For Hartstein and Economic Concepts to sell their Pendulum Plan, they had to have specially designed policy. Enter Indianapolis Life. Upon information and belief, in early 1999 Hartstein contacted representatives of Indianapolis Life. Indy Life had a product that they believed would work. It was the Executive VIP. It was developed in the early to mid 1990’s to allow the transfer of money from pension plans or corporations with excess retained earnings.
What made the Executive VIP policy a perfect fit for the Pendulum Plan was the blooming of the cash value as the surrender charge burned off. The problem with these policies was the position the IRS had been taking back to the 80’s on springing cash value policies. In fact, the Executive VIP policy had originally been marketed to fund multiple employer welfare plans under 419A(f)(6) of the Code. These plans worked much like the Pendulum Plan. The IRS targeted these plans in the mid 90’s and designated plans with the characteristics outlined in Notice 95-34 a “listed transactions” in 2000.
It has been reported that Indianapolis Life had internally discussed the springing cash value risk associated with its Executive VIP policies throughout the 90’s and was concerned that the IRS could successfully challenge the policies and create “adverse tax consequences” for the pension plans and individual policyholders.
With 419A(f)(6) effectively shut down, enter Hartstein, his 412(i) plan, and the lure of money.
In late March 1999, Hartstein proposes to Indy Life that the Executive VIP policy be the exclusive product for his Pendulum Plan. In return, Hartstein wanted to control the distribution of the plan for which he promised millions of dollars of new commissionable premium. The policy was renamed the PenPro to co-brand with Hartstein’s Pendulum Plan.
In June of 1999, Hartstein meets with Indy Life representatives. At this meeting, they discussed the springing cash value risks of the policy. Knowing these risks, it is believed that Indy Life agreed to marked the Pendulum Plan through its agents and represent that the Pendulum Plan as a qualified 412(i) plan, that the premiums were fully deductable, and that the insured could purchase the policy after a few years for it's suppressed value.
At no time did they agree to disclose the tax risks.
Hartstein then presents the plan to Bryan Cave attorneys, requesting a tax opinion letter to be used for marketing purposes. More on Bryan Cave in future postings.
Indy Life, on the other hand, seeks an opinion from Robert G. Thurlow, a nationally recognized expert in the pension industry. In early December of 1999, Mr. Thurlow warned Indy Life that the Pendulum Plan would not qualify and the premiums would not be deductible. It is also believed that internally, there were serious reservations about these plans.
Despite these warnings, the lure of money was just too great, and Indy Life dispatched its agents and producers out to sell--not insurance, but a tax deductible plan loaded not only with excessive fees, loads, and expenses, but also a known risk of audit to its policyholders.
Not surprisingly, these plans were enormously successful. So successful, in fact, that other insurance companies began looking to take advantage of this niche market. More on other insurance companies in future postings.
