The majority of trust owned life insurance (TOLI) settlements do not come after a court case, they are paid out behind closed doors to avoid publicity.  But the cases that wind their way to court guide the TOLI trustee hoping to avoid liability.  In this two-part series we will review several cases and outline the key takeaways for a TOLI trustee.

Stuart Cochran Irrevocable Trust v. KeyBank, NA 

The KeyBank case, was decided in March of 2009 and centered on a life insurance policy replacement.

KeyBank, the successor trustee to an ILIT exchanged the policies in the trust for two variable life policies tied to the equity market, totaling $8 million in death benefit, in the first quarter of 1999, shortly after taking over the ILIT.

After 9/11, the equity market dropped and in both 2001 and 2002 the policies lost money.   Around this time the grantor, age 52, had a financial setback and announced he would no longer fund the trust.  KeyBank paid for an outside review firm who found that with no additional premium the policies could not be expected to run past age 70 of the insured.

The agent for the grantor suggested the purchase of a John Hancock Guaranteed Universal Life (GUL) policy using the cash value in the existing policy and no further contributions.  The new policy dramatically reduced the market risk of the trust as it was contractually guaranteed to run to age 100, but with a much lower death benefit.  KeyBank placed the policy in force in June of 2003, with a death benefit of $2,536,000.  Less than a year later the insured died unexpectedly, and the beneficiaries received the lower death benefit. The beneficiaries filed suit claiming, among other things, that “KeyBank had breached its fiduciary duties as [t]rustee.”

Most pundits believe the court set a low bar in its ruling, but nonetheless, KeyBank won on every point with the court finding that the replacement was prudent under the circumstances since the existing policy had the “likelihood of ultimate lapse” and the trustee decisions made were “consistent with the standard established by the prudent investor rule.”

As is often the case, the agent for the policy suggested the replacement and the beneficiaries claimed that KeyBank “imprudently and improperly” delegated certain decision-making processes to the agent and the grantor.  The court disagreed and the fact that KeyBank hired an advisory firm with no “financial stake” in the outcome to review the policy replacement and provide recommendations was a major reason the court found against the beneficiaries claims.

KeyBank did not review many options, in fact, they reviewed only one policy type from one carrier, an issue the beneficiaries brought up in their suit. Though the court agreed KeyBank  “could have done more,” they found the review process “adequate.”

The beneficiaries  complained that KeyBank failed in its duties since they did not provide enough information on the transaction, but the court pointed to the trust document that provided the trustee with power to “surrender or convert the policies without the consent or approval of anyone.”

Finally, the beneficiaries claimed the bank breached its fiduciary duty of loyalty to them because of the contact with the grantor and agent during the replacement.  The court did not agree and pointed out as a “practical matter” discussions would occur with a grantor/insured since the underwriting process could not be “effectuated without communication.”

Key Takeaways from the KeyBank Case

  • While the court agreed that the referenced replacement was “prudent,” the rapid replacement of the
    policies, first in 1999, then another 2003, both driven by an agent’s advice could be construed as a “flavor of the month” selection process. In general, policy replacements should not occur that quickly—they come with costs, in this case over $100,000 in surrender charges.  Make sure that all replacements are warranted, not rapid.
  • Using an outside vendor was critical in the court’s decision. The vendor provided guidance the bank did not have in-house and came from an entity with no “financial stake in the outcome.”  By utilizing an outside vendor, the bank overcame the beneficiaries claim they were “improperly delegating” the decisions to the agent and grantor.
  • That grantor was a part of the policy process and the court rightly decided that was proper. However, the influence of the grantor toward a transaction should be avoided and a trustee must stand firm in its decision making with documentation that outlines the reasons for a prudent decision.
  • The replacement policy review, while deemed “adequate,” certainly set a low bar and a more rigorous review of the existing policy and alternatives should occur. Lately, we have found more liability in policy replacements than any other aspect of TOLI administration.
  • Another low bar – the notification of the beneficiaries. While the court said the bank had no “requirement” to alert the beneficiaries because of trust language, perhaps if they had and if the they had documented that conversation this case would not have moved forward.

