Imagine a client applying to a carrier for a million dollar life insurance policy. The client wants his or her policy to be owned by an irrevocable life insurance trust, commonly referred to as an “ILIT.” This traditional arrangement is aimed at keeping the policy proceeds out of the insured’s estate and has significant estate planning benefits.
Regardless of its benefits, life insurance policies purchased in these trusts carry an added level of scrutiny for life insurance carriers. When the application is submitted, a copy of the trust is requested for review.
Trust review has become an increasingly common practice among life insurance carriers. While the degree and issues addressed vary among carriers, most generally perform a review whenever a policy will be owned by a trust. The purpose of the review is to determine whether the proposed policy owner has an insurable interest in the life of the insured. Insurable interest statutes differ among states; however, it must exist at the inception of the contract, not necessarily at the time of loss.
From a life insurance perspective, the insurable interest requirement generally calls for a substantial interest involving love and affection in the case of persons related by blood, and a lawful and substantial economic interest in the continued life of the insured in other cases. An insured is always considered to have an insurable interest in his or her own life.
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In addition, the spouse and dependents of the insured are typically considered to have an insurable interest. The policy owner is expected to sustain some emotional or pecuniary loss from the insured’s death. In many cases, this trust review requirement places an additional, albeit necessary, hurdle in the trust-owned policy applications process.
Trust review becomes more challenging when we examine certain considerations involved under the uniform trust code. The UTC is the first national codification of the common law of trusts in the United States. Since its approval by the National Conference of Commissioners on Uniform State Laws (“NCCUSL”) on Aug. 3, 2000, the UTC has been enacted in 20 jurisdictions. (See Image 1 for the UTC states.) All states can adopt, delete or modify certain optional subsections of the UTC, resulting in the code having subtle differences between the jurisdictions where it has been enacted.
The UTC contains a limited number of mandatory rules. Section 105 of the UTC provides 14 rules that prevail over the terms of a trust. This is particularly relevant where the terms of the trust are in conflict with these mandatory rules. In such cases, these mandatory UTC provisions govern regardless of the settlor’s express intent.
Filling in the blanks
The UTC is primarily comprised of default rules. These rules apply where the terms of the trust fail to address or do not adequately deal with an issue. Where the trust is silent or does not provide sufficient direction regarding the settlor’s intent, the enacted UTC terms apply. Depending on where a trust is silent, the default rules may play a larger role and have a greater impact than expected. The default rules are intended to ‘fill in the blanks’ of the trust.
However, if the actual terms of the trust are vague or simply missing, the blanks may be abundant. The result can be a trust that significantly relies on the enacted UTC for direction. When a trust is in clear opposition to a default provision of the UTC, however, the terms of the trust will govern.