Life Insurance Fiduciary Review 21700 Copley Drive, Suite 395 Diamond Bar, CA 91765 866.444.4964 www.lagosadvisors.com
Why conduct periodic life insurance reviews? While many trustees are facing increased scrutiny of their investment performance in these difficult economic times, trustees of trusts holding life insurance face additional challenges in their management of this special asset. The Uniform Prudent Investor Act ( UPIA ) and similar statutes require as rigorous a management model for life insurance as of other types of assets.
Some Background Statistics According to a survey reported by Trusts and Estates (April 1999), 70-95% of trust owned life insurance (TOLI) has no current service agent One might expect professional corporate trustees would provide more oversight than family members or friends serving as trustee. Not the case. A more recent survey by Trust and Estates (May 2003) of approximately 550 trustees roughly equally split between professional trustees and family or friends acting as trustee reported similarly. o Of professional trustees, 83.5% indicated that they had no guidelines and procedures for handling TOLI o More disturbing, 95.3% stated they had no guidelines of procedures for handling the asset allocation components of variable life insurance o For nonprofessional trustees, 71.2% indicated that they had not reviewed their trusts life insurance policies in the last 5 years o As with professional trustees, 94.7 reported they had no formal procedure for managing variable contracts
Possible reasons for the lack of management of trust owned life insurance Trustees are not aware of the variables within a life insurance contract that can affect the performance of the policies. Their primary focus with respect to the life insurance asset is accepting premiums; sending Crummey notices and paying premiums. Many trustees as well as individuals view life insurance as a long-term asset not intended to mature for many years or decades. They do not have access to insurance professionals willing to assist in the review and monitoring process. It is estimated that as much as 90% of trust owned policies are orphaned policies not having an assigned servicing agent. They may not have the time or knowledge to determine how to conduct a policy review and audit.
The Uniformed Prudent Investor Act (UPIA) and other standards of care Just as a trustee might monitor the investment assets in a trust to ensure their performance is meeting expectations, a trustee should also consider monitoring and reviewing the life insurance assets in a trust for which they are responsible. Bank regulatory agencies, states and the UPIA have set standards related to the selection, purchase, and monitoring of trust owned life insurance contracts with a similar standard of care. Particularly applicable are the UPIA and standards set out by the Office of the Comptroller of the Currency (OCC) with respect to standards of care for the purchase of life insurance. While these standards have not always influenced court decisions in case involving judgment or lack of judgment over life insurance, the themes of the UPIA set a standard for trustees that should be considered a minimum threshold. It is important to note that the UPIA sets a basic standard which may vary from state to state. Additionally, any specific trust documents may be drafted whereby the trustees are held to an even higher standard then set forth by the the UPIA.
The trustee s responsibilities First, trustees must act in what is known as a fiduciary capacity, in effect bearing the burden of carrying out the trust s objectives for all beneficiaries. The UPIA specifically notes: if a trust has two or more beneficiaries, the trustee shall act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries. Additionally, the Act is very specific in noting that when acting in such a fiduciary capacity, the trustee must consider the purpose, terms, distribution requirements and other circumstances of the trust. Clearly, the trustee of an irrevocable life insurance trust must always be aware of the purpose for which the trust was established and undertake all actions to ensure those objectives are met. The Act holds all trust assets to the same standards and requires trustees not only to monitor performance, but to also assess the risks and quality of assets in the trust. Two key provisions note both requirements: o the trustee s continuing responsibility for oversight of the suitability of investments already made, as well as the trustee s decisions with respect to new investments o Within a reasonable time after accepting a trusteeship or receiving trust assets, a trustee shall review the trust assets and implement decisions concerning the retention and disposition of assets in order to bring the trust into compliance with the purpose, terms, distribution requirements of the trust
Practical standards a trustee should follow upon initial procurement of the policy Determining the need and quantification of the life insurance death benefit amount in conjunction with the clients counsel and other financial advisors supported by the overall estate plan. Vendor and agent selection Review and selection of the appropriate types of life insurance Product selection and diversification Carrier selection and diversification Investment policy and ongoing monitoring process for variable contracts
Practical standards a trustee should follow for ongoing monitoring of the policy The frequency of ongoing reviews and the monitoring process is subjective. A variable contract subject to market volatility should be reviewed similarly to any other investment portfolio and with consideration given to the current economic climate. Fixed portfolio rate contract should be reviewed perhaps annually. Review of initial, issued policy design illustration, i.e. how was the policy designed initially based on the then assumed funding schedule, crediting rates and cost of insurance. Based on actual results, in force illustrations should be requested from the insurance company projecting how the policy is expected to perform going forward. A comparison of the initial policy design and intended results, and actual performance and projected results should be compared and any shortfalls addressed with the client and counsel. If the client is still in good health and insurable, a market study should be conducted to determine if there are alternative contracts available that could better meet the objectives. Furthermore, the internal costs of newer policies can be lower than older contracts allowing for the purchase of more death benefit for the same premium commitment. Newer contracts many times also provide better guarantees. If the client is not insurable, the contract should be redesigned to maximize expected results and a suitable servicing agent should be appointed. Evaluations should include: carrier financial strength; projected date of potential lapse; funding requirements; internal rates of returns for various life expectancy assumptions. Although replacement is sometimes prudent extra care should be given with respect to surrender charges, higher internal costs, reduction of cash values, and guarantees.
How a trustee might be sued All cases depend on the facts and circumstances of each individual situation and the specific wording of the trust document. There is a strong sense in the legal community that many cases are settled out of court because of the relationship of the parties or because a corporate trustee wants to avoid adverse publicity. In most cases the beneficiaries bring suit. The client who established the trust and the insured typically does not have the legal standing to bring suit. However, in few circumstances of extreme negligence, the trust grantors were given the right to sue, or they attempted to sue the trustees. Negligence in maintain the life insurance policy. In one case the beneficiaries sued a CPA acting as trustee for failing to pay premiums due to problems related to the practice that caused premiums to be missed. In another, a corporate trustee failed to pay premiums despite receiving the gifts. Note, many irrevocable trusts include language allowing the trustee not to pay premiums, often a key consideration in cases such as these. Bad investment decisions. There are numerous cases where trustees have been sued due to investment decisions in variable contracts, loans or other decisions that failed. Poor initial policy design or improper policy assumptions. There are several cases where initial funding scheduled were not adhered to, or the then current high crediting rate assumptions were not met resulting in the policy not performing as expected. This is one area where regular policy reviews can identify potential problems providing time to take corrective measures. Over funding a contract for cash accumulation when maximum death benefit was the objective. In many circumstances, the premium commitment can provide a higher death benefit with the same guarantees instead of cash accumulation. Again, what is the objective for the insurance? Poor vendor selection. In one case involving a bank trustee the policy was purchased from a known felon whose life insurance license was revoked.
Other considerations and cautionary notes This outline was prepared by Lagos Wealth Advisors from various sources and is intended to be educational in nature and should not be considered a recommendation. The ongoing reviews should not be viewed as a planned replacement. No insurance should be canceled or replaced until the trustee is certain that any replacement offers an improvement to the trust and the beneficiaries. Any replacement will result in a new contestability period which should be disclosed and discussed with the trustee. Replacements may result in the imposition of surrender charges In some circumstances the sale of the current policy in the secondary market results in a larger economic benefit as compared to a 1035 exchange of its cash values.