How is cash value calculated?

[tranquility]

What is the name of your state? CA

Although this is really a tax question, I need to understand the underlying issue to make a decision there.

A client has received a 1099 from the Conseco Life Class Action settlement. He says it is for a one time payment in settlement for the company surreptiously increasing the cost for life insurance in policies with a cash value, eventually eating up all the cash value. He does not know how much of the values were taken, but is sure it was in excess of the settlement amount. When I read about the settlement on the web, this seems like a good summary of what the pending class action filing claimed.

How is the cash value calculated?

It's important because it depends on how the settlement is taxed (or not). If it is simply the amount paid on premiums, the settlement would only be taxed as a capital gain only for the amount in excess of the basis. But, if it is also a return on the investment, then we're kinda hosed (technical tax term) on trying to calculate how much of the settlement is income.

Since I think we're kinda hosed (absent a brilliant insight from the list), my plan is to take the surrender value he received when he cancelled the policy and add it to the settlement amount. Then I will compare that amount to the cash value of the policy at the time. If the cash value is greater, I will wipe my hands on my pants and move on with no income. If less, I will take the amount as ordinary income.

Does anyone have a better idea? I think this would understate the ordinary income but would overstate if capital gain. This was for actions taken back in the early 1990s and I'm trying to do anything I can to keep this from being simply a "ballpark guestimate". (Which really is a technical tax term--case law and everything. They aren't allowed.)

 

[Betty]

tranquility - I worked at a life ins. co. as an underwriter & know some about the calculation of cash value & the taxation of life insurance. However, this was beyond my answering since underw. was my expertise. I asked three of my underwriter friends (good workers/smart people) but it was beyond their answering also. We all decided you need an actuary.

Maybe someone will come along yet that can help you. No better idea than what you suggested from the four of us.

 

[wheel]

You can't 'calculate' cash values, there's no set formula for that. Each company determines internally it's own cash value calculation.

If the policy has guaranteed cash values, they'll be listed in the policy. If they're not guaranteed, they could be anything. For example, some cash values come about as the result of the payment of 'dividends' from the insurance company. The dividends are decided by the company each year and paid to the policies. Goodness knows what any specific company has done through the years.

The only way to determine for sure what the cash values are for a policy is to call the company and ask for an 'inforce illustration'. Customer service should be able to do that for you.

 

[tranquility]

Thanks for the comments. It's pretty much as I thought. (aka "hosed") The cash vaule is roughly premiums paid plus investment profit less an actuarial calculation of insurance cost. Since the company cheated the client by inappropriately increasing the insurance cost beyond the agreed amounts thus decreasing the investment profit and the cash value over time, I think I'll stick with my ballpark guestimate.....I mean my educated estimate regarding the income from the settlement.

 

[wheel]

I re-read your post and it's not 100% clear to me exactly the status of what you're doing, or the exact type of policy you've got, or if it's still in force. However, if you're looking to keep the policy in force but with a different company (i.e. move the cash without getting taxed) you can look into doing a 1035 transfer. Not enough info to tell for sure if that's applicable to what you're doing.

 

[tranquility]

1. Client bought whole life-type policy and pays premiums for many years.

2. Conseco life (actually I believe a company Conseco later bought out) secretely ups the insurance cost beyond the amount allowed by the insurance contract making the cash value increase less or decrease faster than it otherwise would have.

3. Client does not think his insurance is performing appropriately so surrenders it for the surrender value.

4. Upright citizen also notices something's wrong and goes to lawyer in shining armor who probably hires a guy to figure out something IS wrong. Lawyer's drool rusts armor as class action lawsuit is begun.

5. Class acton lawsuit is settled because insurance company illegally charged too much for insurance in whole life policies.

6. Client gets a big fat check.

7. Client gives record of big fat check to very tired tax preparer who wonders how the heck to report it.