Private Client Services Update – Adding Value as Trustee of a Life Insurance Trust

    By Robert C. Goodman Jr., Estate, Trust & Wealth Transfer

    Over the last few months, as either an advisor or trustee, I have been reviewing various existing and proposed life insurance policies, both conventional and universal life. In each case, my starting point has been to think about the purpose of the policy, the risk tolerance of the client or trust and the assumptions on which the income projections of the policy are based. Often this process involves having the insurance agent run new projections for a policy.

    The current environment with low-interest rates is by necessity changing the way that all of us need to evaluate the performance of insurance policies. In fact, one of the local companies recently put out a “Due Care Bulletin” that discussed the impact of low-interest rates on life insurance products. The long and short is that, as a trustee or an advisor, we need to recognize that future performance, at least for some period of time, is going to be affected by this change in the marketplace.

    The other interesting point is that there are a number of products on the marketplace that can help policyholders to deal with the volatility of market returns. I will discuss a couple of these below.

    The starting point is to analyze the purpose of the policy. For example, what amount of the proceeds is “mission critical” and what amount is “icing on the cake.” Then it is important to understand the math of a life insurance policy, particularly how much is charged monthly, quarterly or annually against the premium or cash value to pay for the life insurance component. For example, in analyzing a universal life policy, you will see that there is a stated charge for the life insurance portion of the policy. The insurance company deducts this charge annually before funds are available to increase cash value or otherwise benefit the policy.

    Next, we should look at what net annual rate of return is really needed for the policy to perform at the level that our client needs or wants, which are two distinct concepts, and what is the risk tolerance of our client.

    Once you have a target range for an average annual return, the next step is to look at what tools may be available from the life insurance company to increase the likelihood of obtaining that performance objective. For example, one insurance company product that we recently looked at offers an S&P type of index fund with a 1% floor and an 11% cap. The effect of this collar is that the portion of the account invested in this fund can never have a negative return. Since there is always is a fixed charge for life insurance policies, avoiding a negative return can have a meaningful positive impact. For example, if the timing of the periodic charge is such that it occurs on a down day in the market, there can be a significant negative impact on returns.

    Another tool that same insurance company offered was a bond fund with a floor currently at 21/2%. The price for the floor was the loss of liquidity on funds invested in the bond fund in that those funds were locked into the fund for a long period of time with a 10% per annun withdrawal right. However, since the policyholder is already making a long term investment with a commitment of at least some portion of the portfolio to bonds, this loss of liquidity was almost like a ‘freebie’ in the sense that from an investment point of view you would intend to keep a position covered in bonds anyway. In all cases, all funds are freed up immediately for policy termination or death benefit.

    The point of all of this discussion is not to promote any particular insurance policy but rather to emphasize that, as a trustee, it is our job to look at all the options and constantly to explore new ways of analyzing the effective and proper way to see that the policies are managed. This is an effort between the attorneys, the accountants and insurance agents who make up the team advising clients in these matters.

    Rob Goodman is a partner at Kaufman & Canoles. His practice focuses on commercial transactions including mergers and acquisitions, sales of businesses, commercial and land leases, formation of business entities, major system procurements, and split-up of family businesses. In addition to his commercial work, he works closely with families and family businesses in generational and estate tax planning, other tax issues, family dynamics, and charitable objectives.

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.