Life Insurance Review Issues

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Life InsuranceReview Issues
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Table of Contents

1. Factors that Necessitate Life Insurance Policies
   to be Reviewed.
2. General Rules of a Trustees Duty to Sell
   Investments that are No Longer Prudent
   Investments.
3. Selected Issues in 1035 Exchanges.A) Contract
   with an Outstanding Premium LoanB) Modified
   Endowment ContractsC) Business Exchange RiderD)
   Exchange for a UL or SUL policy.
   
   
4. Exchange in Life Insurance Contracts.
5. A Life Insurance Analysis Prepared for Sample
   Client
6. Exchange to a No Lapse Guarantee

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Factors That Necessitate Life Insurance Policies
to Be Reviewed
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Factors That Necessitate Life Insurance Policies
to Be Reviewed

• A possible Decline in ratings of the in-force
  insurance carrier.
• A Comdex review of the in-force carrier. The
  Comdex gives the average percentile ranking of
  this company in relation to all other companies
  that have been rated by the rating services. The
  Comdex is the percentage of companies that are
  rated lower than this company.
• The impact of declining interest rates or
  dividend scales on the non-guaranteed assumptions
  of the in-force policy.
• A review of structural policy risk. Is most, if
  not all of the risk with the insurance company
  through contractual guarantees OR has it been
  transferred to the policyholder through dividend
  projections and non guaranteed pricing?

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Factors That Necessitate Life Insurance Policies
to Be Reviewed (continued)

• Has the insurance company changed its operating
  structure through a conversion from a mutual
  company to a publicly traded company? Has the
  in-force dividend scale declined suggesting a
  move away from policy holder focus to stockholder
  interest?
• Your job of helping people get the most insurance
  for their money contains a second responsibility
  which is making sure that the insurance product
  is of a high quality and reliability.
• A review of policy provisions is to confirm that
  they are clear and fair in regulation for
  solvency or its equivalent and to see that the
  promise can be performed when it comes due. In
  regulation, the relationship between the insurer
  and policyholder is to see that the promise is
  indeed performed fairly and that the buyers
  reasonable expectations as to what was bought are
  not too rudely disappointed.

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Factors That Necessitate Life Insurance Policies
to Be Reviewed (continued)

• Guarantees are only as good as the guarantor. A
  thorough evaluation of the carrier should be
  paramount to selection of contracts promising
  long term guarantees.
• Review the rules of your state on trustee duties
  and responsibilities.

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An Analogous Situation
General Rules Of A Trustees Duty To Sell
Investments That Are No LongerPrudent Investments
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General Rules Of A Trustees Duty To Sell
Investments That Are No LongerPrudent Investments

• General rule is a trustee must review investments
  on a regular basis and dispose of investments
  that are no longer prudent within a reasonable
  time- this extends to all assets, including life
  insurance policies.
• A trustee who ignores this duty can be personally
  liable for any loss to the investment.
• This rule applies to investment management both
  inter vivos and testamentary (during and after
  lifetime).
• Fifty states with different statutes and/or case
  law interpretation of a trustees duties under
  specific fact situations.

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General Rules Of A Trustees Duty To Sell
Investments That Are No LongerPrudent
Investments (continued)

• In most states, the trust document trumps state
  law unless trust provisions are clearly illegal
  or against public policy.
• The majority of states have statues that read
  It is the duty of the trustee to exercise
  prudence in determining whether to retain
  investments made by the settler.
• Professional responsibility is to review the
  investment to determine if the trustee is acting
  in a prudent manner. The courts have ruled a
  trustee is not justified in retaining investments
  if it becomes imprudent to do so, even if
  directed by the settler.

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Selected Issues In1035 Exchanges
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Selected Issues In 1035 Exchanges
The ability to defer gain in a life insurance,
annuity or endowment contract through a section
1035 exchange can be of significant benefit to a
policyholder. As the above discussion indicates,
however, it is important that the exchange be
effected correctly, and that all potential tax
implications are fully considered. Failure to do
so may result in a loss of the deferral. Section
1035 exchanges are an integral part of the life
insurance business. Unfortunately, these
exchanges can have unexpected results and their
income and estate tax implications are not always
fully understood. This information will review a
variety of exchange transactions. It will explain
the known tax ramifications of these
transactions, and point out those instances in
which the results are not entirely clear. As most
may be aware, the law is often unclear, making
the business of exchanging life insurance
difficult at times. Nevertheless, the objective
is to provide you with guidance to help you avoid
some of the pitfalls posed by section 1035
exchange. This advice should not take the place
of your tax advisor who should be sought before
any decisions to exchange an insurance policy are
made.
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Exchanges in LifeInsurance Contracts
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Exchanges in LifeInsurance Contracts
Section 1035(a) of the Internal Revenue Code
provides that no gain or loss will be recognized
on the exchange of a life insurance contract for
another life insurance contract, for an annuity
contract or for an endowment contract. As the
following will indicate, certain conditions will
apply and the transaction may have other
implications that should be understood

