Fiduciary Duties for Trust Owned

Life Insurance Under UPIA

Reprinted with permission of Michigan Lawyers Weekly


By John E. Mayer

A corollary to Murphy’s Law is, “If everything appears to be going well, most likely you are not aware of everything that is going on.”

This statement is on the money as it pertains to changes taking place in the fiduciary world of trust owned life insurance (TOLI). This author can almost guarantee that attorneys are not aware of changes regarding their duties and responsibilities to the beneficiaries. Not only are these changes extensive, but they affect all assets under fiduciary care.

Eugene Maloney, a nationally-known fiduciary expert in the legal community, states, “a fiduciary, who is not complying with the new process standards of care, has begun to look like a future defendant. Those who breach their duties may be liable for monetary relief to the beneficiaries of the trust over whom they exercise discretionary authority or control.” 

Perhaps the most important step attorneys can take to keep from becoming future defendants in a nasty court battle is undertaking a fiduciary review.  This article discusses the changes that have taken place – and what constitutes an effective fiduciary review.

What Changed?

The duties and responsibilities of fiduciaries has been redefined under a set of “safe harbor” provisions in the Uniform Prudent Investor Act (UPIA), which became effective in Michigan on April 1, 2000. Fiduciaries are required to operate by these new standards of care as they discharge their duties going forward. However, a “hold harmless” clause in existing ILITs may not provide 100 percent protection as these new rules become the new community standard.


“[A] fiduciary, who is not complying with the new process

standards of care, has begun to look like a future defendant.”


An investment fiduciary/trustee is defined in the UPIA as a person who:

·        manages property for the benefit of another;

·        has discretionary control over assets; or

·        is a professional held in a capacity of trust that renders investment advice. 

Further, the UPIA, at Sec. 2(a), reads: “A trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements and other circumstances of the trust.  In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.”

Also, it should be remembered that the UPIA is default law. Simply put, this means the grantor can draft around it, thus enabling the trustee greater flexibility by offering, for example, the option to not diversify out of non-liquid assets. Therefore, if the trust document fails to draft an exception, the default law prevails.

Unfortunately, the vast majority of trustees have only a vague knowledge of their duties and responsibilities beyond paying the annual premium and sending out the crummey letters.

One of the most important duties includes investigating any and all information that would affect the value of the asset. The trustee shall consider among other things:

·        general economic conditions;

·        inflationary issues;

·        tax consequences of decisions;

·        other assets of beneficiaries; and

·        risk and return tolerance.

The new rules require the fiduciary to act within an ongoing process, one that calls for a comprehensive knowledge base in many fields. Trustees would be well advised to seek help from an insurance expert when carrying out duties on behalf of their beneficiaries.

TOLI Implications

Trust-owned life insurance has long been a popular estate-planning tool. It provides income and estate-tax-free dollars to one’s heirs at death to replace assets lost to estate taxes and or assets left to charity. However, life insurance is a unique asset and, as such, typically has been poorly managed by the fiduciaries and advisors involved.

To give an idea of the magnitude of the potential problems, it should be noted that life insurance death benefits stood at $15.5 trillion in 1999 as compared to $13 trillion for retirement plan assets. While much has been written on fiduciary duties for retirement plan assets, little has been written on fiduciary duties of life insurance.

ERISA has long required annual fiduciary reviews for qualified retirement plans but, until recently, nothing compelled the fiduciary of TOLI to go through an annual review process. Annual fiduciary reviews or audits for TOLI are the only method of navigating the myriad changes taking place. These changes are coming from improvements via better life insurance products, fiduciary due care changes and changes outside the life insurance policy.

Improvements In Life Insurance

Studies conducted by several national accounting firms – as well as trust administrators of TOLI – have found that beneficiaries are either receiving too little and/or are paying too much for the life insurance death benefit. One study found that up to 85 percent of the TOLI policies could be restructured to provide more value – at least 40 percent more death benefit for the same premium, or the same death benefit for at least a 40 percent lower premium. 

As a fiduciary, when was the last time you explored the possibility of finding if better insurance rates were available due to changes in health, non-smoking status or changes in underwriting rules by the insurance companies? 


“One study found that up to 85 percent of the TOLI policies

could be restructured to provide at least 40 percent more value.”


