Trustee is a Four Letter Word
By Seth Spreadbury, National Family Office Practice Leader, MMA
March 28, 2018
Serving as a family trustee seems common, innocuous, and almost flattering in the same way being asked to be a godparent is flattering. However, a trustee position is fraught with exposure and the potential for personal liability. For people with a high net worth, there are obvious financial exposures related to serving as trustee. What’s often overlooked is the ancillary damage arising out of a financial dispute caused by the intimacy of the trustee, settlor and beneficiary.
Serving as a family trustee is a difficult position. Trustees are tasked with multiple responsibilities, from management of investments, selection and oversight of outside service professionals, approval of disbursements that are sometimes at the trustee’s discretion, financial reporting to beneficiary, valuation of illiquid assets and more. When dealing with a high volume of assets, an error in any one of these services could result in drastic financial consequences. Considering all of the duties of a trustee, it can be surprising people trust unqualified family members to serve. It would be unusual for someone to ask a person with no financial experience to serve as a financial planner. Why should it be any different when it comes to a trustee position, which has similar obligations?
“My family would never sue me!” This is the reaction most people have when confronting the idea of potential exposure they incur as a trustee. It’s true that family members are often hesitant to litigate against other family members. This is mostly because of the personal relationships formed, but also due to an internal reluctance to hold a layperson to the same level of expectations as a hired professional. However, inter-family litigation, while rare, does occur, and when it does, it can be much more contentious than the typical lawsuit. In these instances, not only has someone suffered financial damage, but they have also suffered emotional damage. Hurt feelings can’t be resolved by cutting a check, and these instances of family suing family rarely settle and typically go all the way to trial, as no one is willing to admit that they are wrong. Consider the following claims examples:
The co-trustees of a trust sued a family member trustee, alleging that the defendant had broken the governing documents of the trust in regards to receiving fees, paying expenses from trust assets, and making improper investments. The outcome was a $115,000 judgment against the defendant after spending nearly $100,000 in legal fees.
A daughter, as a beneficiary, sued her father, as a trustee, claiming a deviation from investment strategy regarding the placement of assets in her trust, as well as impartial treatment as all the family’s charitable giving was directed out of her trust. Due to the daughter’s philanthropic passion, the family had decided, without her input, that all charitable efforts would be directed out of her trusts. As a result of the daughter’s suit, her trust stopped the family’s charitable giving, leading to secondary suits from non-profit organizations who had received financial commitments from the trust, but no funds. While the final outcome is undisclosed due to pending litigation and privacy concerns, the initial demand, including punitive damages, was $5,000,000,000.
The children of a family sued their father and uncle as trustees, alleging deviation from the payout schedule. While the financial damages and defense costs are undisclosed, the litigation caused the termination of the father and uncle from positions within the family company and a divorce for the father.
These claims illustrate the potential severity of trustee litigation, the unwillingness of family members to settle inter-family suits, and possible ancillary effects of these claims. Again, while litigation against a family member is rare, the consequences can be stark.
Current Trustee Litigation Trends
Despite the claims examples used here, trustee litigation is in a low period of activity. This can be related to the performance of traditional investments, as trustees have an exposure similar to traditional wealth managers. Wealth managers don’t frequently get sued when investments are going, even if that growth is lagging the market. Instead, the highest period of exposure is during market contraction. Wealth managers and trustees alike are much more likely to be sued if the value of assets is decreasing, even if those assets are still performing better than the market as a whole.
Still, strong market performance doesn’t completely insulate trustees from claims. Their unique responsibilities lead to exposures that aren’t shared by most traditional wealth managers. In addition to standard exposures, recent losses have revealed five trending exposure areas for trustees.
The first area is referred to informally as “Elder Kidnapping.” This occurs when an elderly family member, often widowed, meets a new romantic partner. Over the course of the relationship, the new partner convinces the elderly family member to amend planning documents such as wills and health care directives so that the new partner is the recipient of all benefits. This typically leads to the family members suing the trustee for allowing these changes to occur, despite the trustee’s inability to act assuming the settlor is not incapacitated.
Next, there are exposures specific to blended families. With multiple branches of the same family unit, there can often be disparate treatment amongst descendants. This can lead to disputes amongst family members and the trustees, including allegations regarding the legitimacy of the estate planning document and arguments that the settlor’s actions are inconsistent with their other actions. Finally, we often see the settlor acting as the “family glue” and keeping family members on their best behavior. However, once the settlor passes, that glue is no longer holding the family together, which can expose the family trustee to litigation.
Charitable giving can often lead to lawsuits against trustees as well. Usually, immediate family members are aligned with the settlor’s interests in terms of philanthropy. However, more distant relatives, such as cousins, nephews/nieces, or grandchildren, might expect an inheritance. When the vast majority or all of an estate is given to charity, those extraneous family members can challenge the trustee on the legitimacy of trust documents.
