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Incorporating Policy Exchanges in ILIT Reviews

A due care checklist is an invaluable tool.

In my last article, “How Trustees Should Incorporate Life Settlements in ILIT Reviews,” a group of trust officers at a midsize trust company assembled in a conference room. Each member of the group is responsible for an extensive portfolio of trusts, many of which are irrevocable life insurance trusts (ILIT). The group also is responsible for training colleagues in their department on ILITs, broadly speaking.

The purpose of today’s meeting is threefold. First, they want to take a fresh look at their standard template for presenting reviews to their ILIT clients. Second, they want to be sure the template addresses some newly expressed “free floating” concerns among upper management about life insurance, apparently based on what they’ve been seeing in the press and hearing at conferences. Third, and somewhat incidental to the first two purposes, the template is a great tool for training colleagues who will one day be responsible for ILITs.

We rejoin the meeting, in a manner of speaking, at the point where the group has completed its discussion about life settlements and is now moving on to policy exchanges. The head of their department, whose name is Charlie, will stay with the group for this discussion.

Introduction and Allegro

The group takes Charlie through an overview of policy exchanges. They cover the essentials of the prototypical situations and plot twists in which the subject of a policy exchange comes up, what benefits an exchange can potentially bring to the situation and what risks it runs if ill-advised or poorly executed, how the transaction works, the difference between internal and external exchanges, the tax implications and much more.

Charlie looks at his notes, reflects for a moment and then says, “I need to understand what can go wrong and how we might be criticized by a given client or beneficiary. So, I’ll sit back and listen as you guys share the experience with these exchanges. Then I’ll tell you what I think we need to do to complete the project.”

The group collects its thoughts. They start by telling Charlie that, as far as they’re concerned, there are two categories of policy exchange proposals: solicited and unsolicited.

The Key Differences

Solicited exchanges typically come about in the course and context of an annual review. if a tweak won’t cut it, they might be well served by asking the agent to look for a better mousetrap. A solicited exchange proposal can also be submitted on an ad hoc basis if the agent happens to find something newly worthy of their consideration AND brings it to them before involving the client.

Unsolicited exchanges don’t come from a review. They come from out of the blue. If there’s any standard theme to these proposals, it’s an exchange from a participating whole life policy to “some form” of guaranteed universal life policy. There’s always some rationale for the proposal. Sometimes it’s about the carrier. Sometimes it’s about a reduction in premium outlay or a more predictable duration of remaining premium payments.

It’s funny, they note, how replacement proposals regularly come from the same agents who, not long ago, sold the policies that would now be replaced or from agents who were asked to provide an objective review of the policy and now propose to replace it. What’s not so funny is that the replacement proposals almost always include a “heads up” that the client has seen the illustrations and would like the trustee to make the exchange as soon as possible. Never mind that the illustrations often reflected an underwriting class that was assumed but yet not offered.

Much like their friends in the charitable planned giving community, the group isn’t comfortable with this approach because instead of engaging with them first for a productive dialogue about the proposal, these agents put them under pressure to deal with something that may or may not be in the best interest of the client and, of course, the beneficiaries. That’s not to say that some of the proposals don’t make sense and won’t save dollars. But the devil’s in the details, and most of these proposals are devilishly short on detail, meaning risks or downsides.

The Protocols

The group has a protocol for each type of exchange. If it’s solicited, they ask the agent to do a feasibility test that includes informal underwriting and some illustrations based on the indicated classification. Do things look promising, meaning that the replacement policy “checks out” and can reasonably be expected to fulfill the client’s objectives more effectively than the existing policy? if so, then they ask the agent to proceed along well established, constantly updated due care guidelines for both the carrier and the product.

If it’s unsolicited, they ask the agent to complete a specially designed questionnaire that asks the agent to lay out in no uncertain terms how and why the features, benefits and risks of the new product and the financial strength and policyholder support history of the new carrier qualitatively and quantitatively tip the scales in favor of the replacement. The proposals are usually promptly withdrawn. But sometimes they’re not withdrawn, and things get testy. If they do, so be it. The group is pretty sure that their lawyers will tell them that “things might get testy” isn’t a defense against a claim of breach of fiduciary duty to the beneficiaries.

The group pauses, waiting for Charlie to react. “OK,” he says. “Here’s what I think. Just like with the life settlements, I see both upside and downside for policy exchanges. And, like with life settlements, nobody is going to congratulate me, or you, if things go well. But we both know the kind of second-guessing we’re in for if they don’t. I’m also concerned that the subject is so dense and technical that you’ll need a Tolstoy to write it up and an Einstein to understand it. Is there some way that we can simplify all this without missing anything important?”

Due Care Checklist

The group responds. “We hear you, and we think we’ve got it covered. We created an ‘interactive and intuitive policy exchange due care checklist,’ which, aside from needing a better title, really helps us address in logical order all of the points, counterpoints, stress points and what ifs that we, the client and the beneficiaries should understand, and any litigators might ask, about the proposed exchange. Bottom line, the checklist allows us to explain to anyone why the current situation is broken and why the proposed solution is a reasonable way to fix it.”

“I like that.” says Charlie. “And so will upper management. So what’s next on your template?’

 For more information on ILIT Reviews, see “A Trustee Designs a Template for ILIT Reviews.”

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