Report from TOLI Expert Panel and Giving Council

THEInsuranceAdvisor.COM founder, Barry D. Flagg, was asked to voice his expert opinion as part of a Trust Owned Life Insurance (TOLI) panel to summarize the first appellate level court case dealing with a claimed breach of fiduciary duty involving the investment of life insurance in an ILIT.

Cochran v. KeyBank. , 901 NE 2d 1128 (Ind. App. 2009) examines the prudence of an exchange of trust-owned life insurance (TOLI) policy holdings in accordance with the principals under the Uniform Prudent Investor Act. The case appears to be the first such breach of fiduciary duty case involving TOLI, and something of a "poster child" case with facts that are common in many irrevocable life insurance trust (ILIT) situations. For instance, the life insurance agent appears to have sold "flavor of the day" products to the same insured on two or three separate occasions over the course of only 15 years, where policy selection and management decisions appear to have been made by the agent and the insured grantor without the ILIT trustee, and where the ILIT trustee was generally involved after the fact and asked to serve more as a "custodian" than a fiduciary. The timing of this case is also fortuitous for life insurance trustees facing similar situations in which TOLI holdings are underfunded due to steadily declining interest rates on universal life and whole life TOLI holdings, and due to stock market underperformance in variable life TOLI holdings, and due to the grantor's own economic situation where they are less/not able to make premium payments.

The case provides clear guidance that ILIT trustees do not need to be concerned about being second-guessed in hindsight provided they have and follow a "prudent process" and particularly when such a process incorporates information from an "outside, independent entity with no policy to sell or any other financial stake in the outcome." The case also raised but did not resolve the duties to "incur only those costs reasonable and appropriate for the purposes of the trust" and have "overall investment strategy having risk and return objectives reasonably suited to the trust" and a corresponding "expected total return from income and the appreciation of capital." In that the court here in Cochran v. KeyBank "recognize[d] that this process was certainly less than perfect", the prudent trustee will certainly want to follow the clear guidance for a prudent process that incorporates independent research, and may also wish to consider justifying TOLI expenses and setting reasonable expectations as to the rate of return on invested assets underlying TOLI cash values.

According to the statistics cited at the TOLI panel, there are many trusts today that hold policies that were purchased years ago and no one has completed a regular review of these policies. The statistics on ILITs are as follows:

95.4% - have no policy statement

83.5% - Have no guidelines / process

70-90% - Have no assigned agent &

71% - Have not had a policy review in 5 years. ^{1 Trusts & Estates (May 2003)}

This case offers many important lessons for trustees of life insurance trusts, including the following:

1. It is critical to have a prudent process. The court held, although KeyBank's decision-making process and communication with the beneficiaries were not perfect, they were sufficient. Accordingly, "prudence" as defined under the Prudent Investor Act is not concerned with whether a trustee is right or wrong in hindsight, and instead requires that trustees follow a "prudent process" which includes "mak[ing] a reasonable effort to verify facts relevant to the investment and management of trust assets." Whether the trustee performs internally the duties to monitor, investigate, and manage, or delegates some or all of these duties to an independent consultant or agent/broker, the trustee should have a well defined "prudent process" that considers at least:

1) the insurer's financial strength and claims-paying ability,

2) the expenses charged to the trust by the insurer of the TOLI holding(s),

3) the stability of such pricing representations by the insurer,

4) the liquidity/availability of TOLI cash values to the extent relevant to trust objectives, and

5) the reasonableness of the rate of return expected on invested assets underlying TOLI holdings.

2. When a trustee does not have the skills and expertise to evaluate the insurance policies and they might have to rely on an insurance advisor to complete the review. Court relied heavily on guidance from "an outside, independent entity with no policy to sell or any other financial stake in the outcome." As reported in previous TIA E-Newsletters, beware of relying on Policy Comparison, Policy Audit and/or Policy Evaluation system or service that may be "advertised" as complete, and independent and objective, but which are not and can result in flawed decisions, faulty recommendations, opinions that could be considered fraud, and breach of fiduciary duty. As such, cautious trustees should "check the fine print" of their policy review reports and seek out independent research to determine and document suitability by 1) justifying TOLI expenses ,2) setting and managing to reasonable performance expectations, and 3) documenting the delegation of responsibility to the independent researcher in accordance with the Uniform Prudent Investor Act.

Confidential Policy Evaluator (CPE) Research Reports measure the pricing, performance and suitability of any given life insurance policy holding using an easy to understand 5-Star Rating and against representative benchmark averages for the universe of peer group products based on the 5 major factors of suitability as to:

1. Financial Strength & Claims-Paying Ability

Those practitioners who equip themselves with the tools necessary to support the Prudent Investor principals will have a substantial competitive advantage over those who do not. Had the trustee in Cochran actually used CPE Research Reports to measure/justify TOLI expenses and/or to set reasonable expectations as to the rate of return on TOLI holdings, they very well may have either maintained the original UL/WL holdings or maintained the VUL policy but perhaps with a reduced death benefit and cash values allocated to the fixed account, either of which could very well have saved the trustee from the time, expense and aggravation of litigation.