Just over a decade ago, we began managing life insurance policies for TOLI trustees. In that time, we have grown from a handful of dedicated team members to the largest life insurance policy management firm in the country with 175 employees and hundreds of clients. It is no wonder the growth has occurred. Life insurance is a confusing asset, and the tax and estate planning requirements around trust administration are cumbersome. Having an expert handle this asset makes sense. Over the years, trustees and advisors have asked us for a list of the most common mistakes we have seen made by TOLI trustees. We have whittled the list down to the five mistakes we see most often.
- Failing to Price Services Correctly: Trustees often price insurance trusts as an accommodation. In an ITM TwentyFirst survey, we found one third of trustees charged under $750 per trust and 15% charged only $250-$500. To properly manage life insurance, you need an expert administrative staff, competent legal counsel and life insurance specialists who understand a complex asset. Can you provide that with a pricing model this low? Most trustees charge $1,000-$1,500, which is more in line with costs and should be the starting price point. We are now seeing pricing models starting at $2,000 and reaching up to three or four thousand dollars per year. If you are in the business, charge what you need to do a top-notch job. There is too much liability attached to this asset to do anything less.
- Failing to Adequately Document a Prudent Process: Per the Uniform Prudent Investor Act (UPIA), a prudent decision is viewed “in light of the facts and circumstances…at the time of a trustee’s decision…not by hindsight.” While this can comfort the trustee who can demonstrate a prudent process, it highlights the shortcomings of many TOLI trustee decisions—too often documentation around a policy decision is insufficient with no uniform process in place followed by all who touch the asset. The UPIA recognizes there are many things outside of your control that affect an outcome, but if you need to prove you upheld your fiduciary duty, you must show the prudent practices you employed.
- Failing to Analyze Policy Options When Trust Goals Change: While TOLI trusts are irrevocable, goals do change. In fact, with the changes in the federal estate tax exemption in the last year, you will see more grantors questioning their life insurance need. Death benefit requirements will drop, and some grantors will stop funding their trusts. Analyzing options is an area of weakness for TOLI trustees and going forward, trustees must have the necessary skills to maximize the asset even when changes in the asset are warranted. This analysis is difficult, but must be done, though some trustees do not know where to start. We have seen decisions made around multi-million dollars assets with no thoughtful and documented process. We believe that this will be an area of litigation going forward.
- Failing to Adequately Communicate with Grantors and Beneficiaries: Communication reduces negative outcomes and liability. Maintaining an active dialogue with grantors and, when necessary, beneficiaries, increases client retention and lowers liability. Recurring communication about the policy is a must. If needed, face-to-face or conference call reviews should be encouraged. Beneficiaries must be notified any time there is a change to trust benefits. Court cases and settlements can be avoided if this simple rule is followed.
- Failing to Adequately Understand Policy Replacements: There are good reasons for a policy replacement, but often trustees do not investigate whether they make sense. In the last two years as the opportunity for new sales in the TOLI market has decreased we have seen a corresponding increase in “bad” replacements that would have put the trust at a disadvantage. In our last webinar we reviewed a replacement that would have left a trust $900,00 poorer. This transaction did not go through (we stopped it), but if it had it was a lawsuit waiting to happen.
Financial settlements for mismanaging life insurance trusts are rising as market stresses and policy complexities increase. You may not read about them in the Wall Street Journal because many consist of checks written behind closed doors. By following these five rules, you lower your chances of writing one of those checks.
In our next two blogs, we will review some cases that have gone to court and the lessons they have taught us.