TRUST INSURANCE: (Trusts and Estates- Whitelaw and Ries)

Life insurance is perhaps the most misunderstood product financial product in existence today. Unfortunately, it is for that reason that it is so improperly and ineffectively analyzed and sold. The authors of an article on trust owned life insurance convincingly identified the problem by offering the initial statement- "suppose that 100% of trust owned life insurance policies will not perform as originally illustrated and that 95% of these policies have no assigned servicing agent. Further, suppose that 80% of these policies warranted either restructuring or replacement." Get the picture?

Life insurance has become a cornerstone of estate planning- primarily for estate taxes- by putting certain types of polices into irrevocable trusts to pay the estate taxes due at death (or perhaps the second to die.) But due to its complexity, there has been a (potential) breach of a fiduciary requirement by trustees to carefully monitor the purchase or use of an an asset that is designed to "work" 10, 20, 30 or even 40 years in the future. "Trustees will be held accountable for the performance of their fiduciary duties if they fail to act prudently under the circumstances."

Such circumstances involve the initial purchase of the policy- a difficult issue in itself unless the trustee has considerable background in the area or uses entities well versed in the subject. The authors noted that agents that sell such trust insurance are "trying to do the right thing. Increasingly they are placed in a competitive bidding situation which results in a win-the-illustration contest. It is not unusual for the policy to quickly become a candidate for restorative actions unless the illustrations is based upon realistic expectations." But I have a clear problem with the statement, "do the right thing". Any agent that wins the illustration by contorting interest rates, mortality or expenses is certainly violating his or her own fiduciary obligation. And such breach is shown by the real life lack of assigned agents to such trust insurance. Certainly, the trustee should hire outside assistance in analyzing such a purchase or for the re-evaluation of such policies in the future.

Regardless of what transpires, new rules clearly put a trustee at risk. The revised "Prudent Investor Rule recognizes that risk is inherent in every investment and sets out the expected standard of care. For trust insurance, trustees need to demonstrate monitoring procedures consistent with other trust investments."

Type of Policies: As I have stated elsewhere and for a considerable period of time, trust insurance is designed for leverage of each dollar for insurance- not for a significant buildup of cash value (though some is/may be inherent in the use of almost all whole or universal life policies). Yet the bulk of policies I have seen advertised and utilized (even second to die) are, more or less, the standard Universal policy with cash value buildup. The article noted, "the primary purpose of an irrevocable life insurance trust is to maximize the death benefit. Cash value accumulation is only a premium financing decision which should be considered and documented by the trustee". Hence, I think many a trustee will find themselves in legal hot water if it could have been shown that another policy of the same quality could have purchased for less premium and less cash value buildup. Such low cash value polices do exist- though they are not necessarily without their detractors either.

So, was the preponderance of the review suggesting changes should be made? Well. the major commentary of the article was a statement that, 'an inforce illustration is essential for a trustee to document and demonstrate the prudence of retaining a life insurance policy". "Such review, as indicated by their examination, would produce a minimum "40% improvement threshold".

1. 65% to 74% of single life polices and 85% of survivorship (second to die) policies met that criteria

2. 53% to 59% greater death benefit for the same premium and

3. 33% to 50% greater death benefit while reducing the premium outlay 64% to 79%.

"Unfortunately, many trustees continue to view trust life insurance's downside risk of doing nothing rather than the upside benefits of being proactive." "The risk of doing nothing is estimated at $812,655 per trust. The reputation risk is incalculable."

In summary, it appears from studies that the vast number of survivorship policies are neglected at best and may have been delinquent at inception. But trustees, even under the requirement of the new Prudent Man Rules, appear reluctant to pursue an area where they have little knowledge. Nonetheless, a fiduciary obligation requires all trustees to actively monitor all investments.

If you have set up an irrevocable trust, are you sure both your agent and your trustee had adequate knowledge of insurance to begin with? Were you sold a policy based on its expected increase in cash value? Lastly, if you have had the policy for five or more years, have you had an inforce illustration run?  If there are any questions, you better do some more homework with those entities that have knowledge and competency.

(See Trusts and Estate, April 1999)