Transcript Life Insurance Review Issues

Life Insurance
Review Issues
Table of Contents
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I.
Factors that Necessitate Life Insurance Policies to be Reviewed.
II.
General Rules of a Trustee’s Duty to Sell Investments that are No
Longer Prudent Investments.
III.
Selected Issues in 1035 Exchanges.
A) Contract with an Outstanding Premium Loan
B) Modified Endowment Contracts
C) Business Exchange Rider
D) Exchange for a UL or SUL policy.
IV.
Exchange in Life Insurance Contracts.
V.
A Life Insurance Analysis Prepared for: Sample Client
VI.
Exchange to a No Lapse Guarantee
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Factors That
Necessitate Life
Insurance Policies to
Be Reviewed
Factors That Necessitate Life
Insurance Policies to Be Reviewed
• A possible Decline in ratings of the in-force insurance carrier.
• A Comdex review of the in-force carrier. The Comdex gives the
average percentile ranking of this company in relation to all other
companies that have been rated by the rating services. The Comdex is
the percentage of companies that are rated lower than this company.
• The impact of declining interest rates or dividend scales on the nonguaranteed assumptions of the in-force policy.
• A review of structural policy risk. Is most, if not all of the risk with the
insurance company through contractual guarantees OR has it been
transferred to the policyholder through dividend projections and non
guaranteed pricing?
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Factors That Necessitate Life
Insurance Policies to Be Reviewed
(continued)
• Has the insurance company changed its operating structure through a
conversion from a mutual company to a publicly traded company? Has
the in-force dividend scale declined suggesting a move away from
policy holder focus to stockholder interest?
• Your job of helping people get the most insurance for their money
contains a second responsibility which is making sure that the
insurance product is of a high quality and reliability.
• A review of policy provisions is to confirm that they are clear and fair;
in regulation for solvency or its equivalent and to see that the promise
can be performed when it comes due. In regulation, the relationship
between the insurer and policyholder is to see that the promise is
indeed performed fairly and that the buyer’s reasonable expectations as
to what was bought are not too rudely disappointed.
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Factors That Necessitate Life
Insurance Policies to Be Reviewed
(continued)
• Guarantees are only as good as the guarantor. A thorough evaluation of
the carrier should be paramount to selection of contracts promising
long term guarantees.
• Review the rules of your state on trustee duties and responsibilities.
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An Analogous Situation
General Rules Of A Trustee’s Duty
To Sell Investments That Are No Longer
Prudent Investments
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General Rules Of A Trustee’s Duty
To Sell Investments That Are No Longer
Prudent Investments
• General rule is a trustee must review investments on a regular basis
and dispose of investments that are no longer prudent within a
reasonable time- this extends to all assets, including life insurance
policies.
• A trustee who ignores this duty can be personally liable for any loss to
the investment.
• This rule applies to investment management both inter vivos and
testamentary (during and after lifetime).
• Fifty states with different statutes and/or case law interpretation of a
trustee’s duties under specific fact situations.
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General Rules Of A Trustee’s Duty
To Sell Investments That Are No Longer
Prudent Investments (continued)
• In most states, the trust document trumps state law unless trust
provisions are clearly illegal or against public policy.
• The majority of states have statues that read “ It is the duty of the
trustee to exercise prudence in determining whether to retain
investments made by the settler”.
• Professional responsibility is to review the investment to determine if
the trustee is acting in a prudent manner. The courts have ruled a
trustee is not justified in retaining investments if it becomes imprudent
to do so, even if directed by the settler.
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Selected Issues In
1035 Exchanges
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Selected Issues In 1035 Exchanges
The ability to defer gain in a life insurance, annuity or endowment contract
through a section 1035 exchange can be of significant benefit to a policyholder.
As the above discussion indicates, however, it is important that the exchange be
effected correctly, and that all potential tax implications are fully considered.
Failure to do so may result in a loss of the deferral.
Section 1035 exchanges are an integral part of the life insurance business.
Unfortunately, these exchanges can have unexpected results and their income and
estate tax implications are not always fully understood.
This information will review a variety of exchange transactions. It will explain
the known tax ramifications of these transactions, and point out those instances in
which the results are not entirely clear. As most may be aware, the law is often
unclear, making the business of exchanging life insurance difficult at times.
