We have not devoted too much space over the years to planned giving products. The reason is simple: While charities and development officers may like them, to us they are just another packaged investment product. Over the years, we have developed packaged product for financial institutions, reviewed them for clients, and been faced with personal investment decisions involving them.
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a client-appreciation dinner at Morton’s, the Steakhouse. We were tempted. It’s cold and snowy. An excellent steak would go great just about now. We, however, are always reluctant to attend client appreciation dinners—there is always a catch. So we asked what was on the program. Our friendly financial advisor, first laughing, responded, “Our annuity division is sponsoring the dinner.” We immediately said, “We’ll take a pass, but thanks.” Laughing, he said “Knowing you, I knew that would be the response, but I thought you might like a good steak.”
We have reread some of the stories that were written at the time the Oklahoma State and other similar schemes were first hatched. While we don’t know all the particulars of the Oklahoma State plan, it appears that it did not involve the lucky 27 alums contributing the funds to pay the policy premiums. Apparently, Oklahoma State borrowed $20 million to finance the premiums and Mr. Pickens guaranteed the loan. That has been described as a temporarily loan, with Oklahoma State apparently planning to refinance the loan with permanent financing to cover the premiums. Presumably, future premiums would be financed in part with the death benefits from policies covering alums who died early on in the program's tenure.
One description of how these schemes works reported that after several years, the college sells the pool of insurance policies to an investor, presumably making a gain on the sale. Of course, that investor has to make a profit, so presumably the investor buys for a discounted amount. Although we don't know for sure, we suspect that Oklahoma State did not plan to sell the pool of policies in a secondary marketplace. Instead, it appears that it would serve as the investor.
We would love to see the spreadsheets that were used to sell this scheme. Given the cost of premiums, carrying costs, and administrative costs, the only way that this scheme would make sense from the university's standpoint is if the actuarial tables turned out to be wrong--and most likely, seriously wrong.
What we suspect happened was that when Oklahoma State began to look at the total premiums it had paid (reported to be $33.3 million) and the current actuarial value of the policy pool. It then concluded that the arrangement didn’t make economic sense from its standpoint. We would not be surprised if Oklahoma State was unable to locate a lender that would make the permanent loan on terms that would permit Oklahoma State to turn a profit.
The lawsuit centers on alleged misrepresentations by the insurance company and lax medical and financial underwriting. Whenever you see the word “misrepresenation” in this context, you know that the deal didn’t live up to expectations. You saw the word "misrepresentation" used when many tax shelters headed south two decades ago and it is making a reappearance in lawsuits currently pending where mortgage-backed securities and derivatives have gone bad.
We thought Oklahoma State's and the other plans were highly suspect (dumb) when we first read about them. The lawsuit bears our suspicions out. Like many other packaged financial products, life insurance often mystifies many people. It definitely has its place, effectively guaranteeing the breadwinner’s earnings should he or she die prematurely. But the coverage doesn’t come free. The insurance company and its agents make money—nothing wrong with that. Given that fact, it is hard for us to see how any scheme where the college pays the premium could make sense. In this case, the insurance company alleges that it paid over $10 million in commissions and other costs to put the policies in place. Moreover, the insurance company isn’t going to charge a $2 a year premium on a $10 million life insurance policy written on the life of an 85-year old man. The lender financing the premiums is going to charge a healthy rate of interest.
The purchase of whole-life insurance policies by a tax-exempt organization makes little sense as a general proposition given that one of the advantages of whole-life insurance policy is the tax-free inside buildup. We may be missing something, but outwardly the purchase looks like equivalent to the purchase of an annuity in an IRA account. And then there is the question whether the premium financing arrangement created unrelated-debt financed income.
In short, we can’t believe those running a university could be that dumb or naïve to believe that there were big dollars to be made in this sort of scheme. Then again the university's athletic department rather than its finance department appears to have been behind the scheme. Maybe somebody took one two many hits when they played college football.
We plan to follow this lawsuit. Regardless of its particulars, there is a bigger lesson in the lawsuit that all donors, their advisors, and fundraisers should take away. You can’t create money out of thin air. From the charity’s standpoint, a $10 million cash gift is always better than a $10 million transfer through a planned giving device. The middlemen must be paid in the case of the latter. Donors also should recognize this fact: The tax rules and the heavy fees and recordkeeping hassle associated with planned giving devices never permit you to receive credit for giving away more than you actually did. You kid yourself by believing that the device someone permits you to give without reducing your net worth.
At the end of the day, simplicity is the best approach, which means that charities in the planned giving game might be better off devoting more resources to demonstrating why they are worthy of the gift and less on developing and marketing gimmicks designed to hide the cost of giving.
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THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NONPROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL. If you liked this post, please visit http://www.charitygovernance.com for a description of our training and consulting services. You will also want to acquire a copy of Jack Siegel's book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good."
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