Blog: Bearmoor Notes

Friday, April 17, 2009

Is Your Insurance Policy a Toxic Asset?

There are worse things in life than death. Have you ever spent an evening with an insurance salesman? While this comment made by Woody Allen does provide a chuckle it might not be that far from the truth when it comes to administering Irrevocable Life Insurance Trusts (ILITs). It is becoming quite apparent why trustees of insurance trusts can’t just sit on the sidelines. There is a need to proactively review the ILIT insurance assets.

ILITs continue to provide an excellent financial planning vehicle and are a key safety net for many. The current volatility in the markets and with investment portfolios down substantially over the past year, the insurance assets may be even more vital. While there are unique risks associated with the administration of ILITs, there are also considerable opportunities.

Let’s first deal with some of the risks. During the next year, you will encounter two important risks associated with your life insurance assets:

1. Policy Lapses – this will definitely be an issue for variable life policies that have been negatively impacted by the market decline.

2. Insurance Company Impairment or Failures – insurance company rating downgrades are occurring with increasing frequency and federal government bailout assistance may not be adequate.

Based upon our experience and knowledge, we believe that substantial increases in ILIT monitoring and administration efforts will be needed. This is much easier said than done when the current environment requires expense control and head count reductions are the norm in the risk mitigations area. However, at the very least the following steps should be taken.

  • Evaluate more frequently – especially your variable life insurance policies.
  • Re-test the policies – obtain current “in-force illustrations” at the very least.
  • Obtain actuarial support – expertise is needed to comply with your fiduciary duty.
  • Review premium adequacy – determine the ability to afford increased premiums.
  • Monitor ratings of insurance companies - understand the limitations of the ratings.
  • Understand account objective(s) – verify that the ILIT is still appropriate and discuss alternatives.

In addition, recent regulatory guidance provides additional information. OCC Banking Bulletin 2008-10 highlights the need to ensure that all assets receive an annual review. The Bulletin states:

In addition to being a regulatory requirement, annual investment reviews are among the most useful tools bank fiduciaries have to ensure they meet their fiduciary responsibilities and properly administer their customers’ accounts. An annual investment review is a point-in-time evaluation of both account assets and objectives. Regardless of the tools employed by a particular institution, management supervision, information systems, and follow-up are all critical to an effective investment review process. An effective investment review process should be based upon policies and procedures that provide clear standards for scope, documentation, and exception reporting and tracking. The process should:

· Ensure that account investment objectives are current and appropriate, and that investments are consistent with those objectives.

· Ensure that the investment review provides for an annual assessment of the portfolio in its entirety. This is particularly important when unique assets make up a portion of the account.

· Include exception tracking that identifies and provides for follow up and resolution of exceptions such as securities not included on “approved” or “retention” lists, assets posing potential conflicts of interest, or asset concentrations.

· Include performance measurements and a process for handling performance outliers.

· Ensure that each asset is valued using an appropriate valuation process.

Unique or hard-to-value assets should be included as part of the annual investment review. The review of these assets should:

· Be sufficiently detailed to document the bank’s determination that the asset is appropriate for the investment objectives of the account and should be retained.

· Include a careful review of Asset Retention letters because these investment directions can require a bank to hold assets that may be inconsistent with the bank’s investment strategies. A bank should accept Asset Retention letters only from authorized parties.

· Provide updated asset valuations appropriate for the type of asset and nature of account.

As a fiduciary the items listed above are your responsibility. Failure to properly address these areas in policies, procedures, and practice subjects your organization to increased risk potential. However; when properly implemented you have created a differentiator for your service and thus created the environment for increased opportunity. Opportunities include:

  • Increase revenue potential – proper priced ILIT administration.
  • Increase knowledge and awareness – better understanding of the product.
  • Increase business opportunities – relationships with estate planners and other COIs (Centers of Influence).
  • Decrease risk and litigation – consistent application of an effective process.

Should you like additional information or detail on any of the items discussed above, please contact us.

1 comment:

TAC-ERW said...

Woody Allen's comment was made long before the aggressive marketing of TOLI policy replacement schemes. Can you imagine spending time today with a commission-based salesperson scripted to lecture a trustee on his/her/its fiduciary duty to restructure a policy so that the salesperson can generate a sizeable commission, yet the salesperson (1) lacks meaningful product knowledge, (2) presents a restructure analysis based on questionable, if not misleading, information and evaluation, and (3) does not provide ongoing policy service?

Is the asset ‘toxic’ or the acceptance and monitoring process? The traditional life insurance sales script and analysis ‘tools’ are 15 years outdated. While credible and appropriate ‘tools’ are readily available, they not used by most trustees, possibly because the traditional script excludes their consideration. Vendor selection and oversight is critical to avoid a toxic process. Vendor selection combines with a TOLI Investment Policy Statement and meaningful TOLI policy monitoring criteria to safeguard insurance trust parties.

Carrier suitability should remain a trustee concern because all carriers are not the same. Third-party ratings and analyst reports are helpful in understanding the differences. Short-term, trustees should be aware that carrier crediting rates are at or near their contractual minimal for non-guaranteed products. As a result, policy charges will increase so that credible premium adequacy and policy lapse evaluation remain critical to policy risk management. In excess of 25% of non-guaranteed policies are now illustrated to lapse during the insured's lifetime so that risk mitigation is needed.

Finally, excellent regulatory and court case guidance is available to avoid a toxic process.