• Contract with an Outstanding Premium Loan
• Modified Endowment ContractsGrandfathered loan
  limits
• Business Exchange riderChange of ownership in a
  policy exchange
• Exchange for a UL or SUL policyExchange into an
  existing contract

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Exchanges in LifeInsurance Contracts (continued)
Policies with Outstanding Loans

• A) Exchange of a policy with an outstanding loan
• In order for an exchange to be tax-free, it
  must be of a like kind, meaning that no money or
  other property (i.e., no boot) can be received
  in addition to the contract. The receipt of the
  boot will cause the gain in the contract to be
  recognized to the extent of the sum of money and
  the fair market value of the property received.
  Sec. 1031(b). If the boot received exceeds the
  gain in the contract, the entire gain will be
  recognized if the boot is less than the gain in
  the contract, gain recognition will be limited to
  the amount of the boot.Both also includes the
  amount of any liability of which the transferor
  is relieved as a result of the exchange. Sec.
  1031(d). A policy loan is treated as a liability
  for this purpose. Thus, The exchange of a life
  insurance contract with an outstanding loan can
  result in the receipt of boot and make an
  otherwise tax-free exchange taxable. The Internal
  Revenue Service has, however, taken the position
  that if the new contract is encumbered by an
  equivalent liability, no gain or loss will
  result. See, e.g., PLR 880658. Although a taxable
  event may be avoided if the new contract is
  issued with an equivalent loan, few insurers will
  do so meaning many 1035 exchanges of contracts
  with the outstanding loans will result in the
  recognition of gain.

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Exchanges in LifeInsurance Contracts (continued)
Policies with Outstanding Loans (continued)

• B) Exchange of the policy following a partial
  surrender
• Since the exchange of a contract with an
  outstanding loan will result in the recognition
  of gain (assuming there is gain in the contract)
  a seemingly logical tactic might be to first
  eliminate the loan by effecting a partial
  surrender of the contract, and the then effect
  the exchange of the now unencumbered policy. A
  partial surrender is not a taxable event unless
  the loan paid off with the surrender proceeds
  exceeds the contract holders basis in the
  contract. Sec. 72(e)(5). The Internal Revenue
  Service has taken the position, however, that
  this is the equivalent of an exchange of the
  contract with an outstanding loan. In PLR 9141035
  the Service invoked the step transaction
  doctrine to collapse the repayment of the loan
  and the subsequent 1035 exchange into a single
  transaction and ruled that the contract holder
  would have to recognize gain to the extent of the
  loan.

