Our two prior blogposts explored the need for regular and ongoing trust-owned policy reviews and examined methods of valuing underperforming, at-risk policies. This third post explores a potential option when a policy review uncovers a poorly drafted or obsolete irrevocable trust.

“Predictions are hard,” said former NY Yankee Hall of Famer Yogi Berra. “Especially about the future.”

Yet somehow clients, their financial advisors and estate attorneys are supposed to gaze into the future and know how newborns will turn out, what legislative, tax and carrier changes will take place, and whether a couple will stay together or divorce, remarry and potentially start second or third families. Based on this perfect seer-like wisdom, all-knowing advisors must create Irrevocable Life Insurance Trusts (ILITs) that can never be altered in any way, shape or form. Challenging? Certainly. But it’s been the status quo for years. Until now.

Twenty-eight states have either passed or are considering legislation that would allow clients to revoke (“decant”) an irrevocable trust. Even California recently conceded the wisdom of former Carmel resident Doris Day’s 1956 hit song “Que Sera Sera”¹ and passed the Uniform Trust Decanting Act in 2018.

California’s new law allows trustees to modify the terms of a trust (with some limitations) without court approval or the consent of beneficiaries’ non-judicial modification). In addition, trustees can always go to court to modify an existing agreement (non-judicial modification).

Policy Reviews and the Irrevocable Trust

Trustees have a fiduciary responsibility to manage assets for the benefit of trust beneficiaries. Yet life insurance is often viewed as a passive asset by trustees. ILITs, in fact, need constant performance monitoring to ensure sufficiency of current premium payments and whether any withdrawals or loans outstanding have affected the policy over time. Failure to do so could subject trustees to an unintended breach of fiduciary duties and legal liability.

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Life is change. That’s why as life goals change, life insurance needs change as well.

Over time, the original need for coverage — like having young children or providing for income replacement — may no longer matter to clients after retirement. They may own policies they no longer need or can afford, especially if one of the policyholders is in poor health. What’s more, sustained low interest rates and the volatility of equity markets may have drastically affected older policies so that original premium funding levels cannot sustain coverage.

The best way to keep track of these changing client situations is through a regular policy audit or policy review, as discussed in our prior blogpost.

During the past several years, our Policy Analysis & Comparative Evaluation (PACE) report has uncovered many underperforming policies. However, before considering a reduction in face amount, surrendering coverage or transferring ownership, a serious effort should be made to determine the contract’s true value.

At first glance, the value would appear to be the policy’s surrender value. Yet that may be the worst way to determine valuation. Nor does it provide a method to assess a term life policy. In fact, our research indicates that most valuation methods are inadequate and outdated, use inconsistent data, and fail to consider the health of the insured(s).

So how should a life insurance policy be valued?

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If you’ve had a physical exam or dental checkup recently, you know how important periodic evaluations can be in preventing small problems from turning into bigger ones.

Health and life changes, such as marriage, divorce, retirement, arrival of a new baby, or the purchase and sale of a home, can affect our financial health, too. That’s why it’s important to periodically check and update customer accounts and other financial documents.

This is especially true when it comes to life insurance coverage. Over time policies can become outdated and rife with simple errors — such as having an incorrect permanent address or phone number for the policyholder. Or referencing one or more deceased beneficiaries. In some cases, medical advances and the entry of new competitors could enable policyholders to obtain better coverage at a lower cost. On the other hand, some policies may be close to lapsing because of outstanding policy loans or failure to maintain premium payments.

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