In “How Trustees Should Incorporate Life Settlements in ILIT Reviews” and “Incorporating Policy Exchanges in ILIT Reviews,” I introduced you to a group of trust officers who are refreshing their template for reviews of the life insurance policies held in irrevocable life insurance trusts (ILITs). Having addressed the more topical and remedial steps of life settlements and policy exchanges, they’re going back to the first and most fundamental step, a bottom-up review of the policy itself.
You’ll recall that the head of their department, whose name is Charlie, sat in on the discussions about life settlements and policy exchanges. Apparently, he found the discussion so riveting that he’s decided to sit in on this segment as well. He reminds the group that the policy review process has to address some concerns he’s hearing from some in upper management who don’t like what they’re seeing in the press about life insurance policies and carriers. Meanwhile, Charlie endorses the group’s concept of the template as a tool for training colleagues who will one day be responsible for ILITs.
Organizing the Template
The department oversees a lot of policies in a lot of ILITs! So, to facilitate discussion, the group decides to segment their review into two categories, unfunded ILITs and funded ILITs. They’ll then break each category into two segments, those supported by cash gifts from the client and those supported by a financing arrangement such as split-dollar or third-party premium financing. For now, they’ll concentrate on one, single purpose template to get everything out on the table. Once completed, they can create discreet templates for each fact pattern. So, for example, they’ll have a separate template for an unfunded ILIT supported by cash gifts and one for an unfunded ILIT supported by a financing arrangement and so forth.
The Opening Statement
The template begins with an opening statement that includes a bullet point description of the features, functionality, benefits, risks and general application of the policy as well as a diagram that completes the picture. They have a set of bullet points and a diagram for every type of product. They’ll also note the carrier and its ratings from the major services. They’ll supplement their description with facts and figures from the carrier’s most recent statement. If the policy offers investment flexibility, they’ll note how the cash value is invested. Finally, they note the name and company affiliation of the agent who’s servicing the policy. In many cases, the agent who sold the policy has retired or left the business without having a successor in place. In those cases, the group has to engage new agents or consultants to recreate a structure for policy information and service. We’ll still refer to the individual(s) that the group is working with today as the “agent.”
So, How’s It Going?
Next is a succinct statement as to how the policy’s doing. Of course, this raises the question, “Compared to what?” The short, but not necessarily satisfactory, answer is, “Compared to what they thought they were expecting when they bought the policy.” So, as part of their preparation for the review, they ask the agent for an in-force policy illustration as well as any observations or recommendations that the agent has with respect to the policy. They’ll already (hopefully) have the original “as sold” illustration in the file. Basically, the as sold shows how the policy was designed, how much premium would be paid for how many years and the key assumptions such as credited interest rate, return on the funds in the separate account or dividend interest rate and the targeted outcome, meaning for example, to support the original death benefit to the client’s age 100 at the then current assumptions about credited interest and costs of insurance. The in-force shows how things have played out, where the policy stands today and where it’s projected to be headed absent any changes. So, for example, they might note that at the current premium, the policy is now projected to lapse at the client’s age 87. They’ve asked their graphics department how to put sentences like that one in flashing yellow. When applicable, there’s a third illustration that shows the (higher) premium projected to be sufficient to get the policy back on track to the targeted result. Also when applicable and with variations on the theme, there’s an illustration that depicts a reduction or elimination of cash premiums without loss of death benefit for the targeted duration.
Support for Policy
Next is either a statement about the cash flow and tax implications of the client’s cash gifts or a succinct description of the structural, economic and tax implications of the financing arrangement, for example, loan regime split-dollar. Realizing that the term “succinct description of the financing arrangement” may be a world class oxymoron, they’ll still do their best. The succinct description will be supplemented by a diagram.