Nevertheless, the objective is to provide you with guidance to help you avoid
some of the pitfalls posed by section 1035 exchange. This advice should not take
the place of your tax advisor who should be sought before any decisions to
exchange an insurance policy are made.
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Exchanges in Life
Insurance Contracts
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Exchanges in Life
Insurance Contracts
Section 1035(a) of the Internal Revenue Code provides that no gain or loss will be recognized on
the exchange of a life insurance contract for another life insurance contract, for an annuity
contract or for an endowment contract. As the following will indicate, certain conditions will
apply; and the transaction may have other implications that should be understood:
• Contract with an Outstanding Premium Loan
• Modified Endowment Contracts
Grandfathered loan limits
• Business Exchange rider
Change of ownership in a policy exchange
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• Exchange for a UL or SUL policy
Exchange into an existing contract
Exchanges in Life
Insurance Contracts (continued)
Policies with Outstanding Loans
A) Exchange of a policy with an outstanding loan
In order for an exchange to be tax-free, it must be of a like kind, meaning that
no money or other property (i.e., no “boot”) can be received in addition to the
contract. The receipt of the boot will cause the gain in the contract to be
recognized to the extent of the sum of money and the fair market value of the
property received. Sec. 1031(b). If the boot received exceeds the gain in the
contract, the entire gain will be recognized; if the boot is less than the gain in
the contract, gain recognition will be limited to the amount of the boot.
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Both also includes the amount of any liability of which the transferor is
relieved as a result of the exchange. Sec. 1031(d). A policy loan is treated as a
liability for this purpose. Thus, The exchange of a life insurance contract with
an outstanding loan can result in the receipt of boot and make an otherwise
tax-free exchange taxable. The Internal Revenue Service has, however, taken
the position that if the new contract is encumbered by an equivalent liability,
no gain or loss will result. See, e.g., PLR 880658. Although a taxable event
may be avoided if the new contract is issued with an equivalent loan, few
insurers will do so; meaning many 1035 exchanges of contracts with the
outstanding loans will result in the recognition of gain.
Exchanges in Life
Insurance Contracts (continued)
Policies with Outstanding Loans (continued)
B) Exchange of the policy following a partial surrender
Since the exchange of a contract with an outstanding loan will result in the
recognition of gain (assuming there is gain in the contract) a seemingly logical
tactic might be to first eliminate the loan by effecting a partial surrender of the
contract, and the then effect the exchange of the now unencumbered policy. A
partial surrender is not a taxable event unless the loan paid off with the
surrender proceeds exceeds the contract holder’s basis in the contract. Sec.
72(e)(5). The Internal Revenue Service has taken the position, however, that
this is the equivalent of an exchange of the contract with an outstanding loan.
In PLR 9141035 the Service invoked the “step transaction” doctrine to
collapse the repayment of the loan and the subsequent 1035 exchange into a
single transaction and ruled that the contract holder would have to recognize
gain to the extent of the loan.
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Exchanges in Life
Insurance Contracts (continued)
Modified Endowment Contracts
A) Exchange of a Modified Endowment Contract
The Internal Revenue Service Code provides that if a modified endowment
contract (MEC) is exchanged for a new contract, the new contract will be a
modified endowment contract. SEC 7702 (a)(2). Thus, it is not possible to
purge a MEC of its MEC Status by exchanging it for a new contract.
B) Exchange of a pre-June 21, 1988 single premium life insurance contract
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A single premium life insurance contact issued prior to June 21, 1988 is
not treated as a modified endowment contract. If such a contract is
exchanged later for a new single premium life insurance contract, will it
lose it’s grandfathered status and be treated as a MEC?
Although the law is not entirely clear, most insurers do not treat the new
contact as modified endowment contract subjecting it to 7-pay premium
testing. In calculating the seven pay limit on the new contract, the formula
takes into account the cash value of the existing contract, but does not treat
it as a premium payment. The new contract will therefore have a very low
or perhaps zero seven-pay limit, but will not be a MEC. This often means,
however, that if any additional premiums are paid into the new contract, it
may become a MEC.
