This article is cited from Steve Leimberg's Estate Planning Newsletter, June 29 2009.
The topics of due care for trust-owned life insurance (TOLI) and liability of irrevocable life insurance trust (ILIT) trustees have been discussed quite frequently in LISI. For instance, Patrick Lannon has discussed in LISI Estate Planning Newsletter# 1342, ILIT trustee liability and state statutes specifically reducing liability for ILIT trustees. On the other hand, Barry Flagg has provided subscribers with a provocative and practical life insurance portfolio management model on this topic (see LISI Estate Planning Newsletter # 1287).
In their latest commentary, Barry and Patrick together provide LISI members in this Part 1 of a 2 Part series with additional eye opening commentary on the first appellate level court case (at least the first known to these authors) dealing a claimed breach of fiduciary duty involving the investment of life insurance in an ILIT.
In addition, be on the lookout for Part 2 of this series in which Barry again discusses life insurance portfolio management "best practices" which possibly could have prevented this case from reaching the point of litigation.
While many trustees are facing increased scrutiny of their investment performance in these difficult economic times, trustees of trusts holding life insurance (often referred to as irrevocable life insurance trusts, or "ILITs") face additional challenges in their management of this "special asset". Acknowledging the potentially serious trustee liability, a few states have passed legislation that reduces the trustee's fiduciary responsibility for life insurance as an investment.
However, such protective statutes do not help a trustee to determine how to manage life insurance to maximize the benefit for the trust beneficiaries.
Outside of the few states with protective statutes, the Uniform Prudent Investor Act ("UPIA") and similar statutes require as rigorous a management model for life insurance as for other types of assets. However, until now trustees have had no court guidance regarding the application of the UPIA to life insurance.
A recent Indiana Court of Appeals case appears to provide some comfort to ILIT trustees (and perhaps some consternation to ILIT beneficiaries) in UPIA states by setting a low bar for investment due diligence with respect to life insurance.
However, this case is the first such case involving a claim of breach of fiduciary duty for ILIT trustees, at least the first such case known to these authors. As such, it can hardly be considered evolved case law.
This case is nonetheless instructive as to the various claims dissatisfied beneficiaries may make.
It is also instructive to examine the appropriate steps taken by the trustees and the possible additional actions they could have taken so as to provide a road map for trustee’s intent on avoiding future lawsuits.
In In re Stuart Cochran Irrevocable Trust, ILIT trust beneficiaries alleging violations of Indiana's version of the UPIA and breach of trust sued KeyBank, N.A. as trustee.
Immediately upon assuming responsibilities as successor ILIT trustee in 1999, KeyBank approved of an exchange of policies in the trust which had been arranged by the insured's insurance advisor (i.e., the agent/broker who appears to have sold the various policies that are the subject of this case).
This exchange raised the collective death benefit from $4,753,539 to $8,000,000.
Due to market losses in 2001 and 2002, KeyBank retained an independent outside insurance consultant to review these replacement policies in 2003.
The review of hypothetical illustrations of policy values suggested that the policies would likely lapse long before the insured reached his life expectancy, but the consultant initially recommended only further monitoring. Even though the independent consultant recommended only further monitoring, the insured's insurance agent/broker/advisor recommended the purchase of a replacement policy with an expected face value of $2,787,624 guaranteed to age 100.
KeyBank's consultant also reviewed this replacement policy, noting that surrender charges of $107,764 would be incurred on the termination of the old policies, but nonetheless recommended that the old policies be exchanged in favor of the new policy.
KeyBank, as trustee, subsequently surrendered the old policies and purchased the new policy.
Soon after the purchase of the new policy, the insured died unexpectedly at the age of 53.
The ILIT beneficiaries promptly sued KeyBank as trustee for breach of fiduciary duty. The trial court framed the question in a way that almost assured the outcome:
Was it prudent for the Trustee to move the trust assets from insurance policies with significant risk and likelihood of ultimate lapse into an insurance policy with a smaller but guaranteed death benefit?
While admitting that the "process was certainly less than perfect," the trial court focused on the prudence of replacing the old policies in general rather than the prudence of choosing the new policy specifically and unsurprisingly determined that the change in policies was prudent.
