Split-dollar life insurance: Which accounting treatment applies?

Collateral-assignment split-dollar life insurance arrangements are becoming popular for two primary reasons: first, because they provide tax-advantaged retirement benefits to executives; and second, because healthcare organizations can structure them as loans rather than expensed retirement benefits. The catch? Not all split-dollar programs are viable to be treated as loans.

In the past, many healthcare organizations used supplemental executive retirement plan (SERP) deferred compensation arrangements, but as tax law has evolved, these are gradually being overtaken by other instruments, including split-dollar life insurance arrangements.

In this article, we’ll look at how split-dollar life insurance plans work and how to determine the proper accounting treatment for your organization’s programs.

Accounting for split-dollar plans

Split-dollar programs are life insurance arrangements in which any number of financial elements — including cash values, premiums, death benefits, or ownership — are shared between an employee and an employer. They ordinarily take the form of a premium loan made to an organization’s executive that is scheduled to be repaid to the healthcare organization via the death benefit associated with the life insurance contract.

Though that sounds simple enough, these arrangements can be complex, and the guidance regarding their treatment is nuanced. Here’s where it gets complicated: If the healthcare organization has effectively agreed to maintain a life insurance policy on behalf of the executive during retirement or provide a death benefit to the executive’s beneficiaries, the cost of the benefit is accrued during the executive’s employment tenure, according to Financial Accounting Standards Board® Accounting Standards Codification Subtopic 715-60. That is to say, if the healthcare organization has an obligation — either stated or implied — to maintain policies in the postretirement period or cover experienced losses of the insurance contract or company, the premium loan must be accounted for as a retirement benefit expense.

This is the case regardless of whether the arrangement is considered an individual deferred compensation arrangement or a postretirement plan, a distinction we won’t address in this article. What’s important is that healthcare organizations evaluate the specific circumstances surrounding these transactions to ensure that, if necessary, their obligations are accurately recorded and disclosed in their financial statements according to generally accepted accounting principles.

To examine what may cause a split-dollar life insurance plan to qualify for loan treatment versus benefit expense treatment, it’s helpful to look at a couple of examples. The following case studies highlight the accounting treatment decisions related to these arrangements and conditions that could be indicative of loan or retirement benefit expense treatment. Note that they don’t address the tax impact on the employee or the employer.

Example one

A large health system implements split-dollar life insurance policy arrangements for four of its senior executives, in substance creating a postretirement plan. The employees are the owners and beneficiaries of the life insurance policies. All members of the team are highly compensated and essential to the success of the system. The split-dollar plan is replacing a previously frozen SERP arrangement with a more attractive plan for the executives, designed to achieve a retirement cash-flow objective for each executive based on his or her retirement date. Other than the customized amounts and timing for individuals, all other aspects of the plan are identical for all executives.

The arrangements provide for each executive to receive a single split-dollar loan at implementation. This split-dollar loan accrues interest at 3.32%, which is the long-term applicable federal rate (AFR) in effect at the loan date. (The AFR is the rate the government prescribes for federal income tax purposes.) The proceeds of each loan are placed in a premium deposit account, accrue interest, and fund the remaining premium payments on the life insurance policies. Each executive has expressly indicated an understanding that the system won’t make additional loans in connection with the plan, and the executives are each fully at risk for the performance of the life insurance policies. Further, the employer doesn’t guarantee the retirement benefit.

Based on the facts above, there’s a clear understanding — implicit and explicit — that the split-dollar loan won’t be forgiven at any point in time. Further, the employer has no obligation to its employees and hasn’t promised that, upon default of the insurance entity, it would maintain a life insurance policy during the employees’ retirement.

Now, let’s look at the accounting treatment this example would require:

• Asset. The employer records a receivable amount for the loans provided to the executives to fund the insurance policies. This has no impact on initial revenue and expenses, since cash will be provided to the executives to fund their insurance policies.
• Liability. No liability is recorded because the employer isn’t obligated to provide additional loans to fund the policy premiums or to guarantee the retirement benefit.
• Gain. The employer recognizes a gain for the amount of SERP liability that was rescinded.
• Other income. The interest receivable accumulates in the loan receivable account, and the employer recognizes it as other income on its income statement.

Example two

The benefit of an existing deferred compensation arrangement for the president of a regional health system in the southeastern United States is due to be vested and paid within two years. Both the president and the organization’s board of directors are concerned the amount of the payment is problematic from two perspectives:

• The community and other system stakeholders may consider it excessive.
• It doesn’t address the system’s need to preserve and build its balance sheet

To address these concerns, the system decides to enter into a split-dollar life insurance arrangement with the president. The goals of the split dollar arrangement are:

• To provide a benefit that’s no less favorable to the president (in terms of retirement cash flow) than the existing benefit
• To terminate the existing deferred compensation arrangement
• To implement an arrangement that would be viewed more favorably by the system’s constituents

The life insurance policies purchased through the split-dollar arrangement are owned and controlled by the president and collaterally assigned back to the system for security.

The organization designs the split-dollar arrangement to achieve a retirement cash flow objective for the president based on his retirement date. The president will receive a series of split-dollar loans (front-end-weighted) beginning at implementation and continuing for a total of five years. Given the multiple loan nature of this arrangement, the interest rate is assumed to be a weighted average rate of 5% (to account for potential increases in the AFR going forward). The proceeds of the loan are placed in a premium deposit account, accrue interest, and provide for the remaining premium payments on the policy.

The system agrees that if the policies perform less favorably than projected, the system will make additional funds available such that the president will have no less than a designated amount of cash flow from the arrangement through his retirement period of 20 years. This agreement between the system and the executive is documented. The current deferred compensation arrangement for the president, who isn’t yet vested, is rescinded.

Even though the president owns the life insurance policy, the system has an obligation to loan additional funds to the president if the life insurance policy underperforms or otherwise guarantee the benefit — an obligation that’s documented. As a result, a liability is recorded for the estimated present value of that obligation.

In this example, the following accounting treatment would be required:

• Asset. The employer records an asset for the cash surrender value of the life insurance policy owned and controlled by the president and collaterally assigned back to the system for security.
• Liability. The employer estimates and records liabilities for its obligation to guarantee the retirement benefit.
• Gain or loss. A gain or loss is recognized for the difference between the net obligation of the previous deferred compensation plan and the new split-dollar plan.

Determining which treatment to apply

Examine the specific structure of your life insurance arrangement to determine whether it allows for loan treatment or is essentially a retirement benefit that should be expensed. If there are obligations incurred as part of the arrangement, these should be recorded and reported.

For insight on your particular organization’s circumstances, or for guidance on properly accounting for your split-dollar or other retirement plans, contact your firm professional.