Evaluation of Financing Arrangement
This is the proverbial second shoe. The plan has been described, but the question now is how the plan is faring against the original assumptions and anticipated outcome. If the group is fortunate enough to have them, they’ll show the client both an as sold illustration that incorporates the arrangement and the in-force. That is, if the policy was sold in a loan regime split-dollar plan, then the as sold would depict the arrangement and its critical assumptions as of Year 1. The in-force would pick things up in the current year. If either or both of these illustrations aren’t available, then someone has to customize a spreadsheet or just explain it all with words. Good luck with that!
The point is to show the client how far along the plan is towards fruition, often referred to as the “rollout,” and the ongoing economic and tax implications for the client up to and at the rollout. Though launched with great fanfare and, in larger cases, with bottles of champagne smashed against the final illustrations, many of these arrangements have fallen on hard times in the past few years. Again, that’s largely attributable to policy “underperformance” vis a vis the initial assumptions, which may now seem questionable in retrospect. It may also be attributable to the client’s failure to do what they were supposed to do, like fund the ILIT with assets that could help with the rollout. The question now is how much longer the client will have to deal with the plan’s economic and tax implications.
Everything is on the table now except for how the client feels about it. Therefore, the group will proceed with a client, policy, ILIT and financing arrangement-adjusted set of questions to get that feedback. As one can imagine, that feedback could call for anything from a tweak to a tow truck. Just by way of example:
- “I’m comfortable with the current situation and content to stay the course, even if the course has been shortened by a couple of holes.” The meeting will move on to other things. They’ll revisit the policy next year or earlier if something comes up.
- “I’m concerned that the policy won’t stay in force to the originally (or maybe even once shortened) age. I still want the insurance, so let’s (perhaps again) increase the premium to sustain the policy to age ‘whatever.’” This is a tweak, unless that increase is so large that it makes sense to see if the policy is a candidate for replacement.
- “You know, I don’t want to give up the coverage, but I really don’t need this much insurance anymore.” What this kind of feedback usually indicates is that it’s not the principle of the thing, it’s the money. Again, this could just call for a tweak, maybe a reduction in the death benefit with a corresponding reduction in the premium projected to carry the policy to the targeted age. Maybe a change in the death benefit option or the dividend option will do the trick. This should be a minor fix.
- “You know, I see that the premium will carry the policy to an age that my doctors and I now know is far in excess of my life expectancy. I don’t want to lose any of the coverage, but can we cut back the premium to carry it to a more realistic age?” That’s a tweak.
- “You’re telling me that the policy is now self-sufficient and can support itself. Mark me down as sufficiently interested in that to pursue it further.”
- “I don’t need it. I don’t want it. I won’t pay for it anymore. If you (meaning the trustee) want to pay for it from investment income or the kids are willing to pick up the tab, fine. But I’m out!” This is the approach shot for a life settlement, as discussed in the other article.
- “So, apparently the policy and the financing arrangement are competing to see which is in worse shape. Am I missing something? I obviously must have missed something when this thing was pitched to me in the first place. Maybe this what those guys meant by “intentionally defective.” OK, what are you going to do about it?” The cast of characters for how this situation will play out can include agents, estate planning attorneys, tax advisors, consultants, lenders, litigation attorneys and expert witnesses.
- A point about the financing arrangements that deserves special mention is that as the marketing for “pre-sunset” wealth transfer planning heats up, any proposed transactions that would use the client’s gift tax exemption should be considered in light of the exemption that might be needed to deal with, meaning rescue, the financing arrangement. Aside from some comments on the role of life settlements in these situations, I’ll leave the discussion of what to do about these arrangements for another time. Meanwhile, see my article “Deconstructing a Leveraged Life Insurance Plan that’s on Borrowed Time.”
The Way Forward
If the situation is fine, then they’ll mark their file ahead. If the situation calls for a tweak, then they’ll tinker with the premium or the policy accordingly. But the situation may call for more than a tweak, such as those discussed in the cited articles.
Importantly, Charlie is comfortable that the group’s approach will detect and address potential problems in a timely manner. The trust company will have that much more padding for what has become a contact sport.
For more information on ILIT Reviews, see “A Trustee Designs a Template for ILIT Reviews.”