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Exchanges in LifeInsurance Contracts (continued)
Modified Endowment Contracts
A) Exchange of a Modified Endowment Contract
The Internal Revenue Service Code provides that
if a modified endowment contract (MEC) is
exchanged for a new contract, the new contract
will be a modified endowment contract. SEC
7702 (a)(2). Thus, it is not possible to
purge a MEC of its MEC Status by exchanging it
for a new contract.
B) Exchange of a pre-June 21, 1988 single premium
life insurance contract A single premium life
insurance contact issued prior to June 21, 1988
is not treated as a modified endowment contract.
If such a contract is exchanged later for a new
single premium life insurance contract, will it
lose its grandfathered status and be treated as
a MEC? Although the law is not entirely
clear, most insurers do not treat the newcontact
as modified endowment contract subjecting it to
7-pay premium testing. In calculating the seven
pay limit on the new contract, the formula takes
into account the cash value of the existing
contract, but does not treat it as a premium
payment. The new contract will therefore have a
very low or perhaps zero seven-pay limit, but
will not be a MEC. This often means, however,
that if any additional premiums are paid into the
new contract, it may become a MEC.
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Exchanges in LifeInsurance Contracts (continued)
Modified Endowment Contracts (continued)
C) Policy loan limits- Exchange of a pre-June 21,
1986 Business-owned contact Prior to the
enactment of the Tax Reform Act of 1986 there was
no limitation on the amount of policy loan
interest a business could claim as an income tax
deduction. The Act added section 264 (a)(4) to
the Code, which limited the deduction of
policy loan interest, with respect to one or more
policies on the life of any officer, employee
or individual financially interested in the
business, to the interest paid or accrued on an
aggregate 50,000 of indebtedness. The Small
Business Job Protection Act of 1996 amended
section 264(a)(4) and added section 264(d),
which placed further restrictions on the
deductibility of policy loan interest paid or
accrued after October 15, 1995. Contracts
purchased prior to June 21, 1986 were
grandfathered under the 1986 Act, and were in
large measure spared by the 1996 changes. Thus,
in the case of these pre-June 21, 1986
policies, interest paid or accrued on an
unlimited amount of policy borrowing continues
to be deductible, albeit subject to an interest
rate cap imposed by the 1996 Act. If however, a
pre-June 21, 1986 contract is exchanged for a
new contract, will its grandfathered status be
lost? The legislative history of section 264
(a)(4) indicates that a contracts grandfathered
status will be lost if it is exchanged for a
contract of a different insurer. Although this
implies that grandfathered status will be
retained by a contract that is exchanged for a
contract of the same insurer, the legislative
history is actually ambiguous on this point.
It suggests that changes to a pre-June 21, 1986
contract, other then minor administrative
changes may cause the contract to be treated as
purchased after June 20, 1986. In light of
the uncertainty, if the deductibility of interest
is a significant consideration , a business
intending to exchange a grandfathered contract
should consult with their tax advisors prior to
the exchange. It should also be kept in mind
that any loan outstanding at the time of the
exchange will, as described above, be treated
as boot, if it is repaid or eliminated in the
process of the exchange.
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Exchanges in LifeInsurance Contracts (continued)
Business Exchange Rider
A) Exchange of a contract under a Business
Exchange Rider Business-owned insurance
contracts often carry a rider that allows the
insured to be replaced with another
employee of the business. The fact that these are
called business exchange riders has led
some to believe that this exchange of
insureds would constitute a section 1035
exchange. Section 1035 requires that the
contracts exchanged relate to the same insured,
i.e.. That the insured under both
contracts be the same. Since an exchange under a
business exchange rider, by its very
nature, involves a change of insureds, such an
exchange does not qualify as tax-free
under section 1035. The IRS made this explicitly
clear in Revenue Ruling 90-109, 1990-2 C.B
191, which held that such exchanges are
treated as surrenders for income tax purposes.
Thus, the exercise of a business exchange
rider will result in the recognition of gain by
the business that owns the contract, as
though it had been surrendered.
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Exchanges in LifeInsurance Contracts (continued)
Business Exchange Rider (continued)
B) Exchange of a contract in conjunction with a
change of ownership Very often, in a business
or estate planning context, the exchange of a
contract will be accompanied by a
simultaneous change of ownership to another
person, or to an entity, such as a trust.
Although an insurer may process the exchange
as a single transaction, for tax purposes this
constitutes two separate transactions a
transfer of ownership and a 1035 exchange.
Although the exchange itself will be
non-taxable (assuming no boot is received) the
transfer of ownership will have income and/or
gift tax implications. If the contract is
owned by a business and is transferred to the
insured employee, the employee will be
subject to income tax on the value of the
contract. If the business transfers the contract
to a member of the insured's family, or to an
irrevocable trust created by the employee, the
change of ownership will likely be treated as
a constructive transfer to the insured, followed
by a constructive transfer to the transferee,
and the constructive transfer by the insured will
be treated as a gift to the transferee.
The direct transfer of the policy by the
business, to a family member of the insured or to
a trust, may also raise a potential transfer
for value, issue. The transfer for value rule
comes into play whenever there is a transfer,
for a valuable consideration, of a right to
receive proceeds of a life insurance policy. A
transfer made in connection with employment,
i.e., in exchange for services rendered, would be
for a valuable consideration. If a transfer
for value occurs, and if no exception to the rule
is applicable, the death proceeds in excess
of the transferees basis in the contract will be
