Valuing Illiquid Assets in PPLI: Rules and Controls

Apply the tax definition to the correct account

Treasury Regulation 1.817-5(h)(9) distinguishes two valuation routes: market value where market quotations are readily available, and good-faith fair value determined by segregated-account managers for other investments. This definition does not itself prescribe a complete appraisal methodology or audit program.

Identify the relevant segregated asset account under paragraph (e), which groups assets by the identical allocation of their investment return and market value to variable contracts. Do not assume every investment shown on one policy statement can be combined for every diversification calculation.

Under the standard test, the largest one, two, three and four investments must not exceed 55%, 70%, 80% and 90% of total account value respectively. Apply the regulation's definitions, aggregation, look-through and alternative provisions before interpreting those percentages. Securities of one issuer, interests in one real-property project and interests in one commodity are each aggregated as a single investment for this purpose.

Listed does not always mean readily quoted at the relevant time. Trading interruptions, unreliable information or a materially different instrument can require attention. For private holdings, keep the valuation date, information date, assumptions, calculations and approval record. Good faith does not justify selecting a convenient number to pass a concentration test.

These checks supplement life-insurance qualification and investor-control analysis. They do not replace either. The investment flexibility guide places valuation in that broader process.

Trace partnership interests and eligible fund tiers

Paragraph (h)(6) includes cash items and partnership interests in its definition of a security, whether or not the interests are registered under securities law. It separately excludes interests in real property and commodities. An unregistered private-fund interest does not escape diversification analysis because it lacks an exchange price.

Where paragraph (f) applies, the account is treated as owning its pro rata share of the vehicle's assets. The relevant ownership and public-access conditions, including permitted exceptions, must be satisfied. Otherwise, the fund interest can remain a single investment. Obtain actual holder and structure information rather than relying on the description “insurance-dedicated.”

Revenue Ruling 2005-7 applies look-through across two eligible regulated investment company tiers on its stated facts. It does not grant automatic look-through to every chain of private funds. Document eligibility at each tier, ownership percentages, underlying holdings and their values.

The operational consequence is a data chain: lower-tier valuations can affect the top account's concentration calculation. Identify who obtains the data and who challenges it. A family may have permitted choices among strategies or managers; that does not authorize instructions about particular investments or valuations. Document the selection permissions for the actual platform.

Use quarterly tests and transaction checks together

Paragraph (c)(1) treats an account as diversified for a quarter if it meets paragraph (b) on March 31, June 30, September 30 or December 31, as applicable, or within 30 days after that quarter end. This is not a universal permission to postpone every valuation, acquisition check or policy transaction until those dates.

A fund's reported net asset value may arrive after the relevant test date. Obtain its reporting timetable instead of assuming an industry-wide 45 to 60 day delay. Where estimates are needed, define who prepares them, what information is used and how later data are reconciled. A late report is not an extension granted by the tax regulation.

Distinguish market fluctuations from acquisitions

Paragraph (d) protects a previously compliant account from being treated as nondiversified in a later quarter solely because of a value discrepancy, unless the discrepancy exists immediately after an acquisition and is wholly or partly caused by that acquisition.

For example, a holding's share rising from 50% to 62% through market performance alone does not automatically cause a diversification failure if the provision's prerequisites are met. A purchase that creates or contributes to the discrepancy needs separate analysis. A purchase and a valuation change occurring in the same quarter do not, without examining causation, determine the result.

Before funding a capital call or other acquisition, calculate its effect using supportable values. Examine distributions and cash leaving the account as well, because they can change holdings and the denominator. A pre-acquisition check complements scheduled testing; it does not authorize the policyholder to instruct portfolio trades.

Account for start-up and liquidation provisions

Paragraph (c)(2) provides start-up treatment until the first anniversary for an account that is not a real-property account on that anniversary. An account qualifying as a real-property account on its first anniversary can have treatment until the earlier of its fifth anniversary or the anniversary on which it ceases to qualify. The anniversary runs from the first qualifying allocation to the account, not necessarily from a particular family's purchase.

The real-property definition has staged asset percentages and a specific first-anniversary alternative. Merely holding a real-estate fund does not establish eligibility. More than 30% of allocated amounts attributable to sufficiently old contracts can end start-up relief prospectively, with the one-year or five-year period and specified transfer exceptions in paragraph (c)(2)(iv). Document the full conditions before relying on relief.

Paragraph (c)(3) separately provides one year for a qualifying non-real-property account liquidation, or two years for a qualifying real-property account liquidation, starting when a liquidation plan is adopted. The account must satisfy the diversification requirements on the plan-adoption date. Neither provision is a general holiday from policy compliance.

Reconcile tax, insurance and accounting requirements

The NAIC Variable Life Insurance Model Regulation, Sections 4D(5)(b) and 6A(4), calls for asset valuations at least as often as benefits vary or are determined, and at least monthly. Section 6E specifies market value on the valuation date, or amortized cost when it approximates market value.

That is model language. The binding requirement depends on adoption, scope and any variations in applicable law. Identify the issuer's domicile and other relevant jurisdictions; do not label every policy subject to an identical monthly rule. NAIC itself explains the role of state adoption of model laws.

ASC 820 is a reporting framework, not the tax definition

U.S. GAAP Topic 820 addresses fair-value measurement. Its hierarchy distinguishes unadjusted quoted prices for identical items in active markets, other observable inputs, and unobservable inputs. These are Levels 1, 2 and 3. The NAIC issue paper on net asset value reproduces the U.S. GAAP hierarchy and relevant Topic 820 text. Classify the actual measurement; the label “private asset” does not settle the accounting answer.

