3.5.2 Modified Endowment Contracts
Because of this, the industry formulated different versions of endowment policies. The Technical and Miscellaneous Revenue Act (TAMRA) enacted by Congress in 1988 redefined the tax law's definition of "life insurance contract" in an effort to eliminate purchasing life insurance for investment purposes or as tax shelters. That is not the intention of insurance.
The enactment of TAMRA actually created a new market for modified versions of endowment insurance. This new market is known as MEC (modified endowment contract). Once an endowment contract is considered a MEC, tax considerations change. There is, of course, a process that determines if the contract can be deemed as a MEC - called the "7-pay test." Insurers and their actuaries are responsible for making sure a policy complies with the 7-pay test. This is how it works:
If the total amount a policyowner pays into the contract during its first seven years exceeds the sum of the net level premiums that would have been payable to provide paid-up future benefits, the policy is deemed a MEC. Once a policy is classified as a MEC, it will remain so throughout the life of the policy.