The appeals court agreed, first determining that there was no imprudent and improper delegation of decision making functions to the insured and his advisor. Instrumental to this determination was the fact that KeyBank relied on guidance from "an outside, independent entity with no policy to sell or any other financial stake in the outcome" to review the policies and the recommendations of the insured's advisor.
Next, the court determined that KeyBank did not imprudently disregard such independent guidance from its consultant. While the consultant did not initially recommend replacement of the old, higher face value, policies, it eventually recommended purchase of the new policy and KeyBank followed this advice.
The appeals court then examined KeyBank's investigation of the alternatives to the purchased policy, and agreed with the trial court that while "the process was not perfect," it was sufficient that the trustee "examined the viability of the existing policies and at least one other option."
Finally, the court noted that the UPIA prohibits the use of hindsight in determining the appropriateness of investments, dismissing the insured's early death and the subsequent recovery of the economy as factors to consider in determining the prudence of the purchase.
The appeals court also considered several other issues, concluding that:
- sufficient information was provided to beneficiaries despite the fact that annual reports were sent to the non-custodial parent of the beneficiaries, made documents available to the beneficiaries but did not mail them copies, and failed to solicit the consent or approval of the beneficiaries prior to changing insurance policies,
- the trustee did not breach a duty of loyalty by its communications with the insured, and
- that the change in insurance policies was not inconsistent with the grantor's intent.
This case is a must-read for any individual or corporate trustee of an ILIT. The quite emphatic and favorable decisions of both the trial court and appeals court should give trustees a degree of comfort, especially considering the unfortunate result for the beneficiaries in light of the insured's unexpected death.
However, the cautious trustee will recognize that the actions of KeyBank were considered by the court to be less than ideal. Any standard for trustee due diligence should consider the actions of KeyBank to be a bare minimum which cautious trustees will strive to improve upon if faced with similar issues .
Most importantly, it appears that this case could easily have gone the other way on the issue of "prudent process."
Under the Indiana version of the UPIA, a trustee is required to "exercise reasonable care, skill, and caution" in managing trust assets as a prudent investor would.
In this case, KeyBank considered only the existing life insurance and one other policy. The court did not shed any light on any examination of underlying costs and performance assumptions that might or might not have been performed.
While admitting that "of course it could have done more," the court found this due diligence adequate. It is difficult to imagine the court reaching the same conclusion had a trustee considered one mutual fund to replace two existing funds, without discussing the trustee's examination of fees, expenses and historical performance for either the universe of possible alternatives or at least a relevant benchmark.
It remains to be seen whether other courts will be similarly satisfied by this level of review in the future.
While this case is silent on the issue, it would be interesting to know whether other life insurance portfolio management activities (such as changing the asset allocation of cash values in existing policies, reducing the death benefit of the existing insurance, and/or considering the purchase of other products of the same or different type) would have achieved a better result under these circumstances.
In addition, Indiana's version of the UPIA provides that a trustee may only "incur costs that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the skills of the trustee."
While the trustee's consultant did make the trustee aware of new expense charges, including commissions and surrender charges (of $107,764), the court does not tell us whether the consultant or the trustee investigated, measured or justified the various internal costs and expenses in either existing policy holdings or the alternative(s) under consideration. Without such details we cannot know whether it would have been more prudent to simply make changes to existing policy holdings or if the trustee could have gotten a better deal on a similar policy.
Some additional lessons from this case are as follows:
- The court makes clear that in this case the insured died unexpectedly. The unexpected nature of the death is bolstered by the fact that the insured had recently qualified for substantial life insurance. While not discussed in this case, a trustee who does not have the benefit of recent information about the health of the insured may want to take additional steps to determine the health and likely life expectancy of the insured (if the insured is cooperative) before making changes to a policy to extend its coverage.
- The court notes that KeyBank relied on guidance from "an outside, independent entity with no policy to sell or any other financial stake in the outcome." Presumably a consultant was engaged because KeyBank either lacked the internal resources to analyze the policies or because it wanted to distance itself from the decisions. It is logical to assume that KeyBank would have faced an uphill battle if could not show either sufficient internal expertise or a disinterested outside advisor. Trustees should make sure that they are compensated sufficiently to retain sufficient expert internal or external advice and/or research as they may need.