Exchanges in Life
Insurance Contracts (continued)
Modified Endowment Contracts (continued)
C) Policy loan limits- Exchange of a pre-June 21, 1986 Business-owned contact
Prior to the enactment of the Tax Reform Act of 1986 there was no limitation on the amount of policy loan
interest a business could claim as an income tax deduction. The Act added section 264 (a)(4) to the Code,
which limited the deduction of policy loan interest, with respect to one or more policies on the life of any
officer, employee or individual financially interested in the business, to the interest paid or accrued on an
aggregate $50,000 of indebtedness. The Small Business Job Protection Act of 1996 amended section
264(a)(4) and added section 264(d), which placed further restrictions on the deductibility of policy loan
interest paid or accrued after October 15, 1995. Contracts purchased prior to June 21, 1986 were
grandfathered under the 1986 Act, and were in large measure spared by the 1996 changes. Thus, in the case
of these pre-June 21, 1986 policies, interest paid or accrued on an unlimited amount of policy borrowing
continues to be deductible, albeit subject to an interest rate cap imposed by the 1996 Act. If however, a
pre-June 21, 1986 contract is exchanged for a new contract, will its grandfathered status be lost?
The legislative history of section 264 (a)(4) indicates that a contract’s grandfathered status will be lost if it
is exchanged for a contract of a different insurer. Although this implies that grandfathered status will be
retained by a contract that is exchanged for a contract of the same insurer, the legislative history is actually
ambiguous on this point. It suggests that changes to a pre-June 21, 1986 contract, other then “minor
administrative changes” may cause the contract to be treated as purchased after June 20, 1986. In light of
the uncertainty, if the deductibility of interest is a significant consideration , a business intending to
exchange a grandfathered contract should consult with their tax advisors prior to the exchange. It should
also be kept in mind that any loan outstanding at the time of the exchange will, as described above, be
treated as boot, if it is repaid or eliminated in the process of the exchange.
Exchanges in Life
Insurance Contracts (continued)
Business Exchange Rider
A) Exchange of a contract under a Business Exchange Rider
Business-owned insurance contracts often carry a rider that allows the insured to
be replaced with another employee of the business. The fact that these are called
“business exchange riders” has led some to believe that this “exchange” of
insureds would constitute a section 1035 exchange. Section 1035 requires that
the contracts exchanged relate to the same insured, i.e.. That the insured under
both contracts be the same. Since an exchange under a business exchange rider,
by its very nature, involves a change of insured’s, such an “exchange” does not
qualify as tax-free under section 1035. The IRS made this explicitly clear in
Revenue Ruling 90-109, 1990-2 C.B 191, which held that such “exchanges” are
treated as surrenders for income tax purposes. Thus, the exercise of a business
exchange rider will result in the recognition of gain by the business that owns
the contract, as though it had been surrendered.
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Exchanges in Life
Insurance Contracts (continued)
Business Exchange Rider (continued)
B) Exchange of a contract in conjunction with a change of ownership
Very often, in a business or estate planning context, the exchange of a contract will be accompanied by a
simultaneous change of ownership to another person, or to an entity, such as a trust. Although an insurer
may process the exchange as a single transaction, for tax purposes this constitutes two separate
transactions; a transfer of ownership and a 1035 exchange. Although the exchange itself will be
non-taxable (assuming no boot is received) the transfer of ownership will have income and/or gift tax
implications. If the contract is owned by a business and is transferred to the insured employee, the
employee will be subject to income tax on the value of the contract. If the business transfers the contract
to a member of the insured's family, or to an irrevocable trust created by the employee, the change of
ownership will likely be treated as a constructive transfer to the insured, followed by a constructive
transfer to the transferee, and the constructive transfer by the insured will be treated as a gift to the
transferee.
The direct transfer of the policy by the business, to a family member of the insured or to a trust, may also
raise a potential “transfer for value,” issue. The transfer for value rule comes into play whenever there is
a transfer, for a valuable consideration, of a right to receive proceeds of a life insurance policy. A
transfer made in connection with employment, i.e., in exchange for services rendered, would be for a
valuable consideration. If a transfer for value occurs, and if no exception to the rule is applicable, the
death proceeds in excess of the transferee’s basis in the contract will be subject to income tax. The
exceptions to the rule are: (1) A transfer to the corporation in which the insured is an officer or a
shareholder; and (2) A transfer in which the basis of the transferee is determined in whole or in part by
reference to the basis of the transferor. Sec. 101 (a)(2).