subject to income tax. The exceptions to the
rule are (1) A transfer to the corporation in
which the insured is an officer or a
shareholder and (2) A transfer in which the
basis of the transferee is determined in whole or
in part by reference to the basis of the
transferor. Sec. 101 (a)(2).
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Exchanges in LifeInsurance Contracts (continued)
Business Exchange Rider (continued)
B) Exchange of a contract in conjunction with a
change of ownership(continued) In the event
a contact is transferred by a business directly
to an employees irrevocable trust, it would be
difficult for the IRS to argue, on the one
hand, that the contract was constructively
transferred to the insured and then to the
trust, and, on the other hand, that the death
proceeds should also be subject to income
tax under the transfer for value rule. The two
positions would appear to be mutually exclusive
since the constructive transfer to the insured
would meet an exception to the transfer for value
rule, and a gift, by its very nature, is not
a transfer for the value. Nevertheless, it is
possible, that in any given situation, the
Service would opt for the position that would
potentially result in the largest amount of tax
revenue. For estate tax purposes,
section 2035(a) of the IRS code requires an
insured to outlive the transfer of an
insurance contract on his or her life by three
years in order for the proceeds to be removed
from his or her estate. If the
exchange of a contract is effected in conjunction
with a change of ownership, e.g., to the
children or to an irrevocable trust, should the
three year rule apply to the new contract? What
if the policy is exchanged by the transferee
after the initial transfer? In each case,
arguably, the proceeds are paid from a new
contract and not from the contract transferred by
the insured within three years of death. But
there is an undeniable link, in each case,
between the old and new contracts. It is
unlikely that the law will be interpreted to
permit the carryover of basis and other
attributes (such as MEC grandfathering) to
the new contract without treating the new
contract as transferred by the insured for
the purpose of the three year rule. This is also
true when an exchange is followed by an
immediate transfer of the new contract. In
both situations, the likely result is estate
taxation of the proceeds if the insured dies
within three years of the transaction.
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Exchanges in LifeInsurance Contracts (continued)
Exchange for a UL or SUL Policy
A) Exchange of a Single Life Contract for a
Second-to-Die Contract The prevalence of
second-to-die insurance brought with it the
question whether a contract insuring one
life or, alternatively, two contracts insuring
two lives, might be exchanged under section 1035
for a second-to-die contract. The IRS set
forth its position in PLR 952037, wherein it
ruled that such exchanges would not qualify
under section 1035 since the contracts exchanged
did not each relate to the same insured in
one of the situations presented in the ruling was
the insured, under the contract exchanges
were deemed taxable. In all likelihood, the
Service would adopt the same position if it were
to rule on the exchange of two or more
individual contacts for a first-to-die contract.
It is worth noting that the Service has ruled
favorably on the exchange of a second-to-die
contract where one of the insureds died and
the survivor sought to exchange the contract for
a new single life contract. PLR 9248013.
There the Service reasoned that since the
survivor remained the only insured under the
contact, the exchange would not result in a
change of insureds and would therefore qualify
under section 1035.
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Exchanges in LifeInsurance Contracts (continued)
Exchange for a UL or SUL Policy (continued)
B) Exchange of a Contract into an existing
contract Section 1035 provides for the
non-recognition of gain when a contact is
exchanged for another contract. It is not
clear, however, whether the literal terms of
section 1035 would be met if a contract is
exchanged into another existing contract.
The Service has never ruled directly on this
question. An argument can be made that if
the exchanged is structured in a manner that is
the equivalent of the issuance of a new
contract, section 1035 should apply. For these
transactions to be equivalent, it would seem
necessary that there be an underwritten
increase in the death benefit of the contract
into which the exchange is to be affected.
If the transaction results in this additional
insurance, this should arguably, satisfy the
requirements of section 1035. The closest
the Service has come to ruling on an exchange
into an existing contract was a ruling
involving the deposit of surrender proceeds from
one annuity contract into another annuity
contract. PLR88010010. The ruling did not
involve the assignment of a contract holder which
he then sought to deposit into the new
contract. Under these circumstances, it was not
difficult for the Service to conclude that
this was not an exchange under section 1035. It
did however, opine that an exchange of
insurance contracts requires that the
taxpayer relinquish ownership in one insurance
contract and, as a result thereof, acquire,
ownership in a second insurance contract. This
language is clear evidence of the Services
likely intent to apply a strict interpretation of
section 1035s requirements. Although it may
be possible to effect a 1035 exchange in the
manner described, given that the procedure
for doing so would be no different that an
original application procedure, there appears to
be little benefit to be gained by taking
this route rather than simply applying for a new
contract (apart from the benefit of ending
up with a single policy).
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A Life Insurance Analysis Prepared ForSample
Client
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What do I Have?
XYZ. Co. Universal Life Policy Issue Age 47,
Current Age 65
Non Guaranteed Results Based on a Hypothetical
Annual Gross Return of 6.00 and current charges
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What Can I Do?
1035 The Net Cash Surrender Valuefrom the
current XYZ Company to a Fully
Guaranteed Universal Life Policyand never worry
about your policy lapsing again.
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Exchange to aNo Lapse Guarantee
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What is a No Lapse Guarantee?