Many insurance companies now offer “preferred” and “ultra-preferred” mortality rates for those over age 70 in good health, where only a few years ago “standard” was the best available to those over age 70. As an example, one client, a 77-year-old male, saw his annual life insurance premium drop from $74,000 to $54,000 for the same death benefit.

Another example showing the benefit of conducting an annual fiduciary review involves a client who, in 1994, purchased a second-to-die policy only to see his wife pass away four years later. The cash value was used in a tax-free exchange to fund another policy on the husband’s life, which resulted in a 50 percent savings in premium, as well as future gift taxes.

People are living longer today than the insurance company tables predicted and, as such, mortality rates inside a life insurance policy have been dropping by about 1 percent per year on average over the last 25 years. As this article goes to print, the Society of Actuaries (SOA) is finalizing it’s report to the National Association of Insurance Commissioners (NAIC) regarding the downward adjustment of the 1990-95 basic mortality experience tables to reflect increased life expectancy. 

These changes aren’t the only ones on the horizon. In 1995, the number of active life insurance companies in the U.S. stood at 2,091. Four years later that number dropped to 1,470 due to consolidations and mergers. Presently, over 85 percent of new life insurance business comes from the top 125 companies, which suggests the trend of merger and consolidations will continue.

One effect of this flurry of merger activity is that significant operating savings have been achieved among these companies. Another is those companies that have demutualized now have less expensive access to capital. As companies re-price their new life products and achieve better economics due to lower operating costs, fiduciaries should diligently search the marketplace for better life insurance values for their clients.

Fiduciary Standards

Uniform standards of care have been developed over time from the fiduciary requirements common to UPIA, ERISA and MPERS.

The Uniform Prudent Investors Act, also known as UPIA, defines the fiduciary standards of care for executors and trustees of private non-qualified trusts and foundations/endowments. Moreover, UPIA evolved from the 1992 Restatement (Third) of Trusts, which restated the legal principles that should govern trust investments with the purpose of reconciling trust investment law with changes in investment practices.

The Employee Retirement Income and Securities Act or ERISA defines the fiduciary standards of care for fiduciaries of qualified retirement plans,

The Uniform Management of Public Employees Retirement Systems Act or MPERS defines the fiduciary standards of care for public retirement plans.

In addition, the Office of Comptroller of the Currency via Reg. 9 sets forth standards that apply to fiduciary activities of national banks. In Section 9.6, fiduciary accounts are required to do three reviews on all accounts:

·        a pre-acceptance review before accepting a fiduciary asset;

·        an initial post-acceptance review to determine if appropriate for the account; and

·        an annual review determining if assets are still appropriate – collectively or individually – for the account.

Uniform Standards

A handful of states have decided to treat life insurance assets differently than non-life insurance assets, which means that fiduciaries holding life insurance assets have little fiduciary responsibility to look out for the beneficiaries interest. Does your state redefine the word fiduciary depending on the type of asset being managed? If a TOLI trustee wishes to avoid future litigation, they would be well advised to adhere to the following Uniform Fiduciary Standards of Care developed by the Center for Fiduciary Studies:

·        Know the standards, laws, and trust provisions.

·        Prepare an investment policy statement (IPS).

·        Diversify portfolio assets.

·        Use professional money managers.

·        Control and account for investment expenses.

·        Monitor the activities of service providers.

·        Avoid conflicts of interest and prohibited transactions.

More information regarding certification in the fiduciary review/ audit process can be found on the center’s web site at

Importance Of An IPS

Perhaps the single most important function a fiduciary can perform to minimize liability and keep on track is to develop an investment policy statement (IPS). This identifies, among other things: 1) the type of policy coverage to be purchased; 2) the ratings required of life insurance companies; 3) risk tolerance; 4) the premium schedule to adhere to; 5) all current assets and investment options; 6) background; 7) the purpose for coverage and statement of objectives; 8) duties and responsibilities; 9) the insurance counselor, investment managers and custodians; and 10) asset guidelines.


“A fiduciary review of TOLI should deliver better value for all involved,

[and] peace of mind for the fiduciary.”


Further, the Prudent Investor Rule found in Restatement Third, Trusts, reads: “The trustee must give reasonably careful consideration to both the formulation and the implementation of an appropriate investment strategy, with investments to be selected and reviewed in a manner reasonably appropriate to the strategy.”

