Ten Mistakes (We See) Many TOLI Trustees Make

At Insurance Trust Monitor, we have seen pretty much everything there is to see when it comes to life insurance management, yet monthly, sometimes weekly, we come across something we have not seen before. I understand that life insurance is a confusing asset to manage, and when you add in the tax and estate planning requirements around trust administration, I totally get it that trustees have a tough job. In our contacts with prospects and clients, we have found ten areas where we see the most problems when it comes to TOLI.  This list is generated from being in the place where we at ITM live: the trenches of TOLI trust/policy management.

Mistake #1: Failing to Understand Trustees’ Fiduciary Responsibilities

Fiduciary responsibility has been in the news lately, with an ongoing debate centering on the level of responsibility one has to a client based on one’s role, but it crystal clear that, as a TOLI trustee, you hold a fiduciary responsibility. The Uniform Prudent Investor Act (UPIA) provides clear guidance, telling TOLI trustees to “manage trust assets as a prudent investor would.” This is pretty broad language, but it does get more specific, instructing trustees to “review the trust assets and make and implement decisions…within a reasonable time after accepting” the asset. In other words, understand the policy and make sure it is appropriate. It goes on to say you must “invest and manage the trust assets solely in the interest of the beneficiaries,” a recurring theme of prudent fiduciary practices. The UPIA does give trustees the ability to “delegate investment and management functions,” which may be the most prudent step if required skills are not available. For those TOLI trustees who fall under the supervision of the Office of the Comptroller of the Currency, the OCC Handbook on Hard to Value Assets, put out in August 2012, provides guidance, some of which mirrors the UPIA. For example, the Handbook states that trustees are “responsible for protecting and managing the life insurance policy for the benefit of the beneficiaries.” Sound familiar? So does this…“A bank fiduciary must understand each life insurance policy that the trust accepts.” The Handbook not only says delegation is okay, it mandates it if the trustee does not have the skills needed, saying he or she “must employ an advisor who is qualified, independent, objective, and not affiliated with an insurance company.” As in the UPIA, a trustee is directed to review the policy, first when it is initially brought in and then annually. In fact, even with states lowering their standards as they relate to life insurance policy management, the OCC Handbook points out that trustees under its jurisdiction still need to provide annual reviews on the policy, the “Reg. 9” reviews that all trustees are aware of.

Mistake #2: Failing to Price Your Services Correctly

A couple of years ago, ITM surveyed TOLI trustees and found that a third of the responders priced their TOLI services under $750 annually. About 15% were in the $250-500 range, and a couple charged nothing, preferring to provide the service as an accommodation. The majority of the respondents were in the $1,000-1,500 range, which is in line with running a profitable business, but those priced at $750 and below, and especially those acting as a trustee as an accommodation, should probably re-think their pricing. After all, there are real costs associated with the service. Competent administrative staff, focused legal counsel, and a life insurance specialist on board will make up the bulk of your costs, but you also must add in liability insurance and the costs of “mistakes” insurance may not cover, along with the cost of a centralized database system, the ever-increasing costs of “compliance,” and a management position to oversee it all. Then you begin to get an idea of the true costs of your service. I would suggest that the “sweet spot” of $1,000-1,500 is more than justified and, in fact, we are seeing pricing rise above that amount to $2,000, even $3,000 and beyond. If you are in the business, you should probably charge what you need to do a good job or get out.

Mistake #3: Failing to Adequately Understand the Trust Document and Policy When Taking in a Trust

Successful management of a life insurance trust starts at the beginning. Onboarding the policy and trust correctly sets the tone. The biggest mistakes we see include inadequate legal trust document reviews, resulting in administrative and even more costly errors; insufficient understanding of the policy; and, when understood, inadequate documentation of that understanding with the grantor. In addition, we often see sloppy general housekeeping, simple things like keeping complete and correct contact information for all those involved with the trust, including any advisors who can be called upon. Having an understanding of the personal “back stories” that drive the trust decisions also will be very helpful.

Mistake #4: Failing to Adequately Document a Prudent Process

According to the UPIA, a prudent decision is viewed “in light of the facts and circumstances existing at the time of a trustee’s decision or action and not by hindsight.” This should bring some comfort to the trustee who can document that a decision made was prudent at the time when it was made, because you should not be held liable if things go askew. However, too often, the documentation is insufficient. In some instances, there is simply no uniform process in place, no rigid method of documentation that all at your firm follow.  Other times, the understanding of the trust document or life insurance policy is not sufficient to render a prudent decision, and even if a prudent decision was made, a central depository had not been established and the memorialization of the decision making process is lost. As I mentioned in a past blog post, The Outcome Cannot Always Be (Completely) Controlled, But The Process Can, in any situation where liability is being reviewed, the focus is not so much on the outcome as on the process employed by the trustee. Many things outside of your control can affect an outcome, but if you are being accused of not living up to your TOLI duty, you had better be prepared to show the prudent practices that you employed. 

