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.

What We Can Learn From Recent Scandals or Back To The Basics

The use of the term “Ponzi scheme” is appearing quite regularly in the financial press these days. While several such alleged schemes have received their fair share of the headlines, what hasn’t been as evident are the warning signs that should have been heeded. Fiduciaries have a duty to control and mitigate the risks associated with all investments. While much focus has been placed on the alternative investment arena, the re-enforcement of some basic risk mitigation policies will provide confidence for your clients and prospects. Perhaps the horse has already left the barn so to speak, but here are some basic “red flags” to consider when making investment decisions:

· Lack of segregated custody

· Use of an affiliated broker dealer

· Use of a small, unknown auditing firm not registered with PCAOB

· Lack of access to Portfolio Managers

· Lack of transparency

· Secretive or unexplainable investment strategy

Nothing in the above list is unique or worthy of a lengthy dissertation, but rather the simplicity of it makes it all the more amazing that approximately $60 billion has been put at risk because due diligence on the above was not adequately addressed.

Earnings Remains a Good Source of Capital - Just Ask the Analysts

Recent reports indicate that bank analysts, along with many other interested parties, will be watching closely the ability of banks to generate sources of fresh capital in 2009. It is understood that due to the large provisions made to the loan loss reserve in the fourth quarter of 2008 that capital ratios will be understandably lower. Analysts have indicated that they will now be watching these ratios to see which organizations will be able to increase capital, and more importantly what is the source of the capital increase. Basically they will be looking to see which organizations have the ability to generate sustainable sources of capital increases.

Retained earnings continues to be a great source of capital; therefore many organizations will once again begin looking to all lines of business for both increases in top-line and bottom-line revenue. Until the credit and liquidity issues are addressed, non-interest income generators will be called upon to assist in delivering increased revenue results. As with any business venture, various risks must be undertaken to produce results. As a professional within the financial services industry, you must ask the following question: Are we generating optimal risk adjusted revenue for the service we provide?

Interesting Conundrum - Increased Regulation and Expense Reductions

As the turbulence continues within the financial services industry, compliance challenges are being created.

• Federal and state regulatory agencies are looking to increase their regulatory influence and the examination process is expected to become more onerous.
• Financial organizations are closely watching their expenses, especially in areas that are not revenue producing (i.e., operations).
  

These opposing views will definitely create some unique challenges for both the regulators and the financial industry. The goal is to create a solution that restores confidence, credibility, and growth within the industry.

• Regulatory red flags will be generated when financial institutions decrease compliance budgets; eliminate staff; reduce training; decrease technology usage, etc.
• Shareholder and analysts concerns will be brought to light when budgets are missed; revenue expectations are adjusted downward; increased losses; etc.

Currently there is plenty of finger pointing regarding the state of the industry. Both sides will need to work together to provide proper regulatory oversight that allows for renewed growth.

401(k) Investments Changing the Retirement Market

According to the U.S. Census Bureau, nearly 8,000 Americans are turning 65 each day, and therefore adding to the number of individuals that need to rely upon retirement savings plans for their source of funds. For years investment professionals have assisted in providing vehicles to save for retirement, one such vehicle being the defined contribution plan, predominately the 401(k). Over the past twelve months, a large percentage of these self-directed plans have experienced a significant decline in value – thus creating a very uncertain time for many of those approaching or contemplating retirement. Uncertainty creates opportunity and in this case insurance companies are rushing to offer annuities for the 401(k) channel.

While the amounts and numbers entering the 401(k) annuity market are unknown, this does seem to be an opportune time for the insurance companies to re-introduce the annuity product to plan sponsors. While there remain some shortcomings to this product, including the fact that not all plan participants would benefit from such a product, interest is growing and therefore will become another option for plan sponsors and participants. To offer a proactive solution to your plan sponsor clients, you should be aware of these annuity offerings and their impact on the business.

If you would like to read more on this subject visit the following link: http://www.iimagazine.com/Article.aspx?ArticleID=2044853&LS=EMS233897

Annual Revenue Loss of $10 Billion - New Credit Card Regulations Will Have an Impact on the Asset Management and Fiduciary Business - Are You Prepared?

According to a study by the law firm of Morrison & Foerster the new credit card regulations could cost the banking industry more than $10 billion annually. The interest and fees associated with credit cards have created enormous revenue flows for the banking industry – this will all cease in 2010. New regulations issued today will prohibit the following:

• Placing unfair time constraints on payments. A payment could not be deemed late unless the borrower is given a reasonable period of time, such as 21 days, to pay.
• Placing too-high fees for exceeding the credit limit solely because of a hold placed on the account.
• Unfairly computing balances in a computing tactic known as double-cycle billing.
• Unfairly adding security deposits and fees for issuing credit or making it available.
• Making deceptive offers of credit.

How will this loss of annual revenue be made up? Will your Asset Management and Fiduciary activities step up and assist in generating optimum risk adjusted revenue? Several revenue opportunities exist within your existing portfolio of accounts. The time for action is now.

The IRS as Your Favorite Secret Santa - Extension on the Required Deductibility of Bundled Fee

An early Holiday gift was delivered to fiduciaries by the IRS. The agency has stated that it is extending for 12 months the requirement for the bifurcation of bundled fees. This is analogous with those gift cards you receive; the benefit must be used within a year. IRS Notice 2008-116 extends to taxable years that begin before January 1, 2009 the interim guidance provided in Notice 2008-32 on the treatment of investment advisory costs and other costs subject to the 2-percent floor that are integrated as part of one commission or fee paid to the trustee or executor (“Bundled Fiduciary Fee”) and are incurred by a trust other than a grantor trust or an estate.

As you all know, on January 16, 2008, the Supreme Court of the United States issued its decision in Michael J. Knight, Trustee of William L. Rudkin Testamentary Trust v. Commissioner, holding that costs paid to an investment advisor by a nongrantor trust or estate generally are subject to the 2-percent floor for miscellaneous itemized deductions under § 67(a). The IRS and the Treasury Department expect to issue regulations under § 1.67-4 of the Income Tax Regulations consistent with the Supreme Court’s holding in Knight. The regulations also will address the issue raised when a nongrantor trust or estate pays a Bundled Fiduciary Fee for costs incurred in-house by the fiduciary, some of which are subject to the 2-percent floor and some of which are fully deductible without regard to the 2-percent floor.

Due to the time requirements for regulations, Notice 2008-32 was issued to provide interim guidance that specifically addresses the treatment of a Bundled Fiduciary Fee. In short, Notice 2008-32 provided that taxpayers will not be required to determine the portion of a Bundled Fiduciary Fee that is subject to the 2-percent floor under § 67 for any taxable year beginning before January 1, 2008.

The time requirement addressed in Notice 2008-32 has now been extended. Taxpayers will not be required to determine the portion of a Bundled Fiduciary Fee that is subject to the 2-percent floor under § 67 for any taxable year beginning before January 1, 2009. Instead, for each such taxable year, taxpayers may deduct the full amount of the Bundled Fiduciary Fee without regard to the 2-percent floor. Payments by the fiduciary to third parties for expenses subject to the 2-percent floor are readily identifiable and must be treated separately from the otherwise Bundled Fiduciary Fee.