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 [1] 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 [2] 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 [3].
This article originally appeared in the Winter 1998 issue of California Trust & Estates Quarterly.