Take the TOLI Challenge: Only Permanent Life Insurance Policies Can Be Sold, True or False?

Earlier this year we started the TOLI Challenge with the question: What is most important when determining the liability of a trustee’s actions? Click here for that answer.  Today, we have a follow up true or false question.

Only permanent life insurance policies can be sold in the life settlement market, True or False?

It may surprise you that the answer is false – some term policies actually can be sold.  Term policies, without cash value, are most often surrendered back to the carriers for no value when, under the right circumstances, they can be sold into the secondary market, providing the trust with additional cash that can be passed down to the beneficiaries or used to fund other policies.

The key is whether the policy is still convertible.  As you may know, term policies can have a feature that allows the policies to be converted to a permanent policy with the same carrier at the same underwriting class but at the new age of the insured.  So, a term policy taken out on a 45-year-old insured ten years ago and initially underwritten as a preferred risk can be converted to a permanent policy at preferred rates for a 55-year-old – without the insured going through the underwriting process.

Most conversion options are for a limited period, or to a certain age, so you must check to see if the term policy conversion option is still available.  If it is, the policy may be marketable.

To see if it is, you will have to ask the carrier to provide you with a conversion illustration showing the premium requirements for the new permanent policy.  Once obtained, you can contact a life settlement broker who will review the policy costs and the health records of the insured to determine whether the policy is saleable and at what price.

Not only are convertible term policies often sold into the secondary market, they rank just behind current assumption universal life policies, as the most popular life settlement policies.  However, most TOLI trustees are unaware of this opportunity.  The fiduciary duty of a TOLI trustee includes maximizing the value of the asset in their trust – even a term policy that appears to have no value.

Canadian Court Rules on Life Insurance Investment Scheme

Back in November, we wrote about the possible “squashing” of “investors’ hopes for unlimited returns using life insurance.” At that time, the government of the Canadian province of Saskatchewan altered the regulations for a specific universal life insurance policy that some investors had hoped would be their pot of gold. However, the regulation change did not affect a court case that has since settled in favor of the insurance companies involved, including Manulife.

The policies in question were Canadian current assumption universal life policies that the investors felt set no limit on the amount of money that could be injected into the policies. Similar policies in the United States place restrictions on premium contributions.

According to a white paper we referred to in our earlier report, one of the policies in question had two cash accounts: a tax-exempt account and a taxable account. Cash placed in the tax-exempt account went to pay policy expenses, but an additional amount over and above that cost could also be contributed. Each year on the policy anniversary date, a test would be run, and any cash over a specific amount would be moved from the tax-exempt account to the taxable account to preserve the tax status of the policy. Both accounts guaranteed at least a 4% return (some other policies had up to a 5% guaranteed return), and the tax-exempt account paid an annual bonus of .85 percent on the policy’s anniversary date.

Investors, including private citizens, hedge funds and money managers, purchased policies hoping to take advantage of the guaranteed returns by placing millions into the policies. The outcome could have been catastrophic for the carriers, with a Manulife expert testifying that a $100 million deposit would cause “an immediate reported loss to the insurer in excess of $45 million,” according to the referenced white paper.

The Saskatchewan regulation change limited investors to contributing only an amount equal to the premiums required under the contract. Last week, a judge of the Court of Queen’s Bench of Saskatchewan agreed with the new regulation. According to a Wall Street Journal article, he stated in his ruling “that although the disputed policies didn’t set investment limits, the contracts were designed to restrict investments for such insurance related costs as taxes and fees.”  (1)

The judge did rule that the Saskatchewan amendment was not retroactive. The investor group plans to appeal the decision and according to the Wall Street Journal article, “the reversal of the retroactive claim means that if the investors are successful with future appeals of the ruling, the province can’t block their investments under the current act.”

Manulife issued a statement that the investment scheme was a “commercially absurd” use of the policies and that they were confident future appeals by the investors would fail.

We will report back with updates, as warranted.

  1. Canadian Insurers Win Court Battle Over Investment Strategy, Jacquie McNish, Wall Street Journal, March 18, 2019

Trustee Alert: Managing Guaranteed Universal Life Policies

Universal life policies came into the market offering premium flexibility and transparency that was unknown in whole life policies. However, universal life policies lacked one thing those whole life policies had – death benefit guarantees. If you paid your premium on a whole life policy, the policy death benefit was guaranteed to be paid.

