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Learn why life insurance policies need regular review due to factors such as carrier ratings, interest rates, and structural risks. Understand trustee responsibilities in selling investments and issues in 1035 exchanges.
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Table of Contents • Factors that Necessitate Life Insurance Policies to be Reviewed. • General Rules of a Trustee’s Duty to Sell Investments that are No Longer Prudent Investments. • Selected Issues in 1035 Exchanges.A) Contract with an Outstanding Premium LoanB) Modified Endowment ContractsC) Business Exchange RiderD) Exchange for a UL or SUL policy. • Exchange in Life Insurance Contracts. • A Life Insurance Analysis Prepared for: Sample Client • Exchange to a No Lapse Guarantee 2
Factors That Necessitate Life Insurance Policies to Be Reviewed 3
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 non-guaranteed 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? 4
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. 5
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. 6
An Analogous Situation General Rules Of A Trustee’s Duty To Sell Investments That Are No LongerPrudent Investments 7
General Rules Of A Trustee’s Duty To Sell Investments That Are No LongerPrudent 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. 8
General Rules Of A Trustee’s Duty To Sell Investments That Are No LongerPrudent 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. 9
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. 11
Exchanges in LifeInsurance 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 ContractsGrandfathered loan limits • Business Exchange riderChange of ownership in a policy exchange • Exchange for a UL or SUL policyExchange into an existing contract 13
Exchanges in LifeInsurance 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.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. 14
Exchanges in LifeInsurance 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. 15
Exchanges in LifeInsurance Contracts (continued) Modified Endowment Contracts A) Exchange of a Modified Endowment ContractThe 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 • 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 newcontact 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. 16
Exchanges in LifeInsurance 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 LifeInsurance Contracts (continued) Business Exchange Rider A) Exchange of a contract under a Business Exchange RiderBusiness-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. 18
Exchanges in LifeInsurance Contracts (continued) Business Exchange Rider (continued) B) Exchange of a contract in conjunction with a change of ownershipVery 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 LifeInsurance 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 LifeInsurance Contracts (continued) Exchange for a UL or SUL Policy A) Exchange of a Single Life Contract for a Second-to-Die ContractThe 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. 21
Exchanges in LifeInsurance Contracts (continued) Exchange for a UL or SUL Policy (continued) B) Exchange of a Contract into an existing contractSection 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 exchangedinto 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).
What do I Have? XYZ. Co. Universal Life Policy Issue Age 47, Current Age 65 Non Guaranteed Results Based on a Hypothetical Annual Gross Return of 6.00% and current charges 24
What Can I Do? 1035 The Net Cash Surrender Valuefrom the current XYZ Company to a Fully Guaranteed Universal Life Policyand never worry about your policy lapsing again. 25
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. 28
Baker Associates’ Sales Teamis available to help you withyour next 1035 exchange case.Gbaker@bakco.comKschettion@bakco.comBcournoyer@bakco.comhttp://www.bakco.com1-888-899-6599 29
Appendix • 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. • 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. • 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. • 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. 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 Trustee: ____________________________Date: _ _/_ _/_ _ _ _ Signature of Witness: ___________________________ Date: _ _/_ _/_ _ _ _ Signature of Witness: ___________________________ Date: _ _/_ _/_ _ _ _ Name of Trust: _______________________________________________________
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.