Exchanges in Life
Insurance Contracts (continued)
Business Exchange Rider (continued)
B) Exchange of a contract in conjunction with a change of ownership(continued)
In the event a contact is transferred by a business directly to an employee’s irrevocable trust, it would be
difficult for the IRS to argue, on the one hand, that the contract was constructively transferred to the
insured and then to the trust, and, on the other hand, that the death proceeds should also be subject to
income tax under the transfer for value rule. The two positions would appear to be mutually exclusive
since the constructive transfer to the insured would meet an exception to the transfer for value rule, and a
gift, by its very nature, is not a transfer for the value. Nevertheless, it is possible, that in any given
situation, the Service would opt for the position that would potentially result in the largest amount of tax
revenue.
For estate tax purposes, section 2035(a) of the IRS code requires an insured to outlive the transfer of an
insurance contract on his or her life by three years in order for the proceeds to be removed from his or her
estate. If the exchange of a contract is effected in conjunction with a change of ownership, e.g., to the
children or to an irrevocable trust, should the three year rule apply to the new contract? What if the policy
is exchanged by the transferee after the initial transfer? In each case, arguably, the proceeds are paid from
a new contract and not from the contract transferred by the insured within three years of death. But there is
an undeniable link, in each case, between the old and new contracts.
It is unlikely that the law will be interpreted to permit the carryover of basis and other attributes (such as
MEC grandfathering) to the new contract without treating the new contract as transferred by the insured
for the purpose of the three year rule. This is also true when an exchange is followed by an immediate
transfer of the new contract. In both situations, the likely result is estate taxation of the proceeds if the
insured dies within three years of the transaction.
Exchanges in Life
Insurance Contracts (continued)
Exchange for a UL or SUL Policy
A) Exchange of a Single Life Contract for a Second-to-Die Contract
The prevalence of second-to-die insurance brought with it the question whether a contract insuring one
life or, alternatively, two contracts insuring two lives, might be exchanged under section 1035 for a
second-to-die contract. The IRS set forth its position in PLR 952037, wherein it ruled that such
exchanges would not qualify under section 1035 since the contracts exchanged did not each relate to the
same insured: in one of the situations presented in the ruling was the insured, under the contract
exchanges were deemed taxable. In all likelihood, the Service would adopt the same position if it were to
rule on the exchange of two or more individual contacts for a first-to-die contract.
It is worth noting that the Service has ruled favorably on the exchange of a second-to-die contract where
one of the insureds died and the survivor sought to exchange the contract for a new single life contract.
PLR 9248013. There the Service reasoned that since the survivor remained the only insured under the
contact, the exchange would not result in a change of insureds and would therefore qualify under section
1035.
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Exchanges in Life
Insurance Contracts (continued)
Exchange for a UL or SUL Policy
(continued)
B) Exchange of a Contract into an existing contract
Section 1035 provides for the non-recognition of gain when a contact is exchanged for another contract.
It is not clear, however, whether the literal terms of section 1035 would be met if a contract is exchanged
into another existing contract. The Service has never ruled directly on this question. An argument can be
made that if the exchanged is structured in a manner that is the equivalent of the issuance of a new
contract, section 1035 should apply. For these transactions to be equivalent, it would seem necessary that
there be an underwritten increase in the death benefit of the contract into which the exchange is to be
affected. If the transaction results in this additional insurance, this should arguably, satisfy the
requirements of section 1035.
The closest the Service has come to ruling on an exchange into an existing contract was a ruling
involving the deposit of surrender proceeds from one annuity contract into another annuity contract.
PLR88010010. The ruling did not involve the assignment of a contract holder which he then sought to
deposit into the new contract. Under these circumstances, it was not difficult for the Service to conclude
that this was not an exchange under section 1035. It did however, opine that “an exchange of insurance
contracts requires that the taxpayer relinquish ownership in one insurance contract and, as a result
thereof, acquire, ownership in a second insurance contract.” This language is clear evidence of the
Service’s likely intent to apply a strict interpretation of section 1035’s requirements.
