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Limiting Life Insurance Trustee Liability in Light of Coronavirus

How fiduciaries can protect themselves.

Trustees of life insurance have a fiduciary duty to beneficiaries to review life insurance policies periodically.  In times of significant financial market volatility, it becomes even more critical to gauge market impact on the policies under their care.  If assumptions no longer make economic sense, they may be personally liable for claims of negligence.  Trustees can prepare themselves by first identifying their roles and responsibilities, determining ways to manage risks, such as hiring the appropriate professionals to review the life insurance policies, and providing documented actions to deal with policy performance issues.  Finally, because all liability can't be eliminated, trustees can transfer their risk through insurance.  Here’s a specific process for trustees to take now to review policies in their clients’ portfolios, as well as an outline of the steps they should take to ensure that they’re minimizing their liability and guidance for evaluating their errors and omissions (E & O) insurance to confirm all of their liability is covered.   

Economic Effect on Carrier Stability

 According to industry experts, as long as the population follows suggested and required guidelines, the current outbreak shouldn’t affect the financial integrity of life insurance carriers. Higher mortality will affect the profitability of life insurance carriers, but based on current projections, carriers should remain stable. Carriers have other products, like annuities, that can offset the higher mortality in their life insurance portfolio. And many carriers spread their risk to other entities, called reinsurers.

Economic Effect on Policy Performance

Coronavirus has and will affect the performance of in force policies for the foreseeable future.  Life insurance carriers collect premiums and invest the money to pay out claims. Performance of permanent (cash value) policies is driven by the rate of return in the underlying assets, and (except for variable contracts), those assets are primarily fixed investments.

What to Do Now

All permanent life insurance policies under a trustee’s  care should be stress-tested by a life insurance professional, comparing past performance projections with a new re-projection at current, as well as lower, assumptions.  All fixed products will most likely have lower returns over the foreseeable future because of the continued low rate environment. Fixed rates have been trending downward for a decade, and unless policies have been reviewed and funding adjusted, modifications will probably be required to keep on track.  While carrier bond portfolios increase in value as the rates drop, carriers are feeling pressure from historically low rates, which now appear to be the new normal.  It doesn’t appear rates will rise soon.

Variable policies, which include equity investments, should be reviewed quickly as they’re likely the ones that will be suffering the most from coronavirus market volatility, with some policies showing cash value drops of 30% or more.  Policies with low cash values will be the most susceptible and should be the first reviewed.    

Trustees should locate permanent policies in their clients’ portfolios with required premiums that must be paid.  Some universal life policies contain death benefit guarantees and will have those guarantees compromised if premiums aren’t paid in full and on time. Whole life contracts have required premiums that can be offset by dividends or policy loans. 

Term policies, since they have no cash value, will lapse if a premium is missed.

In times of financial stress, like we’re experiencing, it would be wise for trustees to reach out to grantors earlier than usual to collect gifts so they can identify any client funding issues early. 

Once policies are reviewed, trustees should discuss the outcome with their grantors and determine prudent steps for dealing with any issues.  Some policies may need additional cash to reach policy goals.  Now’s the time to review trust goals and funding with the grantors.  All aspects of policy review, grantor conversation and policy revision should be documented for the trust file.

All trustees should appropriately review their clients’ life insurance portfolio. The challenge is that it takes an expert to identify risks unique to each situation and apply correct assumptions. A proactive approach to policy review will help mitigate a trustee’s liability and increase customer service. It’s essential now because liability is a more significant issue for life insurance trustees in times of policy stress.  This is one reason that the trustee’s next step should be reviewing their E & O liability insurance.  

Stress Testing E&O Insurance

Trustee liability insurance is a type of errors and omissions coverage that’s similar to directors and officers patterns for the institution. These insurance policies are structured by defining what’s insured (the insuring agreement), exclusions, definitions and conditions. Generally, these policies cover defense costs until a court determination of negligence and/or damages if/when there’s a settlement.

The insuring agreement is designed to define what’s covered, specifically the trustee’s acts such as E & O in carrying out his duties and/or alleged breach of fiduciary duty.  It’s extremely important to review the definitions contained in an insurance policy. These definitions, found throughout, have a significant impact on the scope of coverage. All definitions must be reviewed and understood. Some key definitions require even more attention than others, such as that of claim, claim expense, damages, insured persons and trustee services. If these and other definitions aren’t structured properly, the insurance may not perform as expected.

Typically, exclusions are included in the fiduciary policy because other insurance policies (such as property and casualty, which is designed to cover certain claims) is, or should be, already in place. Exclusions for illegal activity, prohibited acts or proven gross negligence are also common. The insurance company won’t cover claims that are excluded from the policy. However, some policies may offer defense coverage until final adjudication of a claim.

There are a litany of available insurance policies and insurance companies with varying degrees of risk appetite. A knowledgeable insurance professional can help a trustee determine which polices and carriers are the best fit for each situation.

Some questions to ask when determining the type of policy to purchase: What policies are in place, and are my employees properly covered? Is the coverage adequate to protect the institution too? If I’m an employed professional and/or have errors and omissions policies in place, is coverage adequate? Can the policy be amended to include excluded items or be clarified for gray areas? 

The Best Path Forward

Enlist an experienced team of advisors, including life and trustee liability professionals to conduct a risk assessment and help identify the risks associate with life insurance held in trust. They’ll know where the claims can come from, what to look for in terms of risk and how to structure insurance to protect the trustee.

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