Trust Owned Life Insurance:
Is It An Accident Waiting to Happen?
Trust owned life insurance is often central to many client plans, enabling clients to provide for survivors, cover estate tax liability planning, balance inheritances among heirs and meet charitable objectives. Trusts can offer clients professional management, the peace of mind that their concerns will be addressed after their death and a level of privacy not offered with other planning devices.
Deciding on a trustee is a critical and personal decision and choosing a family member, a family friend or a professional trustee all offer certain benefits. In many cases, however, trustees may not be managing the life insurance as actively as they may manage other assets. In such cases, this could put a clients goals and the care of beneficiaries at risksetting up the possibility of a lawsuit.
This article will explore the standards increasingly applicable to trustees and trends in recent court cases that should be of concern to all trustees. It also will examine how trustees may or may not be handling TOLI. But the best place to begin is to consider the many changes the life insurance industry has seen in recent years which might affect trust owned life insurance.
Areas where TOLI is vulnerable
In many cases, trustees charged with managing a trust will actively look at the investment portfolio or hire others to fill that role. It would be unheard of, given the volatility of todays equity marketplace, not to do a periodic review of trust assets. However, that is exactly what may be happening with many TOLI policies. There could be many reasons for this. For example, perhaps life insurance is viewed as a long-term hold whose true purpose will not be needed, ideally, for decades. Or perhaps trustees are intimidated by the complexity of life insurance contracts, or are lulled into a false sense of security due to the risk-shifting nature of life insurance. It appears that trustees are, by and large, simply handling the maintenance duties of accepting gifts, sending out Crummey Notices and paying premiums. However, a failure to review could be devastating to a trust.
Consider the impact that factors in both the economy and the industry might have on life insurance that is residing in trusts. (See box on this page.)
A jump in premiums is a particularly sensitive area. Many trustees may find a longer premium-paying period or larger than expected premium payments. In many cases trustees may also face grantors that are not in a position to make these gifts for a number of reasons. There could be the death of a spouse, effectively halving a clients annual exclusion gifting power. Other clients may be hesitant or unable to utilize their exemption equivalent because of other estate planning factors. Still, others may stop paying premiums simply out of anger at the added cost. Because the grantor has no obligation to make gifts to the trust, the trustee is left in the bind of trying to meet trust purposes in the face of lower than expected financial policy performance.
Additionally, many life insurers have seen financial and/or management changes that would cause an otherwise investment-savvy trustee to re-examine a particular asset in their portfolio.
Are Trustees Living Up to the Task?
With all of these external pressures, are trustees rising to the challenge as it concerns life insurance? A series of surveys reported, in part, in "Trusts and Estates" would indicate that this is not necessarily the case.
One 2004 survey involved professional trustees, as well as family and friends acting as trustees. While one might expect that professional trustees would monitor their trust assets more closely than an individual acting as a trustee as a favor for a close family friend or relative, neither group showed much attention to the life insurance assets.
Among professional trustees, fully 83.5% indicated they had no guidelines and procedures for handling trust owned life insurance.
For non-professional trustees, 71.2% indicated they had not reviewed their trusts life insurance policies in the last 5 years.
Both groups did not focus closely on handling the subaccounts for variable life. Among professional trustees, 95.3%, had no guidelines for handling the asset allocation components of VL. Among non-professionals, 94.7% indicated they had no procedures in place for the allocation component of VL.
Another pair of surveys indicated that anywhere from 70%-95% of all trust owned policies do not have a life insurance agent servicing the contracts.
This would appear to indicate that many trust owned policies are simply in a maintenance mode. One professional trust owned life insurance service firm indicated that as many as 92% of existing TOLI policies could be restructured to provide 20% greater value. In fact, that same firm concluded, after a survey of policies, that 74%-87% of these contracts could be restructured to provide either a 40% increase in death benefit, or 40% reduction in premium.
The Uniform Prudent Investor Act and Other Standards of Care
Just as a trustee might monitor the assets in a trust, reviewing whether the individual investment performance is meeting expectations, a trustee should also consider monitoring and reviewing the life insurance assets in trusts for which they are responsible. Does this mean removing or replacing policies on a regular basis? No. It simply indicates that a greater level of care is required.
