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Re-examining Your Client’s Trust-Owned Life Insurance Policy

Evaluate its current value in the marketplace

Many wealth managers and estate-planning advisors will counsel their high-net-worth clients to purchase life insurance policies inside of a trust. Trustees, which are often professional management firms, then maintain the policies, which are often professional management firms. This can be very smart financial planning, as trust owned life insurance (TOLI) can allow families to achieve a variety of important tax planning and charitable giving objectives.

When a trust owns life insurance, the trustees are assigned the responsibility (under the prudent investment rule and relevant state laws) to exercise proper oversight of that asset in the trust. This involves evaluating the financial health of the policy, considering prudent techniques for paying the policy premiums and managing the policy in a way that integrates with other estate-planning strategies.

Unfortunately, many wealth management professionals fail to view the underlying asset inside the trust—the life insurance policy itself—the same way they would consider other assets (e.g., stocks, bonds and real estate) and rarely re-examine the life insurance policy for its current value in the marketplace. Perhaps this is because they assume life insurance is just a stagnant holding with a pre-determined cost of maintenance and an eventual payout to the trust when the insured person dies.

But this isn’t the case.

Evaluate Policy’s Financial Health

Wealth managers and estate planning advisors can’t afford to be asleep at the wheel when it comes to evaluating the financial health of a life insurance policy sitting inside of a client’s trust. Due to its long-term investment horizon to maturity, trustees charged with managing the overall trust often overlook TOLI. But as Jeff Hallman, managing partner of LISA member Asset Life Settlements, LLC, points out: “The percentage of TOLI policies at risk of lapsing is expected to increase, due in large part to the low interest rate environment, which is jeopardizing the expected earnings potential for universal life policies.”

In addition to the risk of inadvertent lapse, there’s the suddenly emerging threat of premium hikes imposed by insurers. If your client’s policy is affected by a premium increase, you need to assess whether the proposed new price makes sense in the context of the overall expenses of the trust portfolio. The best way to do that is to understand the financial upside to retaining the policy versus exploring alternatives, such as selling the policy to an institutional investor in a life settlement transaction.

A life settlement is the sale of a life insurance policy to a third party for a value in excess of the policy’s cash surrender value (CSV), but less than its death benefit. The trust receives a cash payment, while the purchaser of the policy assumes all future premium payments and receives the death benefit upon the death of the insured. Approximately 40 percent of life settlement transactions involve TOLI policies. 

Consideration of this Option

Consider this true story courtesy of LISA member EnTrust Settlements based in Omaha. Bill, a trust officer, identified a policy to be significantly underfunded. The projected annual premium to mature the policy was $84,020 and, with no further funding, the policy was projected to lapse in six months. The grantor didn’t want to contribute any more money to the policy, and there was only $10,000 of CSV. An evaluation showed the potential to have significant value above the CSV on the secondary market. Bill disclosed this option with the grantor, who then wanted to proceed with a life settlement option. EnTrust Settlements was able to secure $360,000, net of fees, and the trust now manages the life settlement proceeds.

Life settlements present an opportunity for your clients to liquidate an asset in their trusts and put that new cash to work for either cash flow needs or for other investments. This not only fulfills the trustee’s obligation to exercise proper oversight of the assets in the trust, but also provides a vehicle for financial advisors to advance client portfolios and bring more assets under management.

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