The earliest universal life policies (current assumption) were fixed investment products developed because interest rates were lofty. The crediting rates assumed in sales illustrations were as high as 12%. This created attractive, low premium, high-cash value products with assumptions that were doomed to fail – and they did.

The life insurance industry reacted, creating a new product – guaranteed universal life, or GUL, which just like whole life, guaranteed the death benefit.  But with GUL the policyholder loses one of the most popular features of a universal life policy – premium flexibility. These policies have a set premium that must be paid in full and on time, or the policy death benefit guarantee will be shortened or lost.  

One of the common problems trustees rarely catch is when a GUL policy is purchased as a replacement, and the required premium in the as-sold illustration includes 1035 Exchange money coming over from the existing policy.  For the policy to maintain its stated guarantees, the 1035 Exchange amount coming over needs to equal or exceed the expected amount. Often, during the underwriting process, the existing policy’s cash value drops because of charges coming out of the policy, or in the case of a variable policy, a drop in the equity markets. Our solution: when the exchange occurs, verify with the carrier the exact amount coming over from the existing policy and make any adjustments needed at that time. Also, with a variable policy, place the cash value in the current policy in a money market or fixed account while the underwriting occurs on the new policy so that a market correction does not cause the cash value to swoon.  

Once the GUL policy is in force, your administrators will have to make sure the premium is paid in full and on time. This means that gift notices must go out on time and if gifts are not received, following up aggressively, making sure the grantor understands the consequences of a late gift. Note: This should all be spelled out in the document you provided to the grantor for signature when the policy is placed in the trust.

GUL payments are sometimes tricky. Over five years ago, we pointed out that one carrier found that after only four years of selling the product, 31% of the policies sold were already off track. The reasons: 8% were because of insufficient premiums, 29% because of skipped premiums, but the majority – 53% – were because of early payments. That is right, 53% were off track because the premium was paid early. This particular carrier has different crediting rates in their shadow accounts depending on funding levels and paying early resulted in a lower credited rate. 

Other carriers have higher sales loads in the early years, so paying early can cause more of the premium to go to fees and charges with less to the policy – again, creating an issue with the guarantees. This can be especially troublesome in the first policy year when charges are highest. A while back, I came across a report by a life insurance analysis firm that claimed you could lose up to “30% of your original guarantee period” by paying the second year’s premium in the first year. According to the report, in a little over half the policies they tested, paying early did not make a difference, but the others “on average lost anywhere from 10 to 20 years off the life of the guaranteed policy.” (1)

Guaranteed universal life takes the market risk out of life insurance, but it adds additional risks that sit squarely with the TOLI trustee.  For all GUL policies you take in you should understand all of the policy nuances – or hire someone who does.  

  1. Early Premium, Sydney Presley, LifeTrends, October 29, 2018

Equity Index Universal Life Illustration Projections to (Thankfully) Get Another Look by Regulators

We have written as recently as November of last year about the issues trust-owned life insurance (TOLI) trustees encounter when dealing with policy illustration projections. If you are a fiduciary managing a policy, a sales or an in-force life insurance ledger may be one of the only tools you have to predict the outcome of a policy under your care.

However, life insurance illustrations are simply hypothetical projections – at best, just a guide. Too often, they are a sales tool, and the person purchasing the policy (you, if you are the trustee) often assumes they can reasonably expect that the outcome projected for the policy will occur.  This is rarely the case for many reasons, chief among them being overly optimistic rate of return projections and non-guaranteed interest rate bonuses and multipliers that are not readily seen in an illustration.

This has been a significant concern for us with equity index universal life policies that we have been tasked to review and then help manage for trustees. These policies have become popular as a ”more conservative” alternative to variable universal life policies because though they track an index (the S&P 500, for example), they have a limit to the downside that “eliminates losses.” Many variable universal life (VUL) policies assumed cash value rates of return of up to 12% annually, and when we first began seeing these EIUL policies (often as a replacement for a VUL policy), the crediting rates in the projected policy crediting rates shown in sales illustrations approached 8%, which the salesperson told the grantor was a reasonable assumption. We disagreed and have pointed out one carrier who actually sells the product has an online “translator” that shows that in order to obtain an 8% crediting rate for the policy, under most common policy parameters (10% cap, 0% floor), the index tracked would have to exceed a 12% return. The regulators also disagreed, and in September of 2015, the National Association of Insurance Commissioners (NAIC) placed limitations on the crediting rate that could be shown on both sales and in-force ledgers to approximately 7%.

