Originally Posted 3/26/18. Updated 10/2/2019
Those of us in the fiduciary world are aware of the rash of lawsuits targeting 401(k) plans. Fidelity, the largest retirement plan provider in the US, settled lawsuits filed by its own employees alleging that its plan choices were too costly (1). Vanguard, a firm known for its low costs, was referenced in a suit alleging that by selecting classes of mutual funds with higher costs when lower-cost funds were available, plan fiduciaries breached their duties under the Employee Retirement Income Security Act of 1974 (2).
While the virtues of each case can be debated and the final verdicts are eventually handed down by the courts, the cases themselves provide those in the trust owned life insurance (TOLI) community with guidance and insight. A few observations follow:
Times are changing. While discussing the Vanguard case, an attorney noted that a fiduciary must not “take anything for granted.” Instead, he/she must “view things new and fresh with respect to evolving fiduciary standards, and have an open mind (2).” We could not agree more. Do you think that the executives at Boeing, when they set up their 401(k) plan to benefit employees, ever thought that they would settle a multi-million-dollar case in which they admitted to violating Employee Retirement Income Security Act (ERISA) provisions (3)? Or that well-respected companies would have ever thought they would be sued for selecting their own funds in their company-sponsored plans? I doubt it. ERISA, the guidebook for 401(k) fiduciaries, is 44 years old, but it took 30 years for the first 401(k) lawsuits to trickle in. Now, it is a tidal wave. The Uniform Prudent Investor Act (UPIA), the TOLI trustee guide, is 26 years old. Will the evolution of fiduciary standards that is battering the 401(k) world hit the TOLI market? Perhaps. Will TOLI trustees be ready if it does?
The UPIA “regulates the investment responsibilities of trustees,” including TOLI trustees. It directs trustees to “invest and manage the trust assets solely in the interest of the beneficiaries,” yet too often, decisions are flavored by the whims of the grantors, to the possible detriment of the beneficiaries. The document points out the responsibility of the trustee to “monitor” and “investigate” the trust asset, yet some TOLI trustees simply do not have in-house experts who are capable of carrying out this task with life insurance. And the result could be catastrophic. In an ITM TwentyFirst University webinar last year, we pointed out a replacement case in which a trustee was advised to replace a policy with one that had costs that were 400% higher. Clearly, that transaction, if completed, would have violated Section 7 of the UPIA that directs trustees to “only incur costs that are appropriate and reasonable in relation to the asset,” leaving the trustee open to litigation. Luckily, it was caught by our remediation team, but how many “bad transactions” are out there?
While the fiduciary climate may be evolving, some truths remain, and an article on designing 401(k) plans to avoid lawsuits pointed out two of them (4).
First, when there is an issue, the trustee will lose in court “when it can be shown [that] the fiduciary was unaware of the issue or otherwise didn’t look at it or understand it.” The Latin term is ignorantia juris non excusat (ignorance is no excuse). In the replacement example above, the trustee could have been held liable for the improper transaction because he/she did not know how to analyze the policies involved. The OCC Handbook on Unique and Hard-to-Value Assets points out that a “fiduciary must understand each life insurance policy that the trust accepts or purchases, or…employ an advisor who is qualified, independent, objective, and not affiliated with an insurance company to prudently manage these assets.”
Second, the article points out issues, such as higher costs are not always necessarily bad, if they can be justified. With life insurance, for example, death benefit guarantees may make a policy costlier, but the higher costs may be justified based on trust investment goals and risk tolerance. But higher fees become “legally problematic” if the fiduciary “isn’t able to demonstrate it engaged in a prudent decision-making process” to show why the higher costs were justified. As emphasized in the article, “prudence — and the documentation of it — is the key ingredient” for trustees and fiduciaries who must demonstrate that they have made a proper decision about an asset.
To successfully manage life insurance in a TOLI setting, you must understand the asset, and then develop and document a prudent process for the decisions that are made regarding the policy. If not, you will open yourself up to liability.
- Fidelity Settles Lawsuits Over Its Own 401(k) Plan, Melanie Hicken, CNN Money, August 18, 2014
- New 401k Suit Targets Vanguard Fund Fees, Greg Iacurci, investmentnews.com, January 5, 2018
- Boeing Settles “Spano” Fee Case, John Manganaro, planadvisor.com, August 27, 2015
- How to Design a 401(k) That’s Lawsuit-Proof, Greg Iacurci, investmentnews.com, March 19, 2018
I agree that that trustees for ILITS and other trusts should be held to the same standard as the ERISA cases re disclosures, fees and risks. Insurance companies. Insurance illustrations are often misleading and unreasonable, and trustee relying solely on an insurance agent who’s either attempting to preserve earn a commission is not reasonable.
Steven: There have been many settlements for mistakes by TOLI trustees. And some of them have come from relying on others simply because the trustee does not have the expertise.