Although it may be possible to effect a 1035 exchange in the manner described, given that the procedure
for doing so would be no different that an original application procedure, there appears to be little benefit
to be gained by taking this route rather than simply applying for a new contract (apart from the benefit of
ending up with a single policy).
A Life Insurance Analysis
Prepared For:
Sample Client
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What do I Have?
XYZ. Co. Universal Life Policy
Issue Age 47, Current Age 65
Year
Cash Surrender
Value
Net Death
Benefit
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22
26
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$88,267
$81,358
$48,322
Coverage Expires
$1,077,308
$1,070,399
$1,037,363
$0
Non Guaranteed Results Based on a Hypothetical Annual Gross Return of 6.00% and current charges
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What Can I Do?
1035 The Net Cash
Surrender Value
from the current
XYZ Company to a
Fully Guaranteed
Universal Life Policy
and never worry about
your policy lapsing again.
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Exchange to a
No Lapse Guarantee
What is a No Lapse Guarantee?
The No Lapse Guarantee provides an extended death benefit guarantee
period up to age 100 or for any period of time specified by the
policyholder up to age 100 provided sufficient premiums are paid
As long as …
• Planned premium is paid on or before the first day of each policy year
that it is due.
• There are no policy loans, withdrawals, increases in face amount or
termination of the No-Lapse Guarantee.
• The Net Policy Protection value is greater than zero, the No Lapse
Guarantee will be in effect.
The coverage cannot terminate even if the net cash surrender value
falls to zero or below.
What happens to the guarantee
provided if premiums are
different than illustrated?
The guarantee period depends on the NLG value, which is highly dependent
upon the amount of premiums that are paid earlier than illustrated, or if higher
premiums are paid, the guarantee period will be longer than illustrated.
Conversely, if premiums are paid later or at lower levels, the guarantee period
will be shortened.
Each annual report you receive for your policy will provide a projection of how
long the policy will remain in-force, based on premiums paid and guaranteed
assumptions. If the projection is not what you expected you as the agent will
need to have run an in-force illustration to solve for the premium required to
restore the guarantee. Each company handles their catch-up provision
differently so make sure you are aware of this so you do not lose the chance to
get back the No Lapse Guarantee.
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Baker Associates’ Sales Team
is available to help you with
your next 1035 exchange case.
[email protected]
[email protected]
[email protected]
http://www.bakco.com
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1-888-899-6599
Appendix
1)
Letter for Life Insurance Review of Current Policies: this letter is used for
agents that are writing to clients that own older policies to make them aware that
since then new products were introduced which might be cheaper then their
current policy so they should review their current situation.
2)
Letter of Authorization to Release Policy Information: this letter is used for
agents that are in need of information in regards to their clients current policy
which they are not the agent of record.
3)
Letter of Trust: this letter is used for policies owned by a trust that are looking
to receive information on their current policies for their annual review of
coverage. The review is required in order to fulfill the trust’s fiduciary
responsibility to regularly monitor the performance of all investments owned by
the trust.
4)
Information about the Trustee Due Diligence Requirements With Respect to
Trust Owned Life Insurance Policies: this is just general information about
trust’s due diligence in regards to owning a life insurance policies.
Date: MM/DD/YEAR
Mr. & Mrs. Valued Client
Street Address
City/ State/ Zip
Re: Life Insurance Policy Review
Dear Mr. & Mrs. Valued Client:
The life insurance industry has gone through some dramatic changes in the past several years in the design and pricing of its products.
These changes are a direct response to consumer demand for products that are more flexible and more readily adaptable to changes in the
insured’s circumstances, the fact that actual mortality experience has been significantly better than what was originally expected when the
products were priced, improved expense management, better than anticipated investment performance and a greater range of investment
alternatives to choose from.
As a result of these changes, it is not uncommon to encounter a situation where an existing life insurance portfolio put into place before these
changes took effect can be dramatically improved upon in terms of coverage, cost, investment alternatives, investment performance and/ or
product flexibility.
If you own (or have in force) life insurance coverage on your life that is more than 5 year old, it is possible that such coverage can be restructured
on a tax favored basis to increase the amount of available death benefit, lower the cost for the same amount of coverage, provide a wider range of
investment choices, improve investment performance and/ or provide you with greater flexibility to adapt the coverage to future changes in your
personal and gamily circumstances.