• The No Lapse Guarantee provides an extended death
  benefit guarantee period up to age 100 or for any
  period of time specified by the policyholder up
  to age 100 provided sufficient premiums are paid
• As long as
• Planned premium is paid on or before the first
  day of each policy year that it is due.
• There are no policy loans, withdrawals,
  increases in face amount or termination of the
  No-Lapse Guarantee.
• The Net Policy Protection value is greater than
  zero, the No Lapse Guarantee will be in effect.
• The coverage cannot terminate even if the net
  cash surrender value falls to zero or below.

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What happens to the guarantee provided if
premiums are different than illustrated?
The guarantee period depends on the NLG value,
which is highly dependent upon the amount of
premiums that are paid earlier than illustrated,
or if higher premiums are paid, the guarantee
period will be longer than illustrated.
Conversely, if premiums are paid later or at
lower levels, the guarantee period will be
shortened. Each annual report you receive for
your policy will provide a projection of how long
the policy will remain in-force, based on
premiums paid and guaranteed assumptions. If the
projection is not what you expected you as the
agent will need to have run an in-force
illustration to solve for the premium required to
restore the guarantee. Each company handles their
catch-up provision differently so make sure you
are aware of this so you do not lose the chance
to get back the No Lapse Guarantee.
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Baker Associates Sales Teamis available to help
you withyour next 1035 exchange
case.Gbaker_at_bakco.comKschettion_at_bakco.comBcour
noyer_at_bakco.comhttp//www.bakco.com1-888-899-6
599
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Appendix

1. Letter for Life Insurance Review of Current
   Policies this letter is used for agents that are
   writing to clients that own older policies to
   make them aware that since then new products were
   introduced which might be cheaper then their
   current policy so they should review their
   current situation.
2. Letter of Authorization to Release Policy
   Information this letter is used for agents that
   are in need of information in regards to their
   clients current policy which they are not the
   agent of record.
3. Letter of Trust this letter is used for policies
   owned by a trust that are looking to receive
   information on their current policies for their
   annual review of coverage. The review is required
   in order to fulfill the trusts fiduciary
   responsibility to regularly monitor the
   performance of all investments owned by the
   trust.
4. Information about the Trustee Due Diligence
   Requirements With Respect to Trust Owned Life
   Insurance Policies this is just general
   information about trusts due diligence in
   regards to owning a life insurance policies.

