Managing Trust Owned Life Insurance is a difficult task, especially when clients stop paying scheduled premiums. ITM finds that over 40% of the policies they review are inadequately funded – either scheduled to lapse prior to maturity or resulting in significantly reduced death benefits. In this blog post, we will explore the challenges trustees face when dealing with suspended premiums on Universal Life and Variable Universal Life policies, and the strategies they can employ to safeguard the interests of the trust beneficiaries.
When faced with the scenario of a client suspending premium, it is necessary to revisit the ongoing needs of the trust and review the suitability of the policy for the trust objectives. This includes assessing the insured’s health, ability and willingness for the grantor to make premium payments, the trust’s risk tolerance level, and the trust’s overall objectives.
Exploring Policy Options
Trustees are faced with more nuanced decisions than simply retaining or terminating the policy. Here are some crucial steps trustees should take:
1. Obtain Updated Illustrations:
Trustees should obtain illustrations from the insurance carrier that project the policy’s performance with suspended premiums. This will provide insight into how long the policy can remain in force without additional contributions. Depending on the insured’s age and previous funding, the policy might lapse in the near future or continue for several years without premiums.
2. Evaluate Reduced Death Benefit Scenarios:
Depending on the policy type, trustees should examine scenarios involving reduced death benefits to maturity or a predetermined risk-acceptable age. The remaining cash value after premium suspension guides the insurance carrier’s flexibility in providing these options. Although reducing the death benefit is an option, it might not be effective if the cash value is minimal.
3. Consider Policy Replacement:
If the current policy’s coverage duration is unsatisfactory, trustees should explore replacing it with a new policy from the same or a different carrier. Utilizing the cash surrender value of the existing policy for a 1035 exchange into a new policy may potentially offer superior coverage.
4. Evaluate Policy Surrender or Life Settlement:
If the need for death benefit coverage diminishes, trustees can consider surrendering the policy for its cash surrender value or exploring a life settlement. A life settlement involves selling the policy on the secondary market for an amount greater than the cash surrender value. Consulting a tax advisor is essential to understand the tax implications of these options.
Universal Life and Variable Universal Life
Universal life and variable universal life policies, often labeled as “flexible premium” policies, are frequently encountered by ITM with fully suspended premiums. In higher interest rate environments, premium suspension may have been anticipated since policy inception, aiming for the policy to endure until maturity. However, if the expected interest or variable earnings fall short, premium payments often extend well past the initial suspension plan.
Fortunately, the costs of maintaining most universal life and variable universal life policies are fairly transparent and the process of identifying the various options to consider should follow the recommendations above. A notable exception is policies with secondary, or “no lapse,” guarantees. Policies utilizing their secondary guarantees to remain in force can be extremely sensitive to the timing of premium payments. A trustee should take extra care to understand how suspending premium may affect this type of policy.
The best course for ongoing policy management when a client wishes to suspend premium will depend largely on the needs of the trust and exact options available for that policy. It is important, however, to carefully consider all available options and work through them with the client to foster a good relationship and present them with alternatives they may not have known existed.
To learn more about how to effectively manage trust-owned life insurance policies, request a consultation for our ILIT administration solution or tolimonitor, and learn how we can reduce the cost and mitigate the risk of administering life insurance trusts while delivering superior results for grantors and beneficiaries.