- The court determined that the beneficiaries were kept sufficiently informed. A cautious trustee will be attuned to such issues as custody of minors and family dynamics generally. While the court was correct to determine that lack of information was not a proximate cause of any damages in any event, in some circumstances a cautious trustee should consider obtaining releases from beneficiaries prior to substantially reducing a death benefit or at least consider a formal or informal accounting that will start the applicable statute of limitations for challenges running. While state's requirements for reporting to beneficiaries varies greatly, in states that require disclosure a failure to disclose can make even innocent actions appear nefarious and perhaps lower the bar for a finding of bad faith.
- The court in this case found no breach of duty associated with coordination with the insured/grantor. While the court's reasoning appears sound, a trustee should be careful to remember that its fiduciary duties run to the beneficiaries and not to the insured/grantor. In this case, the court ignored such items as the "outside, independent entity" repeatedly referring to the insured as KeyBank's "client." If, for example, the insured/grantor had hired KeyBank to manage his other assets, the court may have investigated the relationship much more closely.
- However, as a practical matter an ILIT trustee will have to coordinate with the insured/grantor to some extent, since (i) ILITs are often dependent upon continuing contributions to support the insurance policy and (ii) many trustee choices, such as the ability to purchase new insurance, are constrained by the insured's willingness to cooperate.
Patrick J. Lannon is Of Counsel with Goldman Felcoski & Stone P.A., in Coral Gables and a member of the Florida and New York bars. He is board certified by the Florida Bar in wills, trusts, and estates. His practice involves all aspects of estate planning and administration, including tax-advantaged transfers of assets, multi-generational planning, the federal and state taxation of trusts and estates, charitable giving, prenuptial and post-nuptial planning, the creation and administration of charitable entities, and issues relating to change of residence.
Barry D. Flagg is a founder of Veralytic, the only patented online provider of life insurance product ratings and pricing and performance research. TIA is the natural outgrowth of his work in managing life insurance portfolios for affluent individuals, their trusts and growth companies that consistently ranks him in the top 1% of all practitioners. Flagg was the youngest Certified Financial Planner (CFP®) in history, a Chartered Life Underwriter (CLU), and Chartered Financial Consultant (ChFC). He has since been an adjunct faculty member of the College for Financial Planning, addressed the national conferences of HSBC Bank/WTAS, Grant Thornton, and National Financial Partners (NFP), and has been on a national radio show for John Hancock. He has been cited in A Practical Guide to Drafting Irrevocable Life Insurance Trusts, and has been published/featured in American Bankers Association Trusts & Investments, AICPA Wealth Management Insider, National Underwriter, Financial Advisor, University of Miami Heckerling Institute on Estate Planning, @ Regulatory from Deloitte, Agent’s Sales Journal, InvestmentAdvisor.com, Bank Investment Consultant, and Empire magazines.
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!
LISI Estate Planning Newsletter #1486 (June 29, 2009) at http://www.leimbergservices.com/ Copyright 2009 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.
In re Stuart Cochran Irrevocable Trust, 901 N.E.2d 1128 (Indiana Court of Appeals, March 2, 2009)
 For a general discussion of ILITs, see Patrick J. Lannon, Planning Opportunities With Irrevocable Life Insurance Trusts, Estate Planning Volume 34, Number 5 (May 2007).
 LISI Estate Planning Newsletter #1342, Patrick J. Lannon.
 LISI Estate Planning Newsletter #1287, Barry D. Flagg, LISI Estate Planning Newsletter #1343, Richard M. Flah and Lori W. Denison.
 Shortly before the actions complained of KeyBank replaced Pinnacle Bank as trustee. According to the published opinion, Pinnacle Bank resigned as trustee based on the insured's insistence on having third parties involved in the trustee's decision-making process. In light of subsequent events, Pinnacle Bank appears to have made the right decision.
 Due to underwriting considerations the eventual actual face value was $2,536,000.
 The court noted that any shortcomings in providing information to beneficiaries were not in any event the proximate cause of any damages.
 For a discussion of how to apply an assets-under-management business model and corresponding fee structure to life insurance, see Barry D. Flag, "$3 Trillion in Neglected Wealth", LISI Estate Planning Newsletter # 1287.