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Interpretation of Surprising Results from the 2nd Annual UPIA/TOLI Compliance and Best Practices Survey
Many thanks to those who responded with thoughts, comments and interpretations of results from the 2nd Annual UPIA/TOLI Compliance and Best Practices survey. I would also like to extend special thanks and acknowledgement to David Sterling, Esq. – former trust officer and independent consultant to high-net-worth families and their advisors on fiduciary and client-advocacy issues – and George Whitelaw, President of TrustBuilder – one of the oldest and largest third-party administrators (TPAs) serving the Irrevocable Life Insurance Trust (ILIT) industry – for their particularly thorough commentary on these results as follows.
Q #1: The Uniform Prudent Investor Act (UPIA) requires ILIT Trustees to set reasonable expectations as to the performance of Trust‑Owned Life Insurance (TOLI) holdings that are appropriate in relation to the purposes of the trust, and the skills of the trustee and more than ½ of all respondents indicated the rate of return to be used in setting such expectations should be the internal rate of return on the death benefit received in relation to the premiums paid. This “represents a general lack of understanding about the inner workings of insurance contracts” says Sterling. For instance, the internal rate of return for a TOLI holding with a $1,000,000 face amount and a $100,000 lump‑sum premium investment would be 23.25% if held for 10 years (i.e., the insured dies in the 10th policy year), and 11.57% if held for 20 years (i.e., the insured dies in the 20th policy year), but only 7.70% if held for 30 years (i.e., the insured dies in the 30th policy year). Clearly, a trustee charged with the responsibility of maximizing benefits relative to risk cannot use the internal rate of return on death benefits as their barometer for the reasonableness of TOLI performance since such it is entirely a function of the timing of the death of the insured and beyond the control of the trustee. A better measure of investment performance, therefore, is the investment performance of invested assets underlying policy cash values, which is needed to cover expected future cost of insurance charges (COIs) and policy expenses, and over which trustees can exert control.
Q #2: Section 7 of UPIA specifically requires ILIT Trustees to "only incur costs that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the skills of the trustee" and almost 48% of respondents consider the premium to be the costs for the purposes of Section 7. “The fact that such a significant portion of your sample responded as such is disturbing” says Sterling. For most TOLI policies, the premium does not represent the cost of the policy, any more than a $2,000 contribution to an Individual Retirement Account represents the cost of the IRA. The costs in either case are the expenses deducted from the TOLI premium paid and/or from the IRA contribution made. To consider the premium as the cost of a TOLI holding is to suggest that a TOLI policy where premiums are “paid up” has no cost, which is just non-sense when cost of insurance charges (COIs), fixed administration expenses (FAEs) and/or cash‑value‑based “wrap fees” (M&Es) are clearly being deducted every month from the trust’s asset value. “This begs the question; do trustees understand the skills required to serve their clients' best interests and to perform the duties of the office they have been appointed to serve?” adds Sterling.
Q #3-4: The Act requires that trustees follow a "prudent process" comprised of the three (3) duties to include the duty to monitor TOLI holdings, but 65% of respondents are either not monitoring or are performing this function internally. Given Sterling’s experience as a trust officer, he is “familiar with the internal operations of many service providers, [and] inclined to combine these two respondents and draw the conclusion that ineffective monitoring is being performed. These results may go a long way to explaining why many contracts fail to perform as expected or lapse. There is no excuse for a trustee to treat an insurance policy as a trust asset that is less deserving of prudent management than a stock, bond or mutual fund holding” cautions Sterling.
Q #5-8: The Act requires that trustees follow a "prudent process" comprised of the three (3) duties to include the duty to investigate TOLI holdings, but Sterling goes on to say “the fact that 23% are not addressing this function at all shamelessly stands on its own.” Of those who are attempting to investigate suitability of TOLI holdings, more than half of indicate they employ a practice that is actually prohibited by the Financial Industry Regulatory Authority (FINRA) because it is misleading (i.e., comparing illustrations of hypothetical policy values that comingle policy expenses and assumed investment performance). To make matters worse, of those (mis)using illustrations of hypothetical policy values to investigate suitability, more than 2/3rd are comparing inforce holdings to no more than 5 other products, which is hardly a representative sample of the market (i.e., less than 1-in-12 chance that randomly selected products would be representative for suitability determinations). In addition, Whitelaw shares from his experience how he is “not aware of many corporate trustees that provide confidential trust objective information or trust file documents to third-party administrators.” In turn, Whitelaw questions “how a third party administrator can investigate and ascertain the relative appropriateness of TOLI holdings as they relate to the trust objective and peer group products without knowledge of the trust objective and documents?” Sterling also “found striking the inclination of ILIT trustees who relegate this duty to investigate to the agent/broker conducting the sale. Agents and brokers are sales personnel [and] there appears to be a misunderstanding of professional relationships involved [where] the agent and broker owe a duty to the company which often stands in conflict with the trustee.” The good news here is that more than 5% of respondents (up for near 0% a few short years ago) are now actually investigating and justifying cost of insurance charges (COIs) and policy expenses as required under Section 7 and investigating and setting reasonable expectations for performance of invested assets underlying policy cash values as required under Section 2. Thanks to those who use THEInsuranceAdvisor.COM to make such investigation easy, fast and more thorough than by any other means.
Q #9: The Act requires that trustees follow a "prudent process" comprised of the three (3) duties to include the duty to manage TOLI holdings in a manner that minimizes/justifies policy expenses and maximizes return relative to risk, and yet almost 1/3rd of all respondents admit to performing no management of TOLI holdings at all. Whitelaw goes on to say “third-party administrators are typically not licensed to give insurance advice and are not provided sufficient trust objective and trust file information by the trustee to make [suitability] determinations.” Sterling also observes “the management function is even more distant from, though not less important, than the duty to investigate. To expect the agent/broker to perform this ongoing function is unrealistic and quite frankly, naive. Combined with the 30% of those who are not actively performing the management function, this can only spell disaster for the clients and ILIT trustees alike. The apparent disregard for this essential function has all the makings of the ideal lawsuit.”
Q #10: UPIA makes no distinction in the standard‑of‑care between investment trusts and ILITs, and while it is common for trustees of investment trusts to use written Investment Policy Statements (IPS), “66% of respondents say they do not have a TOLI Investment Policy Statement (TIPS), Statement of Suitable TOLI Holdings or Delegation Agreement” observes Whitelaw, who again questions ”how can a third-party administrator investigate and ascertain the appropriateness of TOLI holdings to undocumented trust objectives? [and] how can a trustee delegate the investigation of undocumented trust objectives to a third-party administrator?” Sterling is also “amused by the thought of expecting those who have not demonstrated an awareness of their duties and responsibilities or an appropriate level of expertise to effectively manage this trust asset, to actually design a meaningful policy statement” and concludes “that trust beneficiaries are at risk and those advisors either serving as trustees or advising trustees will be asked to ‘foot the bill’.”
Our thanks again to those who responded with thoughts, comments and interpretations of results from the 2nd Annual UPIA/TOLI Compliance and Best Practices survey, and particularly to David Sterling, Esq. and George Whitelaw. If you have not yet participated in the UPIA/TOLI Compliance and Best Practices survey, then please click here to help contribute to an increasingly better understanding of how the Uniform Prudent Investor Act (UPIA) applies to the proper management of Trust-Owned Life Insurance (TOLI) policy holdings.
Also remember to check out our TOLI Toolbox for sample presentations, reference materials, example working documents and educational brochures all of which help the ILIT Trustees and those who work with ILIT trustees to better understand and fulfill their fiduciaries duties to monitor, investigate and manage TOLI holdings.
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