In order to determine whether you life insurance portfolio is capable of being improved, we will need to obtain basic information regarding your
existing policies and your current health status. Once we have completed our analysis, we will be able to quantify for you whether a change would
be in your best interest taking into consideration the expected future performance of the existing policies, your current age and your current health
status.
Sincerely,
Your Name
Authorization to Release Policy Information
Date: MM/DD/YEAR
To: Name (If Insurance Company)
Attention: Policy Owner Service Department
Street Address
City, State ZIP
Re: Policy Number # xxxxxxx
To Whom it May Concern:
Please be advised that I (we), __________________________________, have retained the right to review the above listed life insurance
policy(ies). In order to conduct this review for we will need to evaluate certain information regarding the past and expected future performance of
the listed policy(ies). I herby authorize the release of any and all information pertaining to the listed policy(ies) including, but not limited to
original illustrations upon which the original purchase was base, current policy values, loans outstanding, current projections of future
performance, illustrations of projected assumptions, policy forms, rider and amendments and such other relevant information that deems relevant
with respect to the evaluation of these policy(ies).
I agree that a photocopy or facsimile of his Authorization shall be as valid as the original. I further agree that this Authorization shall be valid for
the longer of lifetime of the undersigned insured (or the last to die of the insured’s if there are two or more insured under the policy) or the
maximum period permitted under the laws and regulations of any state having subject matter jurisdiction over this Authorization.
Policy Owners:
Signature: ________________________ Date: _ _/ _ _/ _ _ _ _
Print Name: ___________________
Signature: ________________________ Date: _ _/ _ _/ _ _ _ _
Print Name: ___________________
Date: MM/DD/YEAR
Name of Life Insurance Company
Street Address
City/State/Zip
Re: [Name of Trust]
To Whom It May Concern:
Please be advised that I (we) are conducting an annual review of the life insurance policy(ies) listed below which are owned by the Trust. The review is required in order to
fulfill my (our) fiduciary responsibility to regularly monitor the performance of all investments owned by the trust.
Policy #'s
Insured 1:
Insured 2:
Owner:
#
#
#
In order for us to complete our review, we will require the following information:
For each whole life policy, please provide an “In Force” illustration showing projected policy performance based upon current dividend crediting rate and assuming the same
duration of premiums payment as was illustrated when the policy was originally purchased. Second, please provide an illustration of the amount and duration of premium
payments that would be required to maintain this policy in force to maturity bases upon current dividend crediting rates and assuming that dividends are applied in the same
manner as was originally illustrated.
For each universal life policy, please provide an “in force” illustration showing projected policy performance based upon the current interest crediting rate and assuming the
same duration of premium payments as was illustrated when the policy was originally purchased. Second, please provide an illustration of the amount of additional premium, if
any, that would be required to maintain each policy in force to maturity at current interest crediting rates again assuming that premiums will be paid for the same duration as
was illustrated when the policy was originally purchased. Third, please provide an illustration of the amount of annual premium that would be required to maintain this policy
in force to maturity based upon current interest crediting rates assuming that premiums are paid annually to maturity. Finally, Please verify that each policy includes a maturity
extension rider or similar policy features what will allow such policy to continue in force beyond maturity without further expenditure of premium and describe the terms and
limitations of such rider or similar policy features.
For each variable universal life policy, please provide an “in force” illustration showing projected policy performance based upon actual historic investment performance (and
assuming that such performance is maintained to the maturity of the policy) and assuming the same duration of premium payments as was illustrated when the policy was
originally purchased. Second, please provide an illustration of the amount of additional premium, if any, that would be required to maintain each policy in force to maturity
based upon historic investment performance (and assuming that such performance will continue until maturity) again assuming that premiums will be paid for the same
duration as was illustrated when the policy was originally purchased.
Signature of Trustee: ____________________________Date: _ _/_ _/_ _ _ _
Signature of Witness: ___________________________ Date: _ _/_ _/_ _ _ _
Name of Trust: _______________________________________________________
Signature of Trustee: ____________________________Date: _ _/_ _/_ _ _ _
Signature of Witness: ___________________________ Date: _ _/_ _/_ _ _ _
Trustee Due Diligence Requirements With Respect to
Trust Owned Life Insurance Policies
Introduction
The Uniform Prudent Investor Act (the Act) was developed by the National Conference of Commissioners on Uniform State Laws in 1995 and
has been adopted with various modifications by all 50 states. The Act sets forth standards of prudence to be followed by trustees in
establishing investment policy and in the selection and monitoring of trust investments. The Act measures prudence in terms of the process by
which investment decisions are made as opposed to classifying categories of investments as prudent or imprudent per se (the so called “legal
list” standard).
The General Standard
The Act requires that the trustee design and implement an investment policy and select investments to carry out this policy in a manner that is
consistent with the trust’s unique purposes and properly reflects the needs and circumstances of the trust beneficiaries. In this regard, the
trustee should invest and manage trust assets as a prudent investor would, taking into consideration the purposes of the trust, its terms and
conditions, distribution requirements and other circumstances. In satisfying this standard, the trustee is required to exercise reasonable care,
skill and caution. Failure to adhere to this standard could subject the trustee to personal liability not only for losses sustained but also, mere
failure to exercise reasonable care, skill and caution even though no actual economic loss is demonstrated.
In addition, trustees are required to confirm to fundamental fiduciary duties of loyalty and impartiality, be prudent in deciding whether and
how to delegate authority in the selection and supervision of agents and incur only those costs that are reasonable in amount and are
appropriate to the trustee’s investment responsibilities.
Due Diligence Standard for Trust Owned Life Insurance
In the absence of language to the contrary in the trust instrument, the Act mandates that the trustee’s duties and responsibilities with respect to
life insurance policies purchased by the trust or contributed by others are to be governed by the same standards as apply to any other trust
investment. Thus, in the selection of life insurance policies to be acquired by the trust, in the evaluation of policies contributed to the trust and
in the ongoing monitoring of the performance of these policies, the trustee will be held to the same standard of care, prudence and due
diligence as applies to any other trust investment.
In this regard, the trustee has the initial duty of acting prudently in selecting the life insurance policy that reflects the risk and return objectives
of the trust. If life insurance policies are contributed to the trust, the trustee has the affirmative duty to review these policies to make certain
that they meet the standards enumerated above. Once acquired by or received by the trust, the trustee has an ongoing responsibility to
periodically monitor these policies and when appropriate, take such actions with respect to such policies are necessary to protect the interests
of the trust and its beneficiaries.
Trustee Due Diligence Requirements With Respect to
Trust Owned Life Insurance Policies (Continued)
Due Diligence Standard for Trust Owned Life Insurance (Continued)
Circumstances where a change in the structure of an existing policy, a replacement of an existing policy with another issued by the same
or another carrier or the surrender other disposition of an existing policy include but are not limited to the following.
1.
an adverse change in the financial strength of the current carrier
2.
a change in the investment or economic environment or economic environment which will or has the potential to adversely
impact the underlying investment performance of the policy
3.
a change in the circumstances of the trust, the settler or its beneficiaries
4.
a change in the tax, legislative or regulatory environment which impacts the need the policy as intended to address
5.
product enhancements, pricing improvements and other favorable product changes which could result in reduced costs or
increased benefits if the change is made
Conclusion
The requirement that the trustee act prudently and exercise reasonable care, skill and caution in carrying out investment responsibilities
applies to life insurance policies as well as other trust investments. In the event that the trustee determines that a change is appropriate, an
analysis should be undertaken to determine what action will serve the purpose of the trust and the best interests of its beneficiaries. This
analysis should include an evaluation of the expected future performance of the existing policies, the financial circumstances of existing
carriers, the current health status of the insured(s), the purpose for which the insurance was originally purchased and such other matters
that are relevant to this analysis.
Failure to adhere to the required standard of prudence can be significant. A trustee can be held personally liable for failing to act
prudently in carrying out its duties and responsibilities under the terms of the trust. Such duties and responsibilities include the initial
evaluation and periodic review of life insurance policies purchased or acquired by the trust. Failure to take appropriate action with respect
to such policies in light of changes in policy performance, deteriorating carrier financial integrity or changes in beneficiary or other
circumstances could be considered a breach of the trustee’s duty of prudence.