. Great news if you think 4% is attainable on a consistent basis.

The problem is what are we to do with older annuities? Under the same analysis on ACGA rates a few years ago, I figured out that you need to return 5% a year consistent returns, to be generally safe from gift exhaustion. Less than that, not always safe.

But the problem gets even stickier. I know from experience that even the biggest and best gift annuity investment/administration providers have seen the CGAs pools on their watch drop over 25% in principal value since January 1, 2008. That is on the conservative side – I am sure many have lost more. And, as CGA payments don’t change, the rate of diminishing principal speeds up even if you return to “normal” investment returns. What I mean is that your program may seem ok but really it’s not – one big annuity that runs out of money could bring the rest of your pool underwater with it. You don’t want to be hoping that your donors don’t live into their 90s because their annuity principals will be gone and perhaps eating up the rest of your pool.

In the midst of working through sticky situations for clients, I finally started feeling a ray of hope. Not that all will be well with every annuity out there – certainly not – as many are paying the price now for offering rates over the ACGA tables, or for the ACGA rates being too high, or for sloppy oversight, or for uncontrolled gift acceptance policies, or for small organizations taking on CGAs when they shouldn’t have, or taking on CGAs much too large for certain organizations.

The point is that proceeding carefully from this point forward can rescue your CGA program from “doom” that might be coming. Wake up now. Ask your provider for an updated “market value” report showing the current value of every annuity. Create an excel spreadsheet calculating what happens to the principal of each annuity under different flat rate assumptions over the next 10 to 20 years. Here is my super-secret excel formula for doing this: =(C1*$A1)+C1-$B1, column A is the assumed rate of return, column B is the fixed annuity payment, column C is current principal, put the formula in column D and then drag it over the next 10 to 20 columns. The $ sign keeps rate of return and payment amount fixed – the rest changes column by column – year by year. If you have trouble doing this, get someone from the finance department to help you.

You will start to see when CGAs are approaching negative. Maybe you will see an exceptionally large CGA that not only might run out of funds in 4 or 5 years, but will literally eat up the rest of the pool should it exhaust. It might be time to meet with that donor to see if he or she will take a lower income stream or would even give up all of the income.

New annuities are great for struggling pools as long as the pool isn’t so far depleted that news funds will only just push off the inevitable exhaustion of the whole pool – that really is more like a Ponzi scheme.

Perhaps it’s time to ask new CGA donors if they will take less than the ACGA rate – preserves a bigger remainder gift and bolsters the whole CGA program.

The biggest change though has to be your “remainder” policy. Dig deep enough into the CGA concept and you will find that the CGA program rests on the theory that “you win some and you lose some.” In other words, “profits” from annuitants dying before life expectancy should cover “losses” from those outliving their life expectancies. But most organizations pull 100% of an annuity’s funds when an annuitant passes away leaving a pool that is filled only with the “losers,” those outliving their life expectancies. Coupled with unexpected 25% investment losses in principal this past year and this is why we’ll soon start seeing CGA programs fail.

You should consider developing a policy to leave something from every annuity in your CGA reserve account – look at it as a rainy day fund. One large charity I know actually leaves all of the “liability” portions of each matured annuity in its reserve – creating an unrestricted endowment within their CGA reserve account. Even after years of offering even higher than ACGA rates, this past year’s market losses didn’t have a material impact on their program.

And, in dealing with a fund currently in danger of exhaustion – or at least a few years away, one solution after adding the proper reserves that the New York State Department of Insurance requires (and not a bad idea for non-New York licensed issuers either) is to leave 100% of new matured annuities in the fund until the pool has recovered. I know that your donor’s wishes may be delayed a bit, but you also have to make sure your program and organization is solvent.

Eventually, with careful supervision and understanding that CGA programs don’t run on autopilot, your program can be back on track for providing long-term financial resources for your institution.

Jonathan Gudema, Esq.
Changing Our World, Inc.