A couple weeks ago we talked about the need to update our strategy when it comes to managing trust assets.  Today we explore just how we might do that along with a comment or two on financial underwriting.  Here is the fundamental change we face - trusts that may have once been funded with annual exclusion gifts that were 100% allocated to the life insurance policy that was the primary if not only trust asset may now be sitting on a pile of cash.  The insurance piece has not changed all that much (although the decision on how to pay premiums - single pay or pay as you go - is still a bit of a debate).  What has changed is we now need to do something with the balance of the trust assets.   

The easy answer is to simply allocate those assets using the same strategy represented by the risk tolerance of the client.  If we take a step back and think about it, however, that may not be the best answer.  These assets have an entirely different time horizon than the rest of the client's portfolio (they are destined for the next generation after all) and then there is the question of how to integrate the insurance DEATH BENEFIT into the allocation model.  That's right, we're talking IRR (Internal Rate of Return) at death here, because that is when the assets pass.  The cash value of the insurance, if any, is completely incidental to the premium and death benefit amounts and does not impact the IRR.

If you are now staring at your asset allocation software and scratching your head, you are not alone, and that topic is beyond the scope of today's discussion.  What we can do, however, is take a look at some results.  Here are the assumptions:

• Male 65 Standard Nonsmoker/Female 65 Standard Nonsmoker
• $5 mil gift to the trust
• 8% of initial trust assets allocated to insurance via lump sum payment
• Survivorship UL guaranteed to age 121

Why use life insurance?  Easy: the use of the death benefit as a non-correlated asset allows for a more aggressive allocation in the rest of the portfolio, resulting in a higher rate of return with an identical level of risk to the no insurance portfolio.  Even if the increase in portfolio rate of return on the non-insurance assets is only 100 basis points, the result of including the insurance is a superior rate of return through at least age 95.  I don't know about you, but a 100 basis point increase for the same risk level sounds like good portfolio design to me.  If there is an early death the IRR increase is just silly (250 basis points at year ten!), and some of the modeling I have seen makes an argument for an increased rate of return on the order of 2% on the non-insurance assets.

Now to drive home the last point:  We have not used any of the traditional financial underwriting metrics to determine the death benefit.  If the Feds did away with the Estate Tax permanently there would be no loss to justify the insurance!  While I don't think that is going to happen any time soon, I do know at least one carrier is having internal discussions about this very topic.  I also know that we need to be talking to our clients about the use of insurance for purposes other than estate tax mitigation.  We made one other point when we touched on this topic back in the fall - this is very, very friendly to the client's other advisors.  The attorney bills for the trust work, the asset manager receives their fee, and a commission is generated for you all while the client enjoys potentially superior investment results.  It's how our business should work.

Enjoy your weekend, and thanks for sticking with me on this one.  It was a bit long!