Imagine that you are the trustee of an Irrevocable Life Insurance Trust (ILIT) or the advisor to an unskilled trustee as well as providing ILIT administration services such as Crummey Notices. Imagine you receive carrier notice that the $2,750,000 death benefit policy in trust is estimated to lapse in the next 12 months. The insured is age 78 and premiums paid to date exceed $500,000. Corrective action is needed — what do you do?
For reasons explained in our earlier article, Why it’s critical to monitor life insurance policy performance, approximately 38 percent of in-force flexible premium non-guaranteed death benefit Trust-Owned Life Insurance (TOLI) policies are illustrated to lapse prior to the insured’s life expectancy. Amateur ILIT trustees, also known as “Accommodation” or “Do Nothing” trustees usually are family members or friends who serve as a favor to the grantor at no expense. They are not familiar with ILIT trustee duties and lack life insurance product and policy evaluation expertise. Rather, they rely upon either the grantor’s attorney — who drafted the ILIT and trust administration guidance — or a tax professional for all ILIT administration and TOLI risk management activities.
Corrective action is needed to avoid policy lapse and, equally important, assure the policy (or policies) are being managed consistent with the ILIT’s current liquidity objectives and trustee’s life insurance product and policy evaluation expertise. It is estimated that amateur ILIT trustees are responsible for approximately 90 percent of in-force TOLI policies. In considering how they can document a prudent and reasoned process consistent with trust objectives, it is important to address the gap between responsibility and capability, and identify the options available to resolve this gap. Clearly, the grantor’s legal and tax advisors play a critical problem-solving role in identifying neglected policies as well as reviewing and implementing these options. If the professional lacks the requisite expertise to credibly evaluate the available options, then it is incumbent upon the advisor to engage a third-party provider with that expertise.
The corrective action first steps are to obtain a ‘credible’ fact-based policy evaluation report and formalize a TOLI Investment Policy Statement (TIPS). TIPS is the single-most important document for the purchase and management of life insurance, no different from fixed income and equity investments. Properly drafted, TIPS formalizes a prudent “best practices” risk management process for informed new, in-force, and restructured TOLI policy determinations. It safeguards all insurance trust parties — grantor, trustee, beneficiary, professional advisors and life insurance agent — in clarifying trust objectives, carrier/product/policy suitability considerations, delegated TOLI consulting and policy risk management functions, beneficiary communication and expected professional advisor roles.
TIPS is not a legal document. It is generally prepared and periodically updated by a TOLI trustee to affirm current trust operation objectives and procedures to systematically monitor trust asset performance. It is based on the grantor’s objectives and expectations as well as guidance set out in the trust agreement and trust operation memo prepared by the attorney drafting the trust agreement. Since an insurance trust may span a 10 to 50 year time horizon, TIPS provides practical guidance in dealing with changes in trust objectives, tax law, grantor gifting capacity, carrier financial condition and life insurance products.
TIPS should outline the trustee’s policy selection and management process, including risk evaluation criteria. If the trustee lacks life insurance product expertise and dispute defensible policy evaluation capabilities, these functions should be outsourced (delegated) to experienced TOLI third-party providers. The Cochran v. Key Bank decision reinforces the importance of delegating the product and policy performance monitoring determinations to an experienced and objective third-party. Subsequently, most skilled institutional ILIT trustees and an increasing percentage of lawyer-trustee, professional advisor co-trustee, and family member personal trustee arrangements have outsourced TOLI product analysis and risk management functions. As a result, TIPS should set out the terms of delegation along with the trustee’s expected provider screening and annual monitoring process.