But there could be a substantial reservoir of cash value within that policy
In considering policy replacement, it is prudent to assess the likelihood or sustainability of any scenario that is projected for the proposed replacement policy. While less than optimal future charges and crediting are also a concern for an existing policy, most new policies have surrender charges that give clients less flexibility for many years if liquidity is needed.
Conditions change. The life insurance policy that fit neatly into your client’s financial plan many years ago may no longer be needed. This is often a driving factor for clients no longer wanting to fund their policy. A taxable gain may be applicable upon policy surrender should the cash value be in excess of the cost basis (typically premiums paid) of the policy.
A life settlement buyer may offer more cash to the owner of the policy than a cash surrender of the policy would yield. Unless serious health issues are present, the insured typically needs to be over the age of 75 for a life settlement to potentially be feasible. Additionally, the policy must be transferable, and its face amount should be $100,000 or more.
Of course, more complex scenarios arise that require further analysis. For example, it is common for trustees to have clients with multiple inadequately funded-or otherwise problematic-policies. At other times, it is necessary to try to meet the needs or goals of several interested parties, keeping in mind the best solutions for each party may compete against each other. Uncertainty regarding the timing of a potential death benefit further complicates any policy management decisions.
Surrendering the policy for its cash value now or before insurance charges begin to rapidly deplete the cash value may be an appropriate action if the policy’s death benefit is no longer needed
With everything to consider, it can seem overwhelming in knowing how to best manage and remediate an inadequately funded policy. RIC can partner with trustees through the process by facilitating arrangements with insurance carriers, providing in-depth analysis of options with actuarially-driven data, or helping to communicate the different options to trustees’ clients. Regardless of the situation, RIC can identify several options and actionable steps to remediate an inadequately funded policy that may be presented to clients. This allows for further discussions with the client as to how the different options might fit into their current financial plan.
If surrendering the policy for cash is considered, investigating the possibility of a life settlement should also be explored
RIC is a nation-leading independent risk manager partnering with over 200 corporate trustees. We provide independent policy reviews, ILIT administration software, and remediation services for Trust Owned Life Insurance. As we do not market or sell insurance of any kind, our entire focus is on reducing fiduciary risk and helping trustees meet regulatory oversight requirements.
More than 40% of the trust-owned life insurance policies RIC reviews each year are identified as being inadequately funded-either lapsing prior to maturity or maturing with a significantly reduced death benefit. The causes of these premature lapses are often beyond the control of the trustee or their clients, as insurance companies increase the costs of an insurance policy or reduce its interest crediting. Many of these premature lapses, however, are caused by policies no longer being funded, as clients decide to suspend premium payments.
When faced with the scenario of a client suspending premium, it is an appropriate time to revisit the ongoing needs of the trust and review the suitability of the policy for the trust, which includes assessing the insured’s health, the trust’s risk tolerance level, and the trust’s overall objectives. Even after this review, the trustee must consider a number of options beyond the simple binary decision of keeping the policy or terminating the policy. There are nuances to each policy and/or plan type that will be discussed further below, but to determine the options available to the trust to best manage the policy going forward, the trustee can initially do the following: