As the federal estate tax laws changed, the use of new irrevocable life insurance trusts (ILITs) diminished, but the work required to administer existing ILITs went up along with the potential liability attached to the asset class. There are several reasons for this.
1. As a country, we are aging and the population of the average TOLI portfolio is aging too. For example, 25% of the insureds in policies we manage for TOLI trustees are above age 80, 6% are above age 90. These demographic realities create decision-making dilemmas with policies, especially those that might be underfunded. Life insurance costs rise with age and problems also increase with age. Longevity combined with poor policy performance makes policy management decisions more complex and the wrong decision can render a policy funded for a lifetime worthless or nearly worthless. For example, there are 72,000 Americans over the age of 100 (1) when most older policies mature. Unfortunately, the outcome at maturity is often not what you (and your clients) may expect. Many older policies mature for the cash value only, creating two issues. If the policy contract matures with significant cash value, the proceeds could be subject to taxation. Or worse – the policy matures with minimal cash value leaving the trust with little value. There is an adage with life insurance, “I want to die with a dollar of cash value in my policy.” Unfortunately, for some who live to maturity, a dollar is about all their beneficiaries get. Try explaining that to a beneficiary that has forgone thousands of dollars over the years by waiving their Crummey rights.
2. Products have not lived up to projections over the years and the problem is growing worse. The use of whole life, with its guarantees, has dropped while the use of universal life (UL) chassis products has increased. Some UL policies have death benefit guarantees, but most are cash value dependent policies driven by policy performance, which has lagged. And in the last few years, many carriers have raised the cost of insurance (COI) on policies, exacerbating the performance problem. Policies with well-known carriers like Transamerica, Lincoln National, AXA, Banner, Genworth and John Hancock, and others, have had carrying costs raised by 200 percent and more, quickly dissipating policy cash value and placing trustees in a precarious situation as policies deteriorate.
3. Even those UL policies with guarantees can have issues. According to an industry expert, (2), a major guaranteed UL carrier performed an audit of policies issued in the 4 years since it started selling the product and found that, in that short timeframe, 31% of the policies already had compromised death benefit guarantees with the major culprit being early payments. Yes, paying early actually damaged policy guarantees putting trustees at risk.
4. The greatest increase in liability and workload for TOLI trustees will accelerate in the coming years as grantors decide they no longer need their policy because of changes in the estate tax law or wish to alter the asset in the trust. The process behind analyzing options besides simply surrendering or lapsing a policy is beyond the capabilities of many trustees and we have come across trustees who have surrendered multi-million-dollar assets with no analysis – a recipe for legal disaster.
5. Policy replacements are flourishing and the number of bad replacements coming into ITM TwentyFirst has increased in the last couple of years. One bad replacement (see Case Study #6, page 146 in the TOLI Handbook) would have robbed the TOLI trust of $900,000 leaving the trustee liable if we had not intervened. Another bad replacement caused a prospect of ours (now a client) to write a 5-figure check to make the client whole because the new policy was inferior to the one it replaced.
It’s a dangerous time out there for TOLI trustees. And it will not be improving but growing worse. In the coming months, we will continue providing some guidance to TOLI trustees. In the meantime, for guidance now, you can download the free TOLI Handbook, a guide for trustees, regulators and fiduciaries dealing with TOLI policies. It is available at www.TOLIHandbook.com.
- Worlds Centenarian Population Expected To Grow Eightfold By 2050, Renee Stepler, Pew Research Center, April 21, 2016, http://www.pewresearch.org/fact-tank/2016/04/21/worlds-centenarian-population-projected-to-grow-eightfold-by-2050/
- Bobby Samuelson, The Life Product Review, https://lifeproductreview.com
Good information per usual.
As for GUL traps, some advisors might warn clients about paying late but I would bet the opposite is true regarding mailing premiums early. It might be of value to review the cause, effect, and results of both in a future post.
I wonder what a GUL carrier would do if a client sent a check post-dated for the policy anniversary?
Miller & Associates
STATEMENT OF CONFIDENTIALITY: The information in this message is privileged and confidential and is intended only for the use of the individual or entity named above. If the reader of this message is not the intended recipient, you are hereby notified that you are prohibited from disseminating, distributing, or copying the information contained in this message. If you have received this message in error, please notify the sender immediately and destroy all copies of the original message.
CIRCULAR 230 DISCLOSURE: Pursuant to recently enacted U.S. Treasury Department Regulations, we are now required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal revenue Code, or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.
This Email is covered by the Electronic Communications Privacy Act, 18 U.S.C. 2510-2521 and is legally privileged. This information contained in this Email is intended only for use of the individual or entity named above. If the reader of this message is not the intended recipient, or the employee or agent responsible to deliver it to the intended recipient, you are hereby notified that any dissemination, distribution or copying of this communication is strictly prohibited. If you have received this communication in error, please immediately permanently delete it from your computer, destroy all copies, and notify us by telephone (316-204-7998).
GUL cases we have seen with early payment problem have been annual mode. For example, a bill comes out 21 days prior to the anniversary saying the premium must be paid by the anniversary. The client complies and the premium gets posted days before the anniversary. The problem occurs if the internal account either invokes a penalty for not making a premium payment in the coming year or invoking a higher load for extra premium in the prior year. It is a Catch 22 for paying your bill on time. Hopefully systems have been or are being corrected.
Another GUL problem is no value for excess premiums. This shows up in illustration systems and will occur in admin systems if not already occuring. An example would be 20 years of premium that would guarantee the DB for life even though the CV goes to zero. The excess premium would only make the account value less negative, but is beyond what is needed for the secondary guarantees. the Cv is still 0.
Regulators need to consider what type of disclosure and adjustments should be made for secondary guarantees.