ILIT Trustee Liability: Cochran vs. KeyBank
Case Overview:
In 1987, Stewart Cochran created an ILIT for the benefit of his 2 daughters. The trust was funded with 3 life insurance policies and an annuity. The total death benefit of these policies was $4.8 million. In 1999 Keybank, the trustee, received a call from the grantor’s life insurance agent recommending that the policies be exchanged for 2 new VUL policies with a total death benefit of $8 million. Keybank approved this exchange.
In 2001 the market dropped and caused these policies to substantially underperform. Following the market drop, Keybank had a third party perform an audit on these policies. This audit revealed that the 2 VUL policies would lapse before the grantor reached life expectancy. The market downturn also had a negative effect on Mr. Cochran’s financial situation that left him unable to supplement the policies with additional premium.
With the help of Mr. Cochran’s insurance agent, the policies were exchanged again for a guaranteed death benefit product that would remain in-force until the insured’s age 100. This exchange was also approved by the third party consultant. The exchange resulted in a reduced death benefit of $2.87 million within the ILIT.
Soon after the exchange, Mr. Cochran died unexpectedly and the ILIT beneficiaries sued the trustee for breach of fiduciary duty. The trial court framed the question as follows:
Was it prudent for the Trustee to move the trust assets from insurance policies with significant risk and likelihood of ultimate lapse into an insurance policy with a smaller but guaranteed death benefit?
The trial and subsequent appeals court both ruled in KeyBanks favor. A deciding factor in this favorable ruling was that KeyBank hired and relied on the recommendations of “an outside, independent entity with no policy to sell or any other financial stake in the outcome”
The court also noted that the use of hindsight in determining the appropriateness of the drop of death benefit to $2.78 million was not acceptable.
My Thoughts:
Life insurance is a unique asset that requires management in accordance with a state’s version of the UPIA. Due to this asset’s complex nature, the trustee of an ILIT is in a difficult position – what is the correct course of action when managing life insurance owned by an ILIT? Given that TOLI is held to UPIA standards, substantial increases in TOLI litigation are likely.
I believe that this case affirms that no major TOLI decision should be made by a trustee without first consulting an independent, third party policy management specialist. Furthermore, the ongoing management of these policies by a specialist will assure that a trustee is operating within the guidelines set by a state’s UPIA. Additionally, many of the issues in this case would have been avoided altogether had the policies been periodically reviewed by a knowledgeable 3rd party.
-Jamison Hibbard
