Are your clients unaware of hidden factors in their financial plans that could cost them and those they care about drastic amounts of money? Do you know how frequently you should be reviewing their life insurance policy?

Although life insurance is sometimes portrayed as a “set it and forget it” type of investment, the reality is that there are a variety of variables that can change along the way.

Everyone’s heard of the common life events that trigger changes in coverage or beneficiary needs. But what if the policy is owned by an irrevocable life insurance trust and managed by a third-party trustee?

This type of life insurance is a unique investment asset that requires critical attention on a regular basis. A lack of policy diligence and structured review processes can wreak havoc on policy performance—or even trigger modified endowment contract status, which causes unexpected taxation on gains when funds are withdrawn from a policy.

Consider this real-life series of events—a perfect example of why it's essential to continue to monitor policies far beyond the time you receive your commissions:

My father established trusts and purchased principal whole life insurance policies for my 25-year-old niece and 27-year-old nephew at the time of their birth. With the subsequent evolution of index universal life products providing collared equity returns, tax-free compounding and transparent pricing, this was truly a no-brainer, win-win exchange to index universal life.

In the final process of completing tax-free 1035 exchanges, we discovered for the first time that the policies had been underwritten with smoker-rate charges. Amazingly, the policies had never been adjusted to non-smoker rates, despite annual notice to the trust offering simplified underwriting reclassification once each relative reached age 18.

Worse yet, both policies had inadvertently fallen into MEC status sometime within the first couple of years of their existence when the trust accepted an automatic policy rider that was deemed a material change.

Since it had been so long since these policies had been reviewed, our first reaction was to find out from the broker how this happened. But the broker had been dead for years.

We are still working to assess the paper trail, but with limited digital records, that’s proving difficult to uncover.

These policies ran into issues within the first couple of years, affecting taxation of withdrawals and conversions. The sub-par smoker rates were never updated when the niece and nephew turned 18, thereby creating additional wasted costs. The policies lost years of compound interest crediting which the niece and nephew could have withdrawn tax-free for future use had the polices not fallen into MEC status during the first few years.

Although there was good intent for setting up these policies within an irrevocable life insurance trust, the niece and nephew will be the ones who suffer from a lack of proper monitoring and due diligence—something that they had no control over.

Other factors, such as a low interest rate environment, could also trigger the need for frequent policy reviews. Lower interest rates mean the policy is receiving lower crediting rates, which could require additional premiums in order to keep the policy performing as intended. Different types of policies offer flexibility, and premiums are often not fixed or guaranteed, meaning amounts could fluctuate.

Trustees in this situation are expected to act as a fiduciary, even though they are often not involved in the initial portfolio or life insurance policy selection process. In fact, once the trustee accepts appointment responsibility, they are expected to manage the life insurance portfolio to minimize risk to the beneficiaries.

However, according to the American Bar Association, “several states have enacted statutes that relieve an ILIT trustee of liability in managing life insurance as an investment.” In those states, the trustee is treated more like a custodian than a fiduciary from a liability standpoint. Therefore, it is important to appoint an individual or professional organization as trustee who is willing to communicate with the advisory team implementing the policy.

Performing consistent reviews is essential to ensuring that implemented structures are still meeting the policy’s intended goals and maintaining competitive pricing. Insurance products evolve and tax laws change. You must be diligent about making sure your client’s financial plan is providing the right assets to the right beneficiaries, in the right way, at the right time.

Scott Diamond is a wealth adviser at Schechter, a boutique, third-generation wealth advisory and financial services firm.