Jan. 29 (Bloomberg) -- Life insurance is sold with the promise that policy-holders can beat at least one of life's two certainties: taxes. That pitch may have to change.

Northwestern Mutual Life Insurance, Prudential Financial Inc., MetLife Inc., New York Life Insurance Co. and other insurers may be facing a new fight to preserve a tax break that has grown to $28 billion a year since it was first written into U.S. law in 1913. As Congress looks for sources of revenue to curb the federal budget deficit, that benefit -- which allows life insurers to market their policies as tax-free savings accounts -- may make an attractive target.

The life insurers' break is one of hundreds of so-called tax expenditures that cost the federal government $945 billion a year in foregone revenue, according to the Congressional Research Service. It's also the largest to benefit a single industry and is overdue to be examined by a fiscally responsible Congress, says Comptroller General David Walker, who heads the congressional agency charged with auditing the budget.

``There is absolutely no question that the tax preferences associated with life insurance represent one of the reasons why you've seen the proliferation of the use of life-insurance products,'' says Walker, who heads the Government Accountability Office. ``We need to review and reconsider all major tax preferences, including this one.''

Life insurance's special treatment means funds invested in policies and deferred-annuity contracts can accrue untaxed. Such investments contained $99.5 billion in 2005, according to the Insurance Information Institute, a nonprofit New York-based trade organization funded by the industry.

Better Returns

Some financial analysts question the value of life insurance as an investment and say better returns can be found elsewhere. As a savings vehicle, life insurance is ``garbage,'' says Errold Moody, author of ``No Nonsense Finance'' and a life and disability insurance analyst in San Leandro, California. ``There are things cheaper and better that the people can utilize to save and invest. Insurance with an investment element in it is not insurance.''

As evidence, Moody says about 90 percent of policy-holders cash out before the term of their contracts, settling for a lower -- and taxable -- payout.

Walker says the tax-free feature also has been linked to questionable business practices that have drawn scrutiny from Congress, the Internal Revenue Service and the courts. In the 1990s, Dow Chemical Co. and grocer Winn-Dixie Stores Inc. lost court decisions when the IRS challenged deductions related to the purchase of insurance on company employees.

Influential Lobby

So far, though, congressional reviews of the industry's tax advantage have been rare. Moody says the longevity of the tax break is tied to the influence of the industry's lobbying groups, which collectively spent more than $10 million in 2005, according to federal filings.

The largest of these groups, the American Council of Life Insurers, successfully headed off efforts to reduce the benefit in 1986. The group is headed by a former governor of Oklahoma, Republican Frank Keating, and one of its senior lobbyists is Kim Dorgan, wife of Senator Byron Dorgan of North Dakota, a member of the Democratic leadership in Congress.

Scrutiny of the industry's tax-free benefit ``just never gets anywhere,'' said Joseph Belth, publisher of the Insurance Forum newsletter and a retired professor who taught risk and insurance at Indiana University in Bloomington for 31 years. ``It's considered a political third rail.''

Competition

Still, in recent years, life insurance has lost some of its privileged status as it faced competition from an increasing number of tax-advantaged savings vehicles such as Individual Retirement Accounts.

That pressure may intensify. President George W. Bush has proposed creating new types of untaxed accounts to help Americans save. He has also called for a permanent repeal of the federal estate tax, which, if enacted, would put further pressure on the industry because many insurers have promoted their policies as a way to set aside money for heirs to pay the levy.

The most recent direct examination of the industry's benefit was in the November 2005 recommendations of an advisory panel on tax reform appointed by Bush. The panel's proposal to repeal incentives for life insurance drew protests from companies such as Milwaukee-based Northwestern Mutual, the nation's leading direct provider of individual life insurance.

Poor Choice?

``This unfavorable treatment of life-insurance products, and the Americans who depend on these products, seems to be an extremely poor public-policy choice,'' Northwestern Mutual Chairman and Chief Executive Officer Edward Zore wrote in a December 2005 letter to the Treasury Department. Treasury has been reviewing the panel's proposals, and the administration hasn't said which, if any, would be adopted.

Mary Flowers, a spokeswoman for Newark-based Prudential, declined to comment on the industry's tax breaks. Chris Breslin, a spokesman for New York-based MetLife also declined to comment. MetLife and Prudential are the largest U.S. life insurers by market value.

Oregon Senator Ron Wyden, a Democrat on the Budget and Finance committees who has drafted a plan to overhaul the tax code, agrees with Walker that lawmakers should re-examine all tax expenditures. He says tax rates could be lowered for everyone if most tax expenditures were eliminated.

``All of this is outdated,'' Wyden said in an interview. ``Let's step back and say, `Let's get rid of this clutter.'''

The industry seems unconcerned. Ann Cammack, senior vice president for taxes and retirement security at the ACLI, says her group is confident life insurance's tax preferences are secure because the policies stimulate savings and retirement security in an era when the national savings rate has dipped into negative territory and baby boomers are approaching retirement.

A Need for Savings

``The justification is exactly the same as it was in 1913,'' she says. ``We clearly in this country have a strong need to encourage personal savings.''

Sy Sternberg, chairman and chief executive of New York Life, the largest U.S. mutual life insurance company, says the policies provide ``fundamental protection that can mean the difference between keeping or losing the family home, college educations, and fulfilling retirements for millions of Americans.''

Insurers paid out $365 billion in life insurance and annuity benefits in 2005. They hold about $4 trillion in long-term savings, according to the ACLI, which counts Northwestern Mutual, New York Life and MetLife among its members.

Ken Kies, a lobbyist at the Washington firm Clark Consulting who represents the Association for Advanced Life Underwriting, says he too believes Congress is unlikely to touch the insurance industry's tax advantage. ``My judgment is nothing like this will happen,'' he says.

`An Unfair Subsidy'

Lee Sheppard, a contributing editor at the journal Tax Notes, says the industry's claim that its almost century-old tax preference remains valid may no longer be persuasive. ``It's an unfair subsidy for a particular kind of investment vehicle, which distorts competition,'' she says. ``A life-insurance company is otherwise the same as any other financial intermediary, like a bank or a mutual fund.''

The Democrats who took control of Congress this year have vowed to enact so-called pay-as-you-go budget rules that would require any new expenditure to be offset by revenue. The proposal, which passed in the House this month, may mean the life-insurance break and other tax expenditures could get a new look from lawmakers.

``This may be one of the areas that Congress revisits as a source of potential revenues,'' former Senator John Breaux, a Louisiana Democrat who was co-chairman of Bush's 2005 tax panel, said in an interview. ``In this city, at this particular time, with tight budgets, I think everybody's going to be on the block, everybody's going to be looked at and looked at very carefully.''

To contact the reporter on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net.

Last Updated: January 29, 2007 11:26 EST