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Life insurance policies enjoy favorable income tax treatment from the IRS, including deferral of tax on any growth in the policy’s cash value and the tax-free receipt by beneficiaries of life insurance death benefits.  In order to enjoy this favorable tax treatment however, each life insurance policy must satisfy the terms of IRC Section 7702 which essentially dictates the relationship between premiums, cash values, and death benefits and also mandates the mortality table that each life insurance policy must utilize.

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Life insurance policies issued since 1-1-09 must be based on the 2001 CSO mortal­ity table (replaces 1980 CSO table).  But IRS Notice 2006-95 also requires that beginning 1-1-09, any change to earlier issued policies must also be based on the 2001 CSO table, an actuarial and administrative impossibility if they were originally based on an earlier (pre-2001 CSO) table.  Notice 2006-95 does provide a “safe harbor” however that permits certain changes to be made using the policy’s original mortality table (1980 CSO or earlier) provided the change is done “pursuant to the terms of the contract”, i.e., the contract verbiage must indicate a specific right to make the change. 

The classic example of such a right exists with most universal life policies which specifically provide for adjustments to the death benefit amount or death benefit option (subject to underwriting approval).  But there are several important “current practice” changes that insurers may not be able to implement.  For example, upgrading a policy’s risk classification, e.g., from smoker to non-smoker (even with underwriting approval), is seldom, if ever, contractually guaranteed.  Adjusting the mixture of whole life and term insurance in “term blends” may also be precluded unless the contract verbiage specifically provides for such a change.  Bottom line – there may be lots of changes policy owners may request of their life insurance companies that will now be summarily rejected because of IRS Notice 2006-95.  The life insurance industry is hoping for clarification of this issue from the :IRS.