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Date MM/DD/YEAR   Mr. Mrs. Valued
Client Street Address City/ State/ Zip   Re Life
Insurance Policy Review     Dear Mr. Mrs.
Valued Client   The life insurance industry has
gone through some dramatic changes in the past
several years in the design and pricing of its
products.   These changes are a direct response
to consumer demand for products that are more
flexible and more readily adaptable to changes in
the insureds circumstances, the fact that actual
mortality experience has been significantly
better than what was originally expected when the
products were priced, improved expense
management, better than anticipated investment
performance and a greater range of investment
alternatives to choose from.   As a result of
these changes, it is not uncommon to encounter a
situation where an existing life insurance
portfolio put into place before these changes
took effect can be dramatically improved upon in
terms of coverage, cost, investment alternatives,
investment performance and/ or product
flexibility.   If you own (or have in force) life
insurance coverage on your life that is more than
5 year old, it is possible that such coverage can
be restructured on a tax favored basis to
increase the amount of available death benefit,
lower the cost for the same amount of coverage,
provide a wider range of investment choices,
improve investment performance and/ or provide
you with greater flexibility to adapt the
coverage to future changes in your personal and
gamily circumstances.   In order to determine
whether you life insurance portfolio is capable
of being improved, we will need to obtain basic
information regarding your existing policies and
your current health status. Once we have
completed our analysis, we will be able to
quantify for you whether a change would be in
your best interest taking into consideration the
expected future performance of the existing
policies, your current age and your current
health status.   Sincerely,   Your Name
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Authorization to Release Policy
Information     Date MM/DD/YEAR   To Name (If
Insurance Company) Attention Policy Owner
Service Department Street Address
City, State ZIP     Re Policy Number
xxxxxxx   To Whom it May Concern   Please be
advised that I (we), _____________________________
_____, have retained the right to review the
above listed life insurance policy(ies). In order
to conduct this review for we will need to
evaluate certain information regarding the past
and expected future performance of the listed
policy(ies). I herby authorize the release of any
and all information pertaining to the listed
policy(ies) including, but not limited to
original illustrations upon which the original
purchase was base, current policy values, loans
outstanding, current projections of future
performance, illustrations of projected
assumptions, policy forms, rider and amendments
and such other relevant information that deems
relevant with respect to the evaluation of these
policy(ies).   I agree that a photocopy or
facsimile of his Authorization shall be as valid
as the original. I further agree that this
Authorization shall be valid for the longer of
lifetime of the undersigned insured (or the last
to die of the insureds if there are two or more
insured under the policy) or the maximum period
permitted under the laws and regulations of any
state having subject matter jurisdiction over
this Authorization. Policy Owners   Signature
________________________ Date _ _/ _ _/ _ _ _
_ Print Name ___________________   Signature
________________________ Date _ _/ _ _/ _ _ _
_ Print Name ___________________

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Date MM/DD/YEAR Name of Life Insurance
Company Street Address City/State/Zip   Re Name
of Trust   To Whom It May Concern Please be
advised that I (we) are conducting an annual
review of the life insurance policy(ies) listed
below which are owned by the Trust. The review is
required in order to fulfill my (our) fiduciary
responsibility to regularly monitor the
performance of all investments owned by the
trust.
In order for us to complete our review, we will
require the following information   For each
whole life policy, please provide an In Force
illustration showing projected policy performance
based upon current dividend crediting rate and
assuming the same duration of premiums payment as
was illustrated when the policy was originally
purchased. Second, please provide an illustration
of the amount and duration of premium payments
that would be required to maintain this policy in
force to maturity bases upon current dividend
crediting rates and assuming that dividends are
applied in the same manner as was originally
illustrated.   For each universal life policy,
please provide an in force illustration showing
projected policy performance based upon the
current interest crediting rate and assuming the
same duration of premium payments as was
illustrated when the policy was originally
purchased. Second, please provide an illustration
of the amount of additional premium, if any, that
would be required to maintain each policy in
force to maturity at current interest crediting
rates again assuming that premiums will be paid
for the same duration as was illustrated when the
policy was originally purchased. Third, please
provide an illustration of the amount of annual
premium that would be required to maintain this
policy in force to maturity based upon current
interest crediting rates assuming that premiums
are paid annually to maturity. Finally, Please
verify that each policy includes a maturity
extension rider or similar policy features what
will allow such policy to continue in force
beyond maturity without further expenditure of
premium and describe the terms and limitations of
such rider or similar policy features.   For each
variable universal life policy, please provide an
in force illustration showing projected policy
performance based upon actual historic investment
performance (and assuming that such performance
is maintained to the maturity of the policy) and
assuming the same duration of premium payments as
was illustrated when the policy was originally
purchased. Second, please provide an illustration
of the amount of additional premium, if any, that
would be required to maintain each policy in
force to maturity based upon historic investment
performance (and assuming that such performance
will continue until maturity) again assuming that
premiums will be paid for the same duration as
was illustrated when the policy was originally
purchased.   Signature of Trustee
____________________________Date _ _/_ _/_ _ _ _
Signature of Trustee
____________________________Date _ _/_ _/_ _ _
_ Signature of Witness __________________________
_ Date _ _/_ _/_ _ _ _
Signature of Witness __________________________
_ Date _ _/_ _/_ _ _ _   Name of Trust
__________________________________________________
_____
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Trustee Due Diligence Requirements With Respect
to Trust Owned Life Insurance Policies
Introduction The Uniform Prudent Investor Act
(the Act) was developed by the National
Conference of Commissioners on Uniform State Laws
in 1995 and has been adopted with various
modifications by all 50 states. The Act sets
forth standards of prudence to be followed by
trustees in establishing investment policy and in
the selection and monitoring of trust
investments. The Act measures prudence in terms
of the process by which investment decisions are
made as opposed to classifying categories of
investments as prudent or imprudent per se (the
so called legal list standard). The General
Standard The Act requires that the trustee
design and implement an investment policy and
select investments to carry out this policy in a
manner that is consistent with the trusts unique
purposes and properly reflects the needs and
circumstances of the trust beneficiaries. In
this regard, the trustee should invest and manage
trust assets as a prudent investor would, taking
into consideration the purposes of the trust, its
terms and conditions, distribution requirements
and other circumstances. In satisfying this
standard, the trustee is required to exercise
reasonable care, skill and caution. Failure to
adhere to this standard could subject the trustee
to personal liability not only for losses
sustained but also, mere failure to exercise
reasonable care, skill and caution even though no
actual economic loss is demonstrated. In
addition, trustees are required to confirm to
fundamental fiduciary duties of loyalty and
impartiality, be prudent in deciding whether and
how to delegate authority in the selection and
supervision of agents and incur only those costs
that are reasonable in amount and are appropriate
to the trustees investment responsibilities. Due
Diligence Standard for Trust Owned Life
Insurance In the absence of language to the
contrary in the trust instrument, the Act
mandates that the trustees duties and
responsibilities with respect to life insurance
policies purchased by the trust or contributed by
others are to be governed by the same standards
as apply to any other trust investment. Thus, in
the selection of life insurance policies to be
acquired by the trust, in the evaluation of
policies contributed to the trust and in the
ongoing monitoring of the performance of these
policies, the trustee will be held to the same
standard of care, prudence and due diligence as
applies to any other trust investment.   In this
regard, the trustee has the initial duty of
acting prudently in selecting the life insurance
policy that reflects the risk and return
objectives of the trust. If life insurance
policies are contributed to the trust, the
trustee has the affirmative duty to review these
policies to make certain that they meet the
standards enumerated above. Once acquired by or
received by the trust, the trustee has an ongoing
responsibility to periodically monitor these
policies and when appropriate, take such actions
with respect to such policies are necessary to
protect the interests of the trust and its
beneficiaries.  

