The Uniform Prudent Investor Act (UPIA) imposes duties of diligence on trustees; read about practical techniques for determining whether insurance is an appropriate investment.

Trustees generally have an obligation to analyze risk and return of trust assets, and make conscious decisions concerning acceptable levels of risk in relation to the purposes of the trust. This essay enumerates and quantifies several levels of risk in a life insurance contract: Liquidity risk, mispricing risk, the risk that the contract will subtract value from the estate if the insured lives “too long,” and so forth. Even if the contract has a negative expected value, it may still be an appropriate investment if:

• it provides a meaningful hedge against loss of value through forced asset liquidation in an illiquid estate, or
• it hedges against the loss of earned income on the death of the insured.

Even where a legitimate hedging need exists, trustees need to compare the expected values of an insurance contract against the expected costs (premiums) on a probabilistic basis in order to determine the suitability of investing in such contracts.

Download Prudence and Suitability: Estimating the Value of Trust Owned Life Insurance.

This article originally appeared in the Winter 1998 issue of California Trust & Estates Quarterly.