For eligible investments measured using the net-asset-value practical expedient under Topic 820, the measurement is not categorized within the fair-value hierarchy. Eligibility, measurement-date information and the required disclosures still matter. The NAIC issue paper reproduces that Topic 820 provision as well. A manager-reported NAV is not automatically an eligible or current measurement.

Do not assume every underlying fund reports under U.S. GAAP. IFRS 13 supplies a fair-value framework where applicable IFRS requirements call for it. Its measurement reflects a market-participant exit price at the measurement date. A fund's audited statements identify its accounting basis and reporting period; an annual audit is not the only possible reporting date.

Regulation 1.817-5(h)(9) does not incorporate Topic 820 or its hierarchy. Accounting evidence may help support a tax valuation, but conformity with one framework does not automatically prove conformity with another. Explain material differences in dates, units of account and assumptions.

Insurer statutory reporting also needs its own review. SSAP No. 56 addresses separate accounts, including distinctions between fair-value and permitted general-account-basis reporting. NAIC's 2026 SSAP No. 56 agenda record shows why the adopted text, effective date and applicable state treatment must be checked. It is not a substitute for the federal tax test.

Apply SEC Rule 2a-5 only where its scope fits

Rule 2a-5 applies to registered investment companies and business development companies. A private fund relying on Investment Company Act Section 3(c)(1) or 3(c)(7) is not brought within the rule merely because an insurance account invests in it. Determine the status of each entity, including any registered fund in the structure.

For covered funds, the rule addresses valuation risks and conflicts, consistent methodologies, testing and pricing-service oversight. Board oversight accompanies a valuation designee's work, with specified quarterly and annual reports, separation from portfolio management and notification of material matters within the board's deadline, no later than five business days after awareness. Read its separate provisions for unit investment trusts.

The rule also gives its own test for readily available, reliable market quotations. That wording does not rewrite the tax regulation. For an excluded private fund, comparable controls can be useful review criteria; their legal or contractual basis must be identified rather than attributing them automatically to Rule 2a-5.

Investigate a wrong value before deciding the tax outcome

A valuation error and a diversification failure are related but different findings. Reconstruct the information available at each measurement date, the correct account values, investment transactions and any applicable special rule. A concentration above 55% alone is not enough to resolve every case.

Under Section 817(h) and Regulation 1.817-5(a)(1), a diversification failure can remove insurance treatment for the affected and subsequent periods. Simply rebalancing in a later quarter does not restore that treatment. The regulation directs ordinary-income treatment for income on a nonqualifying contract under Section 7702(g) and (h).

Relief under paragraph (a)(2) requires showing that the failure was inadvertent, restoring compliance within a reasonable time after discovery, and agreeing to required adjustments or payments. Revenue Procedure 2008-41 supplies an issuer closing-agreement process and payment calculations. It superseded Revenue Procedure 92-25 and made Notice 2000-9 obsolete.

The issuer must establish eligibility and supply the required representations and supporting records. Have counsel check the current submission procedure and affected reporting obligations. Relief is conditional, not permission to breach the rules or a guaranteed inexpensive cure.

Treat gates and side pockets as facts to investigate

A gate restricts withdrawals; a side pocket separates designated investments under a fund's arrangements. Neither label alone fixes fair value, ends look-through or creates a diversification exemption. Identify the interest held, governing documents, holder eligibility and transaction history. Determine whether the restriction changes the asset, the holder's rights or both.

Accounting rules can distinguish restrictions on an asset from restrictions on its holder. For equity securities within its scope, FASB ASU 2022-03 clarifies that a contractual sale restriction on the holder is not included as a discount in the security's fair value. That does not establish one valuation answer for every gated fund or side pocket. Apply the relevant instrument, accounting scope and transition provisions.

The tax analysis still uses the account's valuation definition, eligible look-through and transaction rules. Liquidity can affect the evidence without independently deciding the tax result. The private-credit liquidity analysis addresses how cash restrictions affect policy funding.

Keep specialized guidance within its scope

• Notice 2016-32 provides alternative diversification guidance for specified government money-market arrangements, including an investor-control condition.
• Revenue Procedure 2018-54 addresses an election for allocating specified generic GSE securities between deemed issuers.
• Revenue Ruling 2005-7 addresses eligible tiered look-through; Revenue Procedure 2008-41 addresses inadvertent-failure correction.

These authorities address particular conditions. They do not supply a blanket safe harbor for illiquid or gated investments.

Keep five controls in the account review file

1. Named valuation responsibility: identify the account managers for paragraph (h)(9), data providers, approvers and independent challenge. Revisit responsibilities when adding an investment manager.
2. Scheduled and acquisition checks: record the applicable test, asset grouping, look-through and any special provision relied on.
3. Late-data procedure: define estimate methods, cut-off dates, escalation and reconciliation of final information.
4. Reporting reconciliation: explain differences among insurance valuations, tax tests and financial statements using their actual dates and standards.
5. Error response: preserve discovery dates, notify the issuer, assign counsel and record correction decisions and reporting implications.

A useful review asks to see the evidence behind the numbers. It does not direct the manager to choose values that produce the desired tax result. Use our editorial standards for the site's sourcing framework, and describe your valuation question with the relevant jurisdiction, asset type and decision.

Illiquid-asset valuation questions