35
Trustee Due Diligence Requirements With Respect
to Trust Owned Life Insurance Policies
(Continued)
Due Diligence Standard for Trust Owned Life
Insurance (Continued) Circumstances where a
change in the structure of an existing policy, a
replacement of an existing policy with another
issued by the same or another carrier or the
surrender other disposition of an existing policy
include but are not limited to the
following. 1.      an adverse change in the
financial strength of the current carrier 2.     
a change in the investment or economic
environment or economic environment which will or
has the potential to adversely impact the
underlying investment performance of the
policy 3.      a change in the
circumstances of the trust, the settler or its
beneficiaries 4.      a change in the tax,
legislative or regulatory environment which
impacts the need the policy as intended to
address 5.      product enhancements,
pricing improvements and other favorable product
changes which could result in reduced costs or
increased benefits if the change is
made Conclusion The requirement that the trustee
act prudently and exercise reasonable care, skill
and caution in carrying out investment
responsibilities applies to life insurance
policies as well as other trust investments. In
the event that the trustee determines that a
change is appropriate, an analysis should be
undertaken to determine what action will serve
the purpose of the trust and the best interests
of its beneficiaries. This analysis should
include an evaluation of the expected future
performance of the existing policies, the
financial circumstances of existing carriers, the
current health status of the insured(s), the
purpose for which the insurance was originally
purchased and such other matters that are
relevant to this analysis.  Failure to adhere to
the required standard of prudence can be
significant. A trustee can be held personally
liable for failing to act prudently in carrying
out its duties and responsibilities under the
terms of the trust. Such duties and
responsibilities include the initial evaluation
and periodic review of life insurance policies
purchased or acquired by the trust. Failure to
take appropriate action with respect to such
policies in light of changes in policy
performance, deteriorating carrier financial
integrity or changes in beneficiary or other
circumstances could be considered a breach of the
trustees duty of prudence.