With interest rates on the rise, those who are serving as trustees of trusts owning life insurance (TOLI) could expect a bumpy road ahead. Is it now time, for example, to exchange that existing policy for a universal policy with better crediting rates?
Unfortunately, most trustees have no idea what crediting rates are – let alone know how to read an in-force policy illustration. In fact, studies have shown that most trustees have little if any competence in this area, and even worse, have no process in place to review how their policies might be impacted by such events.1 Why should these trustees be concerned?
First, there’s a significant amount of life insurance held in trusts. By one estimate, the extent of life insurance owned in trusts in the United States is in excess of $1 trillion.2 With such a massive amount of money at stake, beneficiaries (and/or their attorneys) are bound to ask a few questions. Second, beneficiaries have, in fact, begun asking questions. Indeed, there are several cases in which disappointed beneficiaries have brought trustees to court,3 and likely multiples more cases in which trustees and beneficiaries have opted to settle their disputes outside of court. In such cases, the beneficiaries will generally accuse the trustee of breaching fiduciary duties, citing problems such as negligence in maintaining the life insurance policy, improper design, failure in maintaining life insurance as an improper investment within the trust, inappropriate selection of a carrier (perhaps due to a change in financial ratings), lack of due diligence in the selection of an agent (perhaps due to revocation of the insurance agent’s license or general lack of competence) or failure to understand and seek more suitable alternatives available – such as products with a more appropriate death benefit amount given changed needs or newer products available that are more cost efficient or that offer better guarantees. Such claims can be emotionally and/or financially draining for trustees who are caught off-guard.
Third, it’s rare that those who agree to serve as trustee of TOLI have expertise both in trust matters and in life insurance matters. For example, a CPA or attorney will often agree to service as individual trustees. Neither of these roles, per se, requires any specialized training on life insurance matters. And for corporate trustees, the Uniform Prudent Investor4 and Office of the Comptroller of the Currency5 standards have heightened their requirements, making potential liability for corporate trustees who are held to such higher standards even more uncertain.
What to Do
So what can TOLI trustees do?
1. Have enough professional liability insurance. Most individuals who are serving as trustee fail to have enough professional liability insurance coverage to cover the death benefit amount. For example, if the trust holds a policy with a death benefit of $10 million or even $5 million, it’s possible that the trustee might need to increase its professional liability limits.
2. Seek a truly unbiased and comprehensive review. Often, insurance representatives will offer to “audit” a trustee’s policy without that trustee paying a fee. You get what you pay for here, and the incentive for these advisors is to replace the policy (otherwise, they make nothing). This might not always be in the trust’s best interests–particularly since a policy sought to be replaced might have steep surrender charges or a new contestability period, or the insured might have a different health status than he had when the policy was first taken out. In such cases, replacing the policy could actually increase your liability. Hiring a professional fee-only advisor who has no financial stake in the outcome is therefore the safest course of action. In addition, if this professional also knows how to read a trust agreement (to get a feel for who the beneficiaries are and how the trust agreement addresses the retention of life insurance in general), even better.
3. Document all decisions. Cases alleging breach often turned on the process by which the trustee arrived at a decision – not necessarily the result. So by keeping good records as to how and why certain decisions were made, trustees can better protect themselves in the future.
4. Conduct your own research. Knowledge is power, and doing a little bit of research to understand how the policy (or policies) that your trusts own operate can go a long way in proving your diligence. There are some helpful free resources, for example, on the National Association of Insurance Commissioners webpage at www.naic.org.
1.See, e.g., Richard L. Harris and Russ Alan Prince, “The Problem with Trusts Owning Life Insurance”, Trusts and Estates, May 2003 (revealing that 83.5 percent of professional trustees surveyed had no guidelines and procedures in place for handling TOLI and 96.3 percent had no policy statements on how to handle life insurance investments).
2.See William M. Arnold, Jr. and Jeffrey C. Harper, “Trust-Owned Life Insurance Poses Hidden Risks,” American Banker, February 3, 1998.
3.See, e.g., Cochran v. Keybank, 901 N.E. 2d 1128 (Ind. Ct. App. 2009); Koehler v. Merrill Lynch, 706 S.2d 1370 (Fl. Ct. App. 1998); Pearson v. Barr. 2002 WL 1970144 (Cal. Super Ct. 2002); Sanders v. Citizens National Bank, 585 S.2d 1064 (Fl Ct. App 1991); Phillips V. Ostrer, 481 S.2nd 1241 (Fl. Ct. App. 1986).
4. Uniform State Laws. Annual Conference, Chicago, Ill. July 29-August 5, 1994.
5. Office of the Comptroller of the Currency Bulletin 2000-23 (July 23, 2000), replacing and updating OCC Bulletin 96-31, Sept. 20, 1996, which at first provided a 10-point list of due diligence for banks as part of a life insurance pre-purchase analysis.