The limitations placed by the NAIC dampened EIUL sales since the policies could not illustrate as well. It was not long until carriers figured out how to game the system by adding interest bonuses and multipliers that were barely decipherable in an illustration. The ploy worked, and sales rebounded, but now the NAIC is going to take another look and has created a subgroup to review the regulations, which according to one article on the matter, “enabled some insurers to show double-digit returns that many considered unrealistic.” (1) We applaud the second look and hope the outcome will generate a more reasonable methodology for EIUL illustrations.

One of the most significant risks to a TOLI trustee is accepting a policy that has little hope for success. Many EIUL policies purchased in the last few years will fail. How many are in your portfolio?     

  1. NAIC To Reopen IUL Illustrations Guideline, John Hilton, January 11, 2019, insurancenewsnet.com

Rating Agency Upgrade for Life Insurance Industry Bodes Well for TOLI Trustees

Less than a year ago we reported that AM Best published a special report in which the rating firm issued a negative outlook on the US life insurance and annuity market.  They cited the continuing low interest rates, a flattening yield curve, regulations, potential for market corrections and the need for innovation as the major reasons for the outlook.  The report highlighted one potentially harmful issue – an abrupt increase in interest rates noting that insurance carriers prefer a slow increase to rates that “allow them to adjust their credited rates on liabilities and their asset portfolios to optimize returns.”

Recently the agency upgraded their life and annuity outlook from negative to stable for 2019, mentioning the moderately increasing interest rates as one of the positive factors.  Other positive indicators were strong sales in the annuity segment which had been down, as well as strong sales in indexed universal life. 

According to the AM Best report, lower effective tax rates going forward will be a boon to the overall profitability of the carriers, as will the general increase in carrier investment returns.

It is this increase in carrier returns that will be most beneficial to TOLI trustees.  Policy performance issues have been centered on the downward slope of fixed interest rates over the last two decades which was exacerbated by the economic crunch of 2008-09 and the Federal Reserve System’s actions that drove federal funds rates to near zero over the last 10 years. Most life insurance products are driven by fixed investments and the last two decades have not been kind to these financial vehicles.  Dividends in whole life policies swooned and crediting rates in many current assumption universal life policies dropped to their guaranteed lows. Some carriers looking to offset the loss in investment income raised the cost of insurance in their products, creating carrying cost increases of 200% or more and making some policies unaffordable for policyholders, many who could no longer purchase newer, more affordable policies. 

This AM Best report provides those of us who manage life insurance for a living with the hopeful prospect that policy performance will improve going forward taking a bit of the pressure off of managing a life insurance portfolio.

Take the TOLI Challenge: Can you answer this?

What is most important when determining the liability of a trustee’s actions?

Over the years, we have noticed that the knowledge of TOLI trustees varies from trust company to trust company. After publishing the TOLI Handbook in 2018, we thought we would “chunk it down” in 2019 with the TOLI Challenge—a series of questions designed to test the knowledge of the typical TOLI trustee. We will be publishing questions throughout the year and hope that you accept the challenge and maybe learn something new throughout the year.

Our first question:

What is most important when determining the liability of a trustee’s actions?

  1. The outcome
  2. Whether they follow the grantor’s instructions
  3. Whether the policy performs as expected
  4. The process

Before we blurt out the correct answer, let’s walk through the options.

The first option is the outcome determines the liability, and certainly, a negative result can draw the ire of the beneficiaries and initiate an action against the trustee, but often, the adverse outcome is outside the control of the trustee. If the outcome is because of direct negligence of the trustee, there may be an opportunity for the beneficiaries to move ahead with their claim.

The second option is whether the trustee follows the grantor’s instructions. If by grantors’ instructions we mean to follow the trust document, then this answer has some validity. After all, a trustee needs to review the trust document and then administer the trust according to the guidelines of that document. However, if it means following the whims of the grantor, then certainly the answer is no, as can be seen in Paradee v. Paradee.  

The third option deals with policy performance, and if this is an issue, then many trustees would be in trouble because in general, policies have not performed well over the last ten years or more. In Nacchio v. David Weinstein and the AYCO Company, we saw a fiduciary held liable for over $14M in a case that centered around policy performance.

