Trusts often rely on insurance policies for a variety of purposes, and if trustees do not actively manage those policies, it could cause trouble for both trust and trustee. However, many trustees don’t even realize they have to do anything with an insurance policy but distribute the funds once the death benefit comes in.
John Ryan, of Ryan Insurance Strategy Consultants in Greenwood Village,Colo., said during a recent webinar on the subject that many times an insurance policy is the only asset in a trust. But while it’s a trustee’s duty to select and monitor policies, he cited the Stephan Leimberg insurance newsletter for some surprising statistics: 81% of the time, trustees had little or no guidance from the grantor about how to treat life insurance policies in the trust—nothing about how often to review or what to look for. Perhaps, given that figure, it’s not all that surprising that 69% of trustees have not reviewed the policies in their care in the last five years.
That’s a big red flag. Trustees have a fiduciary duty under the Uniform Prudent Investment Act (UPIA) to review trust-owned life insurance policies, and they are further required to produce reasonable returns, said Ryan. Failure to do so could send unhappy beneficiaries to court—which means big trouble for the trustee—and over half the policies in trusts are underperforming.
Advisors whose clients are trustees, or who perhaps serve as trustees themselves, should be aware that a regular review can reveal the policies they oversee that fail to perform. If they do not feel prepared to tackle such a review, and many don’t, they should consult an expert.
Volunteer trustees, or those with no experience, may have been chosen by the client because of a personal relationship, not their knowledge of a trustee’s duties. They may have no idea that they are liable for the performance of the trust, or they may feel they’re not qualified to carry out an examination of the policy’s performance. If they do give it a shot, they could feel as if they’re drowning in paperwork from the insurance company. And if the person who bought the policy doesn’t want to get involved, that can make it harder.
Professionals such as accountants, attorneys and planners might be reluctant to demonstrate a lack of expertise on the subject, or to expose themselves to liability for taking on a task they’re really not qualified for. However, said Ryan, “if you hold yourself out as a comprehensive financial planner, this is an area you have to delve into to do what’s right by the client.”
Or the problem could be the agent, who may have a personal relationship with the donor that makes any change or suggestion of poor performance difficult. Alternatively, the agent could be prejudiced in favor of a certain type of policy or, even if he advises a change, simply more concerned with an opportunity for additional profit than with making sure a new policy will perform better.
Many things can affect that performance, including the timing of the purchase. Ryan cited an instance in which a client bought a variable life policy a year before the market dropped 40%. “These products are so highly sensitive,” he said, “that when a loss like that is sustained in the first few years, it’s difficult for the policy to catch up. If they’re not monitored and managed like an investment, there could be dire consequences later on.”
Illustrations from policies in the late 1980s, he added, particularly from California, would offer crediting rates of 14%, 16%, even 18%. Now, however, 4.5% is “actually a decent crediting rate for a universal life policy.” A policy that was purchased based on a projection of premiums and values in the range of 9%, 8.5% or even 8%, but now only crediting 4.5% or less, is not performing as it was originally designed, explained Ryan.
Then there’s the question of which rate is used for crediting and which is used for the illustration: the gross rate (before fund management expenses and mortality and expense charges), the net rate (less one or the other of the expenses), or the net-net rate (after deduction of both investment expenses and mortality and expense charges). That can lower a gross crediting rate from 9% to an actual rate of around 6%.
Mortality is an issue as well, and while it has improved drastically, he said, companies generally won’t go out of their way to pass on the benefit of improved pricing based on mortality rates to existing clients.
Trustees may not be aware, either, of how easily policy guarantees can be voided. For instance, an insured pays for the no-lapse guarantee on a universal life policy by accepting a lower return. But Ryan cautioned that “many policies say that the guarantee is only valid as long as the client or trustee makes the annual policy payment on time every year, and never misses or is late, and never makes a loan or withdrawal.” Should a new trustee, unaware of this, make a late payment, skip a premium altogether or take a loan, suddenly there is no guarantee. Some companies do offer a catch-up provision, however.
Term life policies also need attention because if the conversion option expires before the insured exercises it, he or she could be priced out of coverage with an “astronomical” premium increase and the trust would be left without the policy—particularly if the insured is no longer insurable because of deteriorating health.
Ryan gave one particularly dramatic example of the difference a policy review can make. A 50-year-old female client brought in four whole life policies for review, with combined coverage of $265,000. Two of the four had ongoing annual premiums to age 65 of $2,500 per year, and the net cash value was $79,000. After review, $55,000 of the cash value was used as a single premium on one new policy that replaced all the others. The new policy offered a guaranteed-to-age-120 death benefit of $266,000, with no additional premium required. That saved $37,500 in premiums over 15 years, and still allowed $24,000 in cash value to be taken out of the old policies with no federal tax.
Trustees need to be aware of all their responsibilities surrounding the trust’s insurance policies and, if necessary, get help to fulfill them. The beneficiaries will be glad they did.