Trust Owned Life Insurance:

Is It An Accident Waiting to Happen?

Trust owned life insurance is often central to many client plans, enabling clients to provide for survivors, cover estate tax liability planning, balance inheritances among heirs and meet charitable objectives. Trusts can offer clients professional management, the peace of mind that their concerns will be addressed after their death and a level of privacy not offered with other planning devices.

Deciding on a trustee is a critical and personal decision and choosing a family member, a family friend or a professional trustee all offer certain benefits. In many cases, however, trustees may not be managing the life insurance as actively as they may manage other assets. In such cases, this could put a clients goals and the care of beneficiaries at risksetting up the possibility of a lawsuit.

This article will explore the standards increasingly applicable to trustees and trends in recent court cases that should be of concern to all trustees. It also will examine how trustees may or may not be handling TOLI. But the best place to begin is to consider the many changes the life insurance industry has seen in recent years which might affect trust owned life insurance.

Areas where TOLI is vulnerable

In many cases, trustees charged with managing a trust will actively look at the investment portfolio or hire others to fill that role. It would be unheard of, given the volatility of todays equity marketplace, not to do a periodic review of trust assets. However, that is exactly what may be happening with many TOLI policies. There could be many reasons for this. For example, perhaps life insurance is viewed as a long-term hold whose true purpose will not be needed, ideally, for decades. Or perhaps trustees are intimidated by the complexity of life insurance contracts, or are lulled into a false sense of security due to the risk-shifting nature of life insurance. It appears that trustees are, by and large, simply handling the maintenance duties of accepting gifts, sending out Crummey Notices and paying premiums. However, a failure to review could be devastating to a trust.

Consider the impact that factors in both the economy and the industry might have on life insurance that is residing in trusts. (See box on this page.)

A jump in premiums is a particularly sensitive area. Many trustees may find a longer premium-paying period or larger than expected premium payments. In many cases trustees may also face grantors that are not in a position to make these gifts for a number of reasons. There could be the death of a spouse, effectively halving a clients annual exclusion gifting power. Other clients may be hesitant or unable to utilize their exemption equivalent because of other estate planning factors. Still, others may stop paying premiums simply out of anger at the added cost. Because the grantor has no obligation to make gifts to the trust, the trustee is left in the bind of trying to meet trust purposes in the face of lower than expected financial policy performance.

Additionally, many life insurers have seen financial and/or management changes that would cause an otherwise investment-savvy trustee to re-examine a particular asset in their portfolio.

Are Trustees Living Up to the Task?

With all of these external pressures, are trustees rising to the challenge as it concerns life insurance? A series of surveys reported, in part, in “Trusts and Estates” would indicate that this is not necessarily the case.

One 2004 survey involved professional trustees, as well as family and friends acting as trustees. While one might expect that professional trustees would monitor their trust assets more closely than an individual acting as a trustee as a favor for a close family friend or relative, neither group showed much attention to the life insurance assets.

Among professional trustees, fully 83.5% indicated they had no guidelines and procedures for handling trust owned life insurance.

For non-professional trustees, 71.2% indicated they had not reviewed their trusts life insurance policies in the last 5 years.

Both groups did not focus closely on handling the subaccounts for variable life. Among professional trustees, 95.3%, had no guidelines for handling the asset allocation components of VL. Among non-professionals, 94.7% indicated they had no procedures in place for the allocation component of VL.

Another pair of surveys indicated that anywhere from 70%-95% of all trust owned policies do not have a life insurance agent servicing the contracts.

This would appear to indicate that many trust owned policies are simply in a maintenance mode. One professional trust owned life insurance service firm indicated that as many as 92% of existing TOLI policies could be restructured to provide 20% greater value. In fact, that same firm concluded, after a survey of policies, that 74%-87% of these contracts could be restructured to provide either a 40% increase in death benefit, or 40% reduction in premium.

The Uniform Prudent Investor Act and Other Standards of Care

Just as a trustee might monitor the assets in a trust, reviewing whether the individual investment performance is meeting expectations, a trustee should also consider monitoring and reviewing the life insurance assets in trusts for which they are responsible. Does this mean removing or replacing policies on a regular basis? No. It simply indicates that a greater level of care is required.

In recent years a series of mechanisms have evolved that offer standards of care for life insurance, as well as other assets. One of the most significant is the Uniform Prudent Investor Act, which sets standards for trustees in managing and investing trust assets as any prudent investor would. It holds them to a standard of reasonable care, skill and caution. This uniform proposed law currently is adopted, in one format or another, in 43 states. Several key areas addressed by the UPIA are noted below. While these always have not influenced court decisions in cases involving a trustees judgment over life insurance, the themes and considerations are very similar.

It is important to keep in mind that the UPIA sets a basic standard that may vary from state to state. Moreover, a client always can draft a trust that holds a trustee to a higher or lower standard. The ability to reduce standards has helped trustees in some court cases. Nevertheless, the trend in holding trustees to a high standard and enforcing it is clear. Although life insurance is never specifically mentioned, it appears to be covered clearly by the scope of the uniform act, which states: “In the trust setting the term portfolio embraces the entire trust.”

The UPIA sets out many standards for trustees, but the ones particularly relevant for life insurance are:

o Assessing risk tolerance, taking into consideration “the purposes of the trust and the relevant circumstances of the beneficiaries.”

o Taking into consideration (1) general economic conditions; (2) expected tax consequences of investment decisions or strategies.

o Adequately diversifying the trust assets.

o Considering an assets special relationship or special value, if any, to the purposes of the trust.

Trustees are allowed to delegate decisions and investment selections to agents, provided that the trustee is ultimately responsible for monitoring the agent. However, as stated above, there appear to be few servicing agents.

These standards and others in the act parallel standards imposed in the banking community regarding the purchase of life insurance. In recent years the Office of the Comptroller of the Currency has imposed fairly stringent burdens on the banks it regulates regarding the purchase and monitoring of life insurance for banking and benefit purposes. In fact, in 1996, it imposed a 10-point pre-purchase assessment analysis. Although the focus of these guidelines primarily concerns use of life insurance relative to the banks operational needs, the standards are similar. In the last several years the OCC has further honed its guidelines relative to variable life insurance.

Clearly, the trend is toward setting standards relative to the monitoring of life insurance, and assuring that there is both a pre-purchase and ongoing review of the policies.

How a Trustee Might Be Sued

There appears to be increasing evidence that trustees are being sued for their lack of adequate conduct relative to life insurance. While there are few court cases specifically dealing with the ongoing review of trust owned life insurance, other cases show a trend toward suits in related circumstances. Moreover, there is a general sense within the professional community that many cases are being settled out of court, either because of the close relationships among trustee and non-trustee family members or because professional trustees are concerned about negative publicity.

In many cases beneficiaries brought the suits, but in a few extreme cases of negligence, grantors were given the right to sue trustees.

See the box on this page for some of the areas where trustees have seen lawsuits recently.

It should also be noted that in many cases the beneficiaries did not win their suits. However, neither beneficiaries nor grantors appear to be hesitant when the stakes are as high as losing a death benefit that is central to a clients long-term planning.

Clearly, trustees are exposed to many potential suits regarding TOLI. Agents can help them by making them aware of these issues. There are several steps they can take to help assess their risk and correct potential issues (see box).

While even a thorough life insurance review will not uncover every problem, taking steps today can help trustees avoid potential problems down the road.

Mark A. Teitelbaum, JD, LL.M., CLU, ChFC, is second vice president, advanced sales, Travelers Life & Annuity. He can be reached via e-mail at mark.a.teitelbaum@citigroup.com.


Reproduced from National Underwriter Edition, May 14, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.