Critical Questions

Life insurance must not only be monitored for performance or a lack thereof within the policy, but from outside forces that can also impact its value. Some critical questions to ask include:

·        Has the policy inadvertently become a modified endowment (MEC) contract, which would trigger income taxation during lifetime under certain circumstances, such as borrowing cash value to pay premiums?

·        Does the split-dollar agreement need to be modified to comply with the proposed split-dollar rules issued in Internal Revenue Service Notice 2001-10? 

·        How should the fiduciary respond to not only current class action suits, but to future suits as well?

·        For those policies that will be surrendered prior to death, it is important to determine if the policy is a candidate for a life settlement. As an example, last year a $20 million universal life policy with $2 million of cash value was purchased/sold for $4.1 million – this means $2 million more is going to the beneficiaries than what was available through surrender. Therefore, is the fiduciary responsible for considering this relatively new planning tool?

·        What impact will demutualization of the life insurance company have on the economic results that flow to the beneficiaries? Are opportunities available to the trustee to enhance the economic return to the beneficiary upon receipt of the cash or stock?

·        Did the insured’s health improve or did the insured quit smoking? As trustee, did you review the medical rated insurance policy for those insureds having purchased life insurance at higher rates in the past because of suspected medical concerns? For instance, say you have a client who has a high PSA score. His insurance company rates him as if he has prostate cancer. But two years later, he has an operation and the lab results show no cancer. Therefore, an opportunity for a lower premium exists.

·        Has a point-in-time illustration on existing coverage been requested on an annual basis, so that the trustee can view performance and compare to more recent policies with lower mortality charges?

·        Did the fiduciary diversify the coverage among multiple carriers where large amounts of coverage are needed?

·        Did the fiduciary use a broker to shop the coverage or did he purchase the coverage from an employee/agent of one insurance company?  Most insurance company employee agents are precluded by contract from soliciting competitive offers outside their own company unless their own company fails to provide an offer.

·        How will policy dividends be utilized? This should be handled in the IPS. As an example, a recent fiduciary review for a trustee found dividends of more than $300,000 coming in throughout the year. These dividends were used to buy small amounts of paid-up additions. This might have been okay had it not been for the extensive outstanding loans generating $300,000 of interest, which was getting capitalized back into even more loans. Restructuring the policy generated significant savings that will accrue to the beneficiaries.

Ticking Time Bomb

Another crucial set of questions to consider is, “Is the fiduciary aware of potential tax issues on existing policies? What are the tax consequences if the vanishing policy premiums return and are not paid and the policy lapses?”

The following example demonstrates just how important a fiduciary review is for all involved.

An accounting firm that also served as trustee requested this author’s fiduciary review services on several trust-owned policies. One policy of over $50 million of gross death benefit with an outstanding loan of $25 million was found, and this was generating an interest charge of $1.5 million annually. The policy was about to lapse for a lack of the premium payment necessary to keep the policy alive.

The main issue uncovered by the review was a $5.5 million taxable gain that was set to arrive on the grantor’s doorstep if the policy were to be surrendered or lapsed for lack of premium payments. Remember the income tax liability flows to the insured/grantor if the ILIT is defective – and the grantor typically does not have access to the cash values to aid them in paying this tax liability.

Through the process of juggling the various values, the future premiums were eliminated for another decade. The ticking tax-time bomb was prevented from going off.

This type of situation is a very real problem for those that have funded their policies with too few premium payments, or borrowed and never repaid the loans. Moreover, most trustees are unaware of this emerging tax issue for those policies that die before the insured. Therefore, becoming aware of this issue while the grantors are still insurable gives the trustee the opportunity to acquire replacement coverage via a 1035 exchange.


A fiduciary review of TOLI should deliver better value for all involved, as well as uncover issues that can have unintended results. Perhaps the most important benefit will be the creation of an investment policy statement and more realistic investor return expectations. The end result will be peace of mind for the fiduciary.



John E. Mayer, CFP, of Fiduciary Review Services, specializes in fiduciary reviews/audits for attorneys and their clients. Mayer is also a licensed life insurance counselor. He can be reaches at (800) 452-4983 or via email at, or visit his web site at .