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Last August, a Wall Street Journal article, "Stung by "Universal Life,'" [superscript]1 described the crisis created by the widespread use and lack of understanding about universal life policies. The article featured retirees receiving notices from their life insurance companies that the annual premiums for the policies had skyrocketed. If this type of policy is held in an irrevocable life insurance trust (ILIT) and the grantor is unwilling or unable to make the significantly increased premium contributions necessary to maintain the policy, the trustee faces serious liability issues. Estimates indicate that flexible premium policies account for 35 percent to 40 percent of the policies held in ILITs. [superscript]2 Attorneys and ILIT trustees should understand the options for fixing trusts holding potentially imploding policies. These options include recourse with the insurance policies, as well as legal alternatives that use the trust agreement or statutory law.
Traditional Policies
Until the 1980s, individuals most often funded ILITs with guaranteed, whole life policies. This type of traditional policy provides lifetime guarantees to the insured with regard to the death benefit, and the issuing insurance company bears the investment risk. In this context, the fiduciary responsibilities of an ILIT trustee primarily involve reviewing the financial stability of the insurance carrier annually, making timely premium payments and issuing Crummey [superscript]3 notices. Certainly, legal and tax issues can arise, for example if split-dollar or other loans are used, but generally the policies as a trust investment function in a straight-forward manner with minimal liability for the trustee.
Non-guaranteed Policies
In contrast, flexible premium, non-guaranteed policies shift the investment risk to the policy owner, the trustee in the case of an ILIT, and don't guarantee the length of the policy coverage. Carriers developed these policies in the 1980s, during an economic period of hyperinflation and high interest rates. The newly created product addressed consumer reluctance to invest in more expensive, traditional whole life policies with conservative investment returns. These universal policies retained popularity into the early 2000s.
With universal life insurance, [superscript]4 the policy owner contributes the premium payment and, after the carrier deducts expenses, the carrier invests the balance of the premium at market rates to cover future costs. Agents prepared illustrations showing the length of coverage using typical interest rates at...