Mistake #5: Failing to Adequately Communicate With Both Grantors and Beneficiaries

Communication is the key to good TOLI trust administration. Without it, you create policy and administration difficulties, increase the chances of a negative outcome and your liability, and, ultimately, increase your costs. The most successful TOLI trustees are those who maintain an active dialogue with grantors and, when necessary, beneficiaries. Rhythmic communication about the policy is a must and, when possible, face-to-face or conference call reviews are beneficial. Too often, relationships with grantors consist only of a gift notice they look at as another bill. Reaching out to a grantor reinforces the validity and purpose of the trust. Beneficiaries need to be notified any time there is a change to the trust’s benefits. Court cases and settlements can be avoided if this simple rule is followed.

Mistake #6: Failing to Administer the Trust and Policy Correctly

Creating a consistent administration process begins with timing. Requesting gifts early, following up promptly, and understanding what to do if slow gifting will cause late premium payments is important. Templates and other efficiency tools will help you to create a profit center, but understanding how to deal with common policy and trust issues will mitigate your liability.  A centralized, dedicated system, committed and focused administrative staff, and complimentary legal and insurance specialists are all components of a successful TOLI administration system.

Mistake #7: Failing to Analyze Policy Options When Trust Goals Change

While TOLI trusts are irrevocable, changes do occur. Grantors stop funding, trust goals and/or death benefit needs change. A trustee must have the necessary skills to determine the best way to maximize a life insurance policy when changes occur. I understand that this is not easy; for example, assume an 86-year-old grantor decides that he or she is no longer going to gift to the trust. It is probable that, without the additional funding, the policy will lose value and eventually lapse. Only an enlightened trustee would be able to review options available to the trust, which might include keeping the current death benefit intact, lowering the death benefit, surrendering the policy, or selling it on the secondary market and investing the proceeds. This is not an easy analysis, but it must be done. I have run across trustees who have made these decisions with no analysis and no dialogue with the beneficiaries – a recipe for disaster. This is where unbiased life insurance advice is necessary to develop a prudent decision. Don’t forget to adequately document the reasons for your decision and get the necessary sign-offs from all pertinent parties.

Mistake #8: Failing to Realize the Real Client is the Beneficiary, Not the Grantor

It is easy to see the grantor as the client. After all, who is funding the trust and paying your fee?  However, as discussed earlier, the UPIA and the OCC Handbook are clear in defining your client as the beneficiary, and case law bears that out. In Paradee v. Paradee, the court ruled that “instead of evaluating what was in the best interests of the Trust, (the trustee) evaluated whether he could please his long-time clients,” who were the grantors. In Schwab et al. v. Huntington National Bank, the court ruled that the grantor of an irrevocable trust even lacked the standing to sue the trustee, a good reason to understand who your real client is. Another one is purely business: most trustees view life insurance trusts as a bit of a nuisance. Yes, they should generate a profit, but the real payoff comes when the benefit is paid, if the beneficiary keeps the funds with your firm. It’s best to start now to make sure that happens.

Mistake #9: Failing to Adequately Understand Policy Replacements

There are good reasons for a policy to be replaced, but often we see that trustees do not have a good grasp on whether a policy replacement makes sense. One example leaps to mind: a trustee passed a replacement policy on to us for review. The trustee believed that the new policy made sense based on some changes in the grantor’s situation.  However, when we looked into the policy, we found that though the agent had created an illustration that the policy’s “premium cost” was equivalent because of the assumptions used, the actual cost of the policy, principally the cost of insurance in the new policy, was four times that of the existing policy. In order to adequately protect the trust, the trustee needs to be able to decipher carrier illustrations and compare products, not an easy task. When the policy is reviewed, the trustee needs to have a document in the file that spells out the policy caveats and parameters, as well as the grantor’s funding obligations.

Mistake #10: Failing to Have Specialized Staff and Resources Focused on TOLI

By this time, it should be clear that the mistakes highlighted in this article stem primarily from either a lack of procedures in place, or a lack of the skillsets needed to manage this complex financial asset. As mentioned, staffing starts with a specialized administrator and includes focused legal counsel and unbiased insurance personnel. Compliance issues dictate the need for a person with oversight of the entire operation with audit capabilities.  A centralized database will also be needed, as all of the trust documents will have to be retained in a secure system for an extended period of time.

The blog above is an adaption of a free two-part webinar provided by Insurance Trust Monitor. The sessions provide CE credit for CTFA and CFP designations and include real-life case studies. The second session will be held Tuesday, May 19th at 1 PM CDT.  See www.youritm.com for additional information.