All the answers above could have some consideration, but we believe the answer is the process. For the other options – each of which could bring liability – a proper process could either alleviate the problem or negate the liability.

If a policy has a negative outcome, it is not necessarily the trustee’s fault. The Uniform Prudent Investors Act (UPIA) speaks to this in Section 8 of the UPIA in reference to prudent decision making as it deals with compliance, which it says is “determined considering the facts and circumstances existing at the time of a trustee’s decision or action and not by hindsight.” As long as the decision making at the time was prudent, liability will be limited. How to ensure it is? Have a prudent process that is followed and documented.

The second choice, following the grantor’s instructions, could be an issue, but not if you had a sound practice in-house to follow the guidelines of the trust document in a prudent manner, and as part of your administrative and decision-making process, you are not swayed by the whims of the grantor. For some trustees, this has been an issue – after all, the grantor pays the bills, but Section 5 of the UPIA is clear when it says a trustee is required to “invest and manage the trust assets solely in the interest of the beneficiaries.”

The third choice, policy performance, could be problematic for those trustees who have not closely tracked their portfolio and made their grantors aware of the situation. In the Nacchio case, the policies brought in had rate of return assumptions of over 10.5%, which were never attained. Again, the process followed could alleviate the issues that could come from a policy that did not live up to expectations. When the policy is taken in, make it your policy to assume very conservative returns for the cash-value investment. Create a document that shows the outcome (and additional costs) at a lower return and have it signed by the grantor and made part of the trust file. As part of your prudent process, review the policy annually, and if the policy is off track, provide the grantor with a solution (typically, more premium).

So, the answer, we believe is the fourth choice: the process followed is the most critical factor when determining the liability of a trustee’s actions. This is not the first time we have said this, and it won’t be the last. We firmly believe in the prudent process. It is the backbone of our business model.

The outcome cannot be (completely) controlled, but the process can.

Life Insurance Premium Financing, a South Dakota Trust and the Life Insurance Trust Company – A Perfect Combination

Life insurance premium financing is a specialized strategy that has gained favor in recent years for high net worth individuals looking to purchase large life insurance policies without tapping their personal or business cash flow.  For these qualified wealthy individuals, the retained capital that would go to pay a premium can be better utilized for investment opportunities they believe will outperform the cost of the third-party financing.

Prospects for these strategies include privately held business owners, corporate executives, hedge fund managers and private equity executives, real estate owners, entrepreneurs, and successful physicians – all working with specialized life insurance advisors in conjunction with insurance carriers that have developed products tailored to the strategy.

To date, there has not been a trust company that specialized in life insurance, including premium financed policies – but now there is.  ITM TwentyFirst, the largest manager of life insurance for trustees and institutions nationwide, has created an affiliated South Dakota-based trust company that focuses exclusively on life insurance. Though the trust company does not provide any financing themselves, it does provide the premium financing market with a logical option for housing premium financed policies.

South Dakota has long been a superior trust situs – ranked as one of the best places to house a trust in the US year after year by leading trust and estate planning publications. South Dakota has the lowest insurance premium tax of any state – 8 basis points.  It prides itself on client confidentiality and does not require trust documents to be filed publicly.  The legislators are cooperative and proactive toward trusts and have levied no state income taxes on trust assets, and state legal statutes allow for the trust creators to direct the trust company to follow the investment decisions of an outside advisor, making the life insurance professional part of the process.

The Life Insurance Trust Company is the perfect company to work with.  Started as an affiliated company of one of the country’s most highly regarded life insurance policy managers, the firm focuses exclusively on life insurance, with no eye toward acquiring other assets.  By utilizing the services of its parent company, the trust company provides expert trust administrators and life insurance specialists that work daily with tens of thousands of policies – this is not a side asset for the company – it is their daily work.  And it shows in the level of services provided.

The staff at Life Insurance Trust Company knows the trust business and understands the life insurance business – many come from that industry.  It is extremely advisor friendly and will work with you to ensure that your clients and their beneficiaries maximize the value of the policy in their trust.

Premium financing is a specialized strategy.  It just makes sense that you partner with a specialized company skilled in the management of life insurance as an asset class.   For more information, contact Leon Wessels, Corporate Business Development Manager, at 605.574.1703 or lwessels@lifeinsurancetrustco.com.