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.
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.
One specific default rule with an optional subsection is noteworthy for trust review. UTC ?411(a) mainly deals with the modification or termination of noncharitable irrevocable trusts. Aside from a judicially petitioned modification or termination of a noncharitable irrevocable trust, ?411(a) has certain language providing that a ‘noncharitable irrevocable trust may be modified or terminated upon consent of the settlor and all beneficiaries, even if the modification or termination is inconsistent with a material purpose of the trust.’ This is optional language that has not been adopted by all states that enacted the UTC. The language allows the settlor and beneficiaries to jointly modify virtually any provision of a trust at any point in time.
As of 2007, half of all states that enacted the UTC have adopted this optional provision within ?411(a). (See Image 1 for the UTC states that include this optional provision.) In those states, it is possible for the settlor and their beneficiaries to modify the terms of a trust at any time after the policy has been issued. If the trust situs of the ILIT is located in a state that has enacted the UTC, then additional considerations should be raised.
One month later…?
Carriers could question whether the terms of the reviewed trust will be in place one month after policy issue or whether they would be modified. The concern is valid, as carriers work with and advisory agents on how they can most effectively amend or redraft trusts to ensure they comply with trust provision standards that have been set by the carrier.
Insurable interest must exist when the policy is issued. What about after policy issue? UTC ?411(a) appears to provide for the settlor and beneficiaries to be able to modify the trust and change trust beneficiaries after policy issue. Even where the trust states that its material purpose is to provide income to heirs for life, beneficiaries can be changed. Modification could even be inconsistent with the material purpose of the trust.
The obvious concern for carriers is that they would not be advised of any change in beneficiaries since the trust remains the policy owner. In these instances, carriers are unable to know the ultimate terms of the trust that will own its policy.
The initial course of action in dealing with this issue is to increase awareness of UTC issues involving trust review by carriers. Carriers need to establish a familiarity with the default rules that may govern trusts under the UTC.
This is necessary for the carrier to be informed of all potentially relevant trust provisions and how each will function and interact with the UTC. Carrier trust review should always identify whether the state where the trust was created has enacted the UTC. Carriers will then need to determine the specific UTC subsections adopted by the state and their effect on the terms of the individual trust.
Each carrier should ultimately determine a specific course of action for handling these UTC issues. Identification of the issues is the first step in effectively addressing them. As ILITs are increasingly reviewed for insurable interest, certain developments in trust law are often overlooked, although their impact may be significant.
Where applicable, clients should be made aware of the UTC and its potential effect on the drafting and planning involved with their individual ILIT. As more states enact the UTC, there will undoubtedly be numerous benefits derived from the code. For purposes of trust review, however, it will all depend on the language in the UTC that individual states decide to enact.
Hugo A. Tomasio, J.D., is assistant vice president of advanced markets for AXA Equitable’s independent life channel, AXA Distributors, LLC, New York, N.Y. Hugo can be reached at .