Should You Replace a Life Insurance Policy in an ILIT – What Trustees Need to Know

Eric Scow, CFA

Chief Operating Officer

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The life insurance industry continues to innovate, offering a wide spectrum of life insurance policies to consumers. Some life insurance companies may trend away from selling certain traditional plans of insurance while introducing newer plans to the marketplace. Their goal is to remain competitive, offering newer products with attractive features and better rates because of increasing longevity and business, and technological advances within the industry and their respective companies.

Not every new life insurance policy dangled in front of the consumer warrants serious consideration, though. As Trustee and part of your fiduciary duty to review the life insurance policies under your management, there are several indicators which should trigger further investigation into altering or replacing the current insurance policy. Policy replacement shouldn’t always be the first option to consider, but being aware of the scenarios in which it may be appropriate can help you 1) navigate the waters of the larger ocean of policy remediation and 2) make a prudent decision as Trustee.

Understanding your client’s current situation as a Fiduciary

As the owner of the policy, staying abreast of any changes in the insured’s health informs many decisions in the ongoing management of a life insurance policy held in trust. On occasions in which an insured’s health or lifestyle has significantly improved (since policy issue), it may be appropriate to seek an updated underwriting classification on the current policy and/or shop for better rates with a new policy. Some examples of health or lifestyle changes that could trigger a better underwriting classification result include:

  • Quitting smoking
  • Overcoming chronic illness
  • Considerable weight loss
  • Significant reductions in bio-markers for disease, like high blood pressure or high cholesterol

 
Should better rates be sought, it is likely medical underwriting will be necessary again—certainly with a brand new policy—and if significant time has passed since issue, the insured’s current age may nullify any positive effects health or lifestyle improvements have on rates.
 
Life changes other than health improvement should also trigger further exploration of policy replacement in your capacity as Trustee. Should the death benefit needs or the capacity to fund the policy increase or decrease, an alternate policy may provide better rates at certain breakpoints than the current policy. While a reduction of the death benefit of the current policy would not require updated medical underwriting, an increase in the death benefit likely would. If an increase is desired, it would be prudent to price new products besides examining the effects of a potential increase on the current policy. Similarly, the risk profile of the trust could have changed since the current policy was issued. Many years after issue, for example, liquidity in the form of increasing cash values and/or the option to participate in market returns may be less attractive than robust policy guarantees, albeit with much less or no liquidity. Policy replacement may be the only way to achieve the updated goals of the trust. 


While it may be possible to restructure a problematic existing policy, it is not uncommon for policy replacement to be a better solution for remediating more complex structural issues. For example, as an insured ages, a policy with an over-reliance on a term insurance component for part of the death benefit may experience costs that far exceed the trust’s funding capacity to sustain the policy’s full death benefit. Replacing the policy with a death benefit fully composed of permanent insurance could be a more cost-efficient scenario. Likewise, policies with loans often have substantially deteriorating values due to the compounding interest of the indebtedness. While a 1035 exchange of the policy will not vanish the loan—it will move to the new policy—a different policy type with alternate means of crediting the cash value, or simply a lower interest rate, may provide a greater or longer lasting death benefit.
 
It is also a possibility, depending on the age, type, and structure of the policy, that the rates of the current policy are simply no longer competitive with newer plans. Or the insurance company may have mispriced the product and, together with a lower interest rate environment, now must charge its contractual guarantees. Sometimes formerly competitively-priced policies just become less cost efficient over time.

As Trustee, you need to be aware of all remediation options

All the above said, it is always prudent to explore your options with the current insurance policy. Purchasing a new insurance policy with a different company will require medical underwriting. If the insured is unwilling to go through this process or it is known their health or age would make them uninsurable, policy replacement is a non-starter.

If policy replacement is pursued, however, it is important that the new policy is issued by a financially secure insurance company and vetting should occur to ensure the company has a history of competitive crediting and charges. Additionally, the surrender charge period will start anew with a replacement policy, reducing the cash available for withdrawal or loan. These charges may apply to a policy for 10-15 years. Hopefully less of a concern, but still a consideration, is the reintroduction of suicide and contestability periods that are in effect for newly issued policies. Generally applicable for only two years from issue, the payment of the benefit might be delayed or complicated if a claim is made during this initial period.

Seek help from an independent provider

Competitive issues, as well as complications arising from policy loans, over-reliance on term insurance, and myriad other policy issues that may require policy restructuring or replacement should be identified in your ongoing policy review process.  If policy replacement is pursued, an independent provider, such as RIC, can perform a replacement analysis to ensure there is cost efficiency in doing so prior to purchasing the new policy (especially useful when one or more of the death benefits, funding, or durations of the current and proposed policy differ from each other), as well as point out any other concerns with replacing the current policy.  This replacement analysis can also serve as documentation to support your fiduciary decisions.


Ultimately, if a life insurance policy is issued by a financially secure insurance company and there is indication a change to the policy may yield better results, RIC typically recommends to first explore what changes are possible with the current policy. If the desired result (reduced costs, policy restructuring, etc.) can be achieved without unnecessary medical underwriting or the reintroduction of surrender charges or suicide and contestable periods, maintaining the current insurance policy is preferred. However, there are times when it is necessary or best to replace a policy. Replacement is not the only option for policy remediation, but it should always be considered as an available tool to achieve the trust’s objectives.

RIC is a nation leading independent Fiduciary Risk Manager that partners with over 200 trust organizations and law firms across the country.  We manage over 15,000 Trust Owned Life Insurance policies and provide policy reviews, ILIT administration solutions, and policy remediation services.

Other RIC Fiduciary Services:

Closely Held Business Valuations for entities held in Trusts, IRA’s, and 706/709 appraisals.                    

Will File Platform to help fiduciaries manage their records when named as Executor or a future trustee.


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