The most common fear for a life insurance trustee is that somehow the ball is dropped and the policy in their care lapses. After all, a trust-owned life insurance (TOLI) trustee, even if they are not sophisticated in all the nuances of life insurance policy management, should at least be able to keep the policy in force. But unintended lapses do happen, and when they do, knowing how to fix the problem is essential. In this post, we will provide you with a guide.
A policy lapse can occur when the premium for the policy is not paid within the grace period (typically 31 days after the premium due date) in policies that do not have underlying cash values to support the policy. Most lapses occur in term policies, policies with dwindling cash values, or in policies with significant loans.
Speed is the most crucial factor when remedying a policy lapse. For most policies, there is a period after the policy has lapsed when the policy can be reinstated with the payment of the back premium owed only. This is typically within 10-30 days of policy lapse, depending on policy issue date (age of policy) and size of the policy. Contacting the carrier within this window will allow you to reinstate the policy without the insured going through any underwriting, answering any health questions or even being aware that the policy lapsed.
Contact the carrier as soon as the lapse is detected and ask them what their policy is. If you are beyond their window for this simple reinstatement, more than likely the insured will have to fill out a reinstatement form that includes many of the items included on the original policy application. Questions about weight (and weight change), smoking habits, driving record (tickets or other issues), travel plans (outside the country), and health information (especially any changes in the last 10 years) will be part of the reinstatement application. As long as the health of the insured has not changed, the policy can still be reinstated with a check for the policy back payments.
A few helpful hints:
- If you have any contacts with the carrier, especially if that contact is in marketing or sales, now is the time to call them. We once had a bank we work with onboard a wealth management client and during the process they allowed a term policy to lapse before it ever got to us. The lapse was still fresh, but outside the reinstate-with-premium-only window. Calls to policy service provided no solution; they would not budge. However, a friend who was in the brokerage world (and had done a lot of business with the carrier) gave me the name of his marketing rep at the carrier, who got the policy reinstated without having to notify the client. We were heroes on a policy before it even came to us. The marketing reps – responsible for generating revenue for the carrier – may be able to get the home office to move when you cannot.
- If you cannot get the policy reinstated, review all the notices from the carrier related to that policy lapse and note any issues that may give you some recourse. We once took over a portfolio of life insurance from a bank, and though one policy was listed in the file, it was no longer in force. That policy, a whole life contract with a substantial loan, had lapsed a little more than two months before our taking over the portfolio because of a loan squeeze. As many of you know, this can cause a taxable event. While we were well outside the official reinstate period, a review of correspondence turned up some inconsistencies in carrier communication. The carrier, after conversations with house legal counsel for the bank, reversed the lapse. The policy limped along (with small interest payments applied to the loan) until the insured passed away, avoiding any taxation to the trust.
- If there are no methods to get the policy reinstated, look to a good life insurance advisor to research the market for a new policy for the insured. Just because the existing policy’s carrier will not reinstate the policy does not mean you cannot get reasonably priced coverage. In fact, I was once called out of the blue by a trustee (not a client) who had allowed a policy to lapse and had no recourse. But after providing her with a referral to a seasoned life insurance pro I knew, she got a new policy issued on her clients that actually saved the trust some premium dollars.
It is not easy to manage a life insurance policy, and policy lapses do occur, even for the most responsible trustee. Knowing what to do next can mean the difference between dodging a bullet, writing a (large) check or winding up in litigation.