A recent Indiana case has shed some light on the duties and liabilities of a trustee of an irrevocable life insurance trust (ILIT). Such case appears to offer some reassurance that if a trustee of an ILIT acts appropriately with respect to reviewing the policies held in the ILIT, beneficiaries will be unsuccessful in challenging a trustee’s decision to change the type of policies held in the ILIT, even if that decision ultimately works to the disadvantage of the beneficiaries.
The ILIT has been a popular estate planning tool for many years. The possibility of large amounts of life insurance proceeds passing to beneficiaries free of estate taxes can make ILITs very attractive to estate planners and clients alike. However, with the recent economic downturn, the fiduciary duty of a trustee with respect to the management of the investments of an ILIT may begin to face additional scrutiny. Because the assets of an ILIT are often limited to life insurance policies, the management of trust assets can be difficult, particularly in these challenging times when insurance companies may not be as financially sound as they once were thought to be.
The majority of states have adopted some version of the Uniform Prudent Investor Act. The Act imposes certain requirements on fiduciaries with respect to the management and investment of trust assets. Generally, the Act applies to the trustees of ILITs in exactly the same way it applies to trustees of other types of trusts. Recognizing that the trustee of an ILIT may be in a more difficult position with respect to the management of investments, a small number of states have enacted laws to provide different standards for trustees of ILITs, including Delaware, North Dakota, Pennsylvania, West Virginia, and Wyoming.
For trustees in the vast majority of states that have not adopted laws providing different investment management standards for trustees of ILITs, their duties (and liabilities) are not as clear. These trustees are faced with concerns regarding their duties and liabilities with respect to the holding of life insurance policies and the continued monitoring of such policies to ascertain their appropriateness as investments. In what appears to be among the first cases addressing these issues, the Indiana Court of Appeals in In re Stuart Cochran Irrevocable Trust, 901 N.E.2d 1128 (Ind. Ct. App. 2009) reviewed a claim for breach of fiduciary duties against the corporate trustee of an ILIT.
In Cochran, the grantor created an ILIT for the benefit of his two daughters. The trust was funded with life insurance policies insuring the life of the Grantor. In 1999, KeyBank began serving as successor trustee of the trust. At that time, the assets of the trust consisted of three life insurance policies and one annuity, with a collective death benefit of approximately $4.8 million. At the request of the grantor, KeyBank exchanged these policies for two new variable universal life (VUL) policies with a combined death benefit of $8 million. The death benefit of the VUL policies was not guaranteed.
In 2001 and 2002, the downturn in the market adversely affected the investments contained in the VUL policies. In 2003, KeyBank retained an insurance consultant to audit the VUL policies. The insurance consultant determined that, based on the grantor’s life expectancy, it was likely that the VUL policies would lapse prior to the grantor’s death. In light of the audit, KeyBank decided to exchange the VUL policies for a life insurance policy with a death benefit of approximately $2.8 million guaranteed until age 100 (the “John Hancock policy”). In January 2004, the grantor died unexpectedly at age 53 and the trust received the guaranteed death benefit of the John Hancock policy. Obviously, such death benefit was far less than the death benefit that the trust would have received if the grantor had died at age 53 with the VUL policies in place.
Soon after the grantor’s death, the beneficiaries of the trust filed a surcharge claim against KeyBank arguing, in part, that KeyBank had breached its fiduciary duties with respect to the management of the trust assets. The trial court ruled in favor of KeyBank finding that KeyBank had “acted in good faith to protect the interests of the Beneficiaries.” Id. at 1135.
Analysis and Holding
In addressing the issue, the Court of Appeals of Indiana noted that the Indiana Uniform Prudent Investor Act provides that “compliance with the prudent investor rule is determined in light of the facts and circumstances existing at the time of a trustee’s decision or action and not by hindsight.” The Court further reasoned that “although it is tempting to analyze these cases with the benefit of hindsight, we are not permitted to do so, nor should we.” Id. at 1141. The Court held that KeyBank’s actions in exchanging the VUL policies for the John Hancock policy were “eminently prudent, reduction in death benefit notwithstanding.” Id. at 1138.
As mentioned above, the management of trust assets within an ILIT can be especially challenging for a trustee. Because there appears to be little judicial guidance concerning the fiduciary duties of a trustee of an ILIT with respect to the management of trust assets, Cochran is a case with which every corporate fiduciary should be familiar. In this case, KeyBank was able to protect itself by engaging an outside consultant to review the VUL policies to help determine if the policies remained appropriate investments for the ILIT.
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