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in the absence of policy loans) the status of these simul

taneous property rights is clarified and the policyholder's interest in the accumulated reserve under the policy is

extinguished. According to the Report, of crucial analytical significance in this very common scenario is the fact

that the policyholder will never have received any of the

increase in the value of his life insurance upon which the

Administration's proposal would impose a tax.

The Report concludes that, in effect, the Administra

tion's proposal assumes that every policy is eventually


an assumption contradicted by fact each time

a policy matures.

To impose a tax on the policyholder


based on this faulty assumption is, according to the
Report, inequitable and, further, may raise due process



Only last year, Congress thoroughly examined life insurance and set stringent standards to assure that life insurance policies are not used to cloak investments and that only those policies designed to provide insurance protection qualify as life insurance for tax purposes.

The Administration argues that a new tax on life

insurance is warranted because insurance may be designed as

a tax-favored investment for the benefit of individuals in

high tax brackets.

To prevent this, and to achieve "tax

neutrality" with other investment vehicles, the Administra

tion urges that life insurance policyholders should be subject to a new tax on the increase in the value of their

permanent life insurance,

The Administration's argument ignores the major over

haul of life insurance taxation made by Congress only last


In enacting DEFRA in 1984, Congress made a thorough

study of life insurance.

It recognized that while most

permanent life insurance policies were designed to provide

protection in the event of death, some were so heavily

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ance protection. These guidelines include a cash value accumulation test and, in the alternative, guideline

premium and cash value corridor requirements.


deemed "investment oriented" in the judgment of Congress

now are not eligible for tax treatment as life insurance.

In making its current proposal, the Administration is

resurrecting a problem that was considered exhaustively by

Congress last year and effectively resolved.


In enacting DEFRA, the Administration agreed that the narrowing of the definition of life insurance created all the more reason for not taxing policyholders on the unrealized increase in the value of their life insurance.

Only recently, the Administration agreed that, with the

tightening of the definition of life insurance and the

placing of narrower limits on the investment orientation of

policies, there was more reason for continuing the longstanding policy of not taxing policyholders on the socalled "inside buildup" in their policies. In 1983, John

E. Chapoton, then Assistant Secretary of the Treasury for
Tax Policy, testified on this point before Congress.



...(T}he treatment of sinside buildup bears) an
important relationship to the definition of life
insurance; that is, to the extent the definition of
life insurance is tightened, thereby placing
narrower limits on the investment orientation of a
life insurance policy, there is more reason for
allowing favorable tax treatment to the (inside
buildup) under policies that fall under a tighter

Tax Treatment of Life Insurance; Hearings Before
the Subcommittee on Select Revenue Measures of the
House Committee on Ways and Means, May 10, 1983,
98th Cong., 1st Sess. 16 (1983).

In accordance with the Administration's position at the

time, the definition of life insurance was tightened and

narrower limits on the investment orientation of life

insurance policies were adopted in 1984.


Permanent life insurance is a unique product designed to provide individuals with fixed-cost lifetime protection, not as an investment vehicle. The Administration's proposal is, in effect, an 'age-indexed

which would penalize future generations of older Americans.


The value in a permanent life insurance policy is a

by-product of the level premium method of paying for life

insurance. Basically, level premium policies were developed as a means by which policyholders spread the total cost of their life insurance evenly over the duration of their policies. This avoids the sharp increase in premiums

that otherwise would occur as the insured individual grows

older, to reflect the fact that the probability of death,

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long-term protection against the risk of death feasible and

has made permanent life insurance a staple for American


It is sometimes suggested that the same benefit can be

obtained by purchasing term insurance.

This ignores the

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of term insurance for all but the wealthiest people becomes

prohibitively high,

Term insurance is not a satisfactory

alternative to permanent life insurance, especially as

individuals grow older.

The dramatic increase with age in the cost of term

insurance may be illustrated by reference to a typical

premium for a $25,000 one-year renewable term life insur

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This problem as applied to veterans' life insurance has

been a major concern to the Veterans Administration.


advising veterans of the problem, the Veterans Administra

tion has stated:

Although the initial cost of term insurance is
small... the premiums increase with age.... The
effect on our term policyholders of the steep
insurance premium increases required at older ages
has been of great concern to both the Veterans
Administration and the Congress.

... In addition to alerting our policyholders to the
increased cost of continuing the insurance on the
term plan at each renewal period, we have also made
several mass mailings of literature about the

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