Bank "X" had received a $5 million life insurance contract on the insured's life, and dealt with the insured's insurance agent. The insured, with the advice of his agent, selected the policy and transferred the contract to the trustee. The trustee held the policy until the insured died and then collected the $5 million. Sparks then began to fly.
The bank was contacted by Lawyer "Z," who had been retained by the beneficiaries of the trust because they believed they were owed more than $5 million. Lawyer "Z" posed these questions to Bank "X":
1. Did you compare the $5 million policy with other policy possibilities to see if the premium paid by the insured could have purchased more insurance with a similarly rated company?
2. Were you not representing the beneficiaries of the trust and not the settlor of the trust? Why did you follow the settlor's instructions without independent investigation?
3. The policy had certain convertible features with more insurance being available if you converted. You did not convert. Why?
4. Did you check the rating of the company annually to protect the beneficiaries?
5. Why did you not borrow the policy's cash surrender value which was earning 4% inside the contract, albeit tax-free, and invest the borrowed proceeds in your own common trust funds which, for a ten-year period, average an annual return of 24%? (You now know the period during which the trust existed; who is now earning 24% per annum?)
6. Did you make it clear to the beneficiaries that they could exercise their right of withdrawal when the premium payments were made by the settlor? You could then have converted the policy to a paid-up policy and the children, if they withdrew the premium money, would have had some cash to invest in attractive markets.
Do you believe this case should have settled? Do you believe being a trustee of an ILIT is about risk? Do you believe the $250 to $1,000 typical annual fee charged by a bank to be trustee of an ILIT warrants the risks involved?
The title of this article is "The Two-Headed Beast," not to imply ILITs are not popular and should not be used, but to point out the complexity of creating and administering an ILIT and the liability side for the trustee. Proceed as in all estate planning: with caution, be well informed, and handle ILITs with care.