Trusts often can hold unique and illiquid assets, such as acres or farmland or timberland, private equity or venture capital investments, or direct holdings of the family business. Providing an accurate valuation of those illiquid assets can prove challenging for any trustee and inaccuracies in that valuation can lead to litigation if a beneficiary is dissatisfied with their benefit. Trustees can protect themselves by taking the expensive measure of hiring expert third-party service providers, but that decision can also lead to exposure if someone challenges spending assets on those valuation experts.
Finally, supplemental or special needs trusts can cause unique exposures for a trustee. These trusts are set up to provide for the care and living expenses of the beneficiary who might have a health care need. However, the definition of expenses eligible for disbursement can often be a gray area, leading to disputes between the beneficiary who feels entitled to the assets of the trust and the trustee, who may have a more conservative interpretation of the governing documents.
The Insurance Solution
Insurance carriers have long recognized the legitimacy of trustee professional liability exposures. However, considering it is often a layperson serving in a role with responsibilities equal to and often superseding those of a traditional wealth manager, estate attorney, tax planner, and other professional roles, it’s no surprise the insurance market is limited. Some of the more traditional carriers, including those that often provide high net worth personal lines insurance, do not have an appetite for individual trustee errors and omissions.
The markets that will provide coverage do so conservatively. The annual premium often leads to sticker shock with new buyers. Premium is primarily based on the volume of assets held in the trust, but even those trustees overseeing a relatively low volume of assets can expect minimum premiums of around $5,000 for a $1,000,000 policy. For more significant assets or higher limits, policy premiums can exceed $25,000 or even $50,000. Further, the retentions on these policies are often significant, with the insured typically being responsible for at least the first $25,000 of loss. Retentions can even climb above $100,000, depending on the features of the risk.
While volume of assets is the primary factor in determining premium, individual risks are underwritten and priced based on their own characteristics. The most material of those characteristics are:
- The existence or absence of illiquid assets in the trust
- The frequency and type of reporting to beneficiaries
- The engagement of outside service providers, such as investment advisors, attorneys and accountants
- The relationship between the trustee and the beneficiary
- The experience and practical skill set of the trustee
- The existence of or absence of co-trustees
- The powers granted to the trustee through the governing documents
Should a Family Member Serve as Trustee?
There are numerous reasons why a family member should serve as trustee. A family member is more likely to share the family values and have an understanding of the family values. Similarly, a family member would be more closely aligned with the settlor’s intent in creating the trust. The family member’s closeness would allow them a better understanding and potential involvement in a family business, and would also allow them the ability to understand the family dynamics and potentially anticipate and navigate emotional issues.
However, as a family member, the exposure is real. One only needs to revisit the loss examples and litigation trends in this article to recognize the potential for litigation. Serving as a family member trustee carries personal exposure and can have long lasting consequences that go beyond a financial impact. A trustee’s personal relationships with the beneficiary and other family members can create tension and high emotional involvement in decisions. Navigating familiar relationships, especially amongst multiple generations, different branches of the family, and in-laws can be extremely difficult.
From an exposure standpoint, the conservative response for a family member would be to decline any trustee position offered. However, if a family member were to serve as trustee, the ideal situation would be to serve with a corporate or third-party co-trustee. This neutral participation and oversight can be helpful in defending decisions made in a trustee capacity. The worst possible environment would be to serve as a trustee with only other family members as co-trustees. This situation yields all the previously referenced exposures with the added consequence of empowering other family members with potentially differing views.
Family trustee positions can be tough to decline, as it can be a very sincere way for family members to become closer. However, these positions do carry a very significant professional burden equivalent to those experienced by attorney, financial advisors, and accountants. Prior to accepting any trustee position, one should consider the potential exposures, the financial dynamics, and the protection a Trustee Liability insurance policy can provide.
Due to the complex nature of Trustee Liability insurance and the discriminating appetite of insurance carriers for these types of risk, it is vital that one partners a knowledgeable and experienced insurance agent for coverage placement. For questions about coverage or for help in obtaining trustee liability insurance, Seth Spreadbury is a trusted resource. Serving as the National Family Office Practice Leader, Seth has helped numerous high net worth clients acquire appropriate protection for their personal trustee exposure. As a former underwriter with ten years’ experience, his appreciation for the technical aspects of insurance and his underwriter relationships are second to none. Seth can be reached at 763-746-8553.
This document is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. Marsh & McLennan Agency LLC shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein. Any statements concerning actuarial, tax, accounting or legal matters are based solely on our experience as consultants and are not to be relied upon as actuarial, accounting, tax or legal advice, for which you should consult your own professional advisors. Any modeling analytics or projections are subject to inherent uncertainty and the analysis could be materially affective if any underlying assumptions, conditions, information or factors are inaccurate or incomplete or should change.