In the first two entries in this series we outlined the TOLI outsourcing model and examined the many advantages of outsourcing the administration of your TOLI trusts. In this entry, we will explore the vulnerability for most TOLI trustees – policy management. While the case to outsource can be made generally on economics alone, we have seen time and time again that trustees simply do not have the requisite skills or training to truly manage a life insurance portfolio in-house. We regularly see situations where the wrong decisions involving a policy create real liability for the trustee. There are three areas where we see this most consistently.
Changes in Policy Performance:
The last decade of market volatility and historic low interest rates has put great stress on policy performance, and the cost of insurance (COI) increases we have seen have wreaked havoc with estate plans as carrying costs on affected policies have dramatically increased. Maximizing the value of a problem policy is required of a TOLI trustee, but sometimes it takes a high level of “insurance intelligence” to do that. Case in point was a COI increase case our remediation team encountered. In that situation, a grantor subject to a 50% increase in premium costs was looking for the best alternative for his existing policy, as his health precluded the purchase of a new policy. We reviewed all policy options, including those not offered by the carrier in their communications concerning the COI increase. By reviewing the policy contract in detail, we found that the trustee could convert the universal life policy to a contractually “paid up” whole life policy. The conversion created guaranteed death benefit coverage that eliminated the COI issue. The trustee provided the grantor and the trust with a prudent decision based on the facts of the case, and the grantor was thrilled with the level of service received. When you deal with thousands of policies, your knowledge of insurance grows. Missing an opportunity to maximize the trust value in a problem policy could create a liability for the uninformed trustee.
Due to changes in the estate tax laws, some grantors’ perceived needs for their existing policy may change. However, a trustee still has a stated fiduciary duty to manage the asset to generate the maximum benefit for the beneficiaries. We often see trustees granting a surrender request with no analysis to determine the prudence of their decision.
When a thorough review is done, it is often found that surrendering a policy is not the best outcome. For example, we reviewed a proposed surrender of a $1.5 million universal life policy with approximately $500,000 of cash surrender value. We found that with no additional premium, lowering the death benefit by just over $300,000 would guarantee the policy to maturity with a death benefit of almost $1.2 million. Even if the policy surrender proceeds were invested at a 7% after tax rate (hard to achieve) the investment account would never surpass the death benefit value in the policy during the life of the insured. The policy death benefit was guaranteed, and the beneficiaries would receive the return tax free. As life insurance products are generally not the specialty of trustees, they typically would not know how to perform the analysis.
Over the last few years we have seen an uptick in policy replacements that are not in the best interests of the trust. In one example, a recommended trusted insurance agent suggested to the grantor that a trustee replace three whole life policies with substantial guarantees with one new universal life policy based on assumptions that may not occur.
When reviewing a replacement, our remediation team focuses not just on the new policy, but on maximizing the benefit of the existing policy. In this case, our review showed that with no additional premium, the existing policies could have been adjusted to provide a guaranteed death benefit of $2.5M, while the new policy would have only provided $2M of coverage, which was not guaranteed. Had the replacement gone through as suggested, the trust would have lost 20% of its benefit, with potential liability to the trustee of $500,000. This type of case is a favorite of plaintiff attorneys.
I could go on, as our remediation team has documented scores of cases like these where we have averted liability to the trustee and maximized the trust benefit for the real client, the beneficiary, the person most likely to sue you, the trustee. But I think you can clearly see the problem.
Most every check written to settle a dispute around a TOLI trust is written in confidence, but many are written. Outsourcing a TOLI trust can not only make your operations more economically efficient and increase client service levels, it can also save you the embarrassment and costs associated with disputes.
It just may be time to consider outsourcing your Irrevocable Life Insurance Trusts to an expert.