Hatleberg v. Norwest Bank, Wisconsin
The Hatleberg case revolved around a TOLI trustee’s responsibilities once made aware of issues in a poorly-written trust document.

A client of the bank utilized an attorney/friend to draft an ILIT, which was pulled from a template book and written without Crummey provisions.  Initially this went unnoticed, but the bank became aware after performing an annual review and alerted the attorney.  Unfortunately, neither party alerted the grantor and it was not until the grantor passed away that the bank alerted the probate attorney handling the estate that the document lacked Crummey provisions.

Because the bank did not draft the ILIT and because the document did not assign to the trustee the “duty to review the trust,” the court found the bank had no responsibility “to ensure its effectiveness as an instrument to avoid estate taxes.”

The court found that once the bank and the writing attorney were aware of the situation, they both breached their duties by allowing the grantor to continue funding the trust even after they both knew “the trust was defective.”   For that, the court found them both liable for the additional estate tax costs.

Key Takeaways from the Hatleberg Case

  • The trustee was not held liable for the mistake in the trust document because it was not assigned that responsibility, but the trustee still must be aware of the contents of that document.
  • The responsibility to alert the grantor of an issue with the document or the trust is a requirement of the trustee.
  • The proper administration of the Crummey provision is the responsibility of the TOLI trustee.

Paradee v. Paradee
In the Paradee case both the trustee and a family member were found liable because of trust transactions.

A life insurance trust was set up by a grandparent William Charles Paradee (Charles Sr.)  for his grandson (Trey), the son of his estranged son (Charles Jr.).  The policy used was a survivorship policy that insured Charles Sr. and his second wife Eleanor.

The agent who wrote the policy was named trustee of the trust and Charles Sr. and Eleanor instructed him to revoke the trust. Charles Sr. had health and possible mental issues and Eleanor appeared to be the “driving force” behind decisions being made by the Paradees, who were feeling financial pressures.

The agent, after consulting with the family attorney, decided the Paradee family would not be allowed to gain access to the policy’s cash value by revoking the trust. Eleanor then asked for the trust to loan the money, and that request was accepted. While the terms were supposed to be at market rates with sufficient collateral, in fact, the cost of the loan on the policy was higher than that charged to the Paradees.

Shortly after the loan request, Charles Sr. passed away, at which time the trustee could have requested all principal and interest on the loan be repaid to the trust – he did not.  Around this time, Trey turned thirty which gave him the right to serve as trustee, though he was not informed of this right.

The writing agent passed away and Eleanor appointed herself trustee. Interest was allowed to accumulate on the policy which soon lapsed.  Eleanor resigned and appointed the family handy man as trustee.  The handyman/trustee insisted Trey be told of his rights, Trey became trustee, demanded the loan be repaid and it was.

The court found that the writing agent had breached his fiduciary duty with help from Eleanor.  The agent, instead of doing what was right for the beneficiary, did not assess “what was in the best interests of the Trust, he evaluated whether he could please his long-time clients.” Eleanor was found liable since the “conduct of one who knowingly joins with a fiduciary . . . in breaching a fiduciary obligation, is equally culpable.” Eleanor was liable for over $1 million in damages, with additional damages shared by her and the writing agent.
Key Takeaways from the Paradee Case:

  • Though neither Eleanor nor the writing agent were corporate trustees, that should not provide the corporate trustee with comfort as they are held to a higher standard.
  • A TOLI trustee cannot put the more profitable business dealings with a grantor ahead of responsibilities to the beneficiary.
  • Personal issues – family squabbles, second marriages, failing physical and/or mental health of the grantor are all red flags that should signal a trustee to take special care around a TOLI trust. We often tell trustees that the liability around a TOLI trust may not come from the policy but the personalities surrounding the trust.

These three cases guide the TOLI trustee.  In our next post, we will review three other cases, including one life insurance case with a court settlement of more than $14 million.

This posting was adapted from Chapter 2 of the TOLI Handbook, a free guide for TOLI trustees that can be downloaded at www.TOLIHandbook.com