What You Don’t Know Can Hurt You: Why You Need Trustee Liability Insurance

A client recently told me about a conversation he’d had with an institutional co-trustee. The co-trustee was pushing back on the approval of a trustee liability policy. The institutional co-trustee's reasoning was that most of their co-trustees don’t purchase the coverage.

That conversation got me thinking. Is the reason many trustees don’t purchase liability insurance that they don’t know it's available? Or do trustees think the institution will protect them in the event of a claim? With the premise of “what you don’t know can hurt you” behind my thought process, I'll explore these and other theories to share the importance of trustee liability coverage.

Why Institutional Trustees Don't Approve the Expense

Let’s begin with the primary reasons why an institutional trustee might not approve the expense:

• Internal Risk Assessment: Trust companies typically conduct risk assessments to evaluate potential liabilities and exposure. If they choose to accept the appointment, the institution believes the risk is manageable for them.
• Legal or Regulatory Considerations: Trust companies operate within legal and regulatory frameworks that govern their activities. Certain jurisdictions or regulatory bodies may have specific requirements or restrictions concerning trustee insurance. The trust company might determine that obtaining trustee insurance is not necessary or compliant with the relevant legal or regulatory obligations.
• Cost-Benefit Analysis: Trustee insurance involves costs, including premiums, and potential deductibles the institution may not want to cover.
• Risk Mitigation Strategies: Trust companies may have alternative risk management strategies in place, such as robust internal controls, audits, regular reviews, and fiduciary best practices, which they consider effective in mitigating the risks associated with trusteeship. They may believe that these strategies adequately protect the trust assets and beneficiaries without the need for additional insurance coverage.

However, these strategies help determine the trust company’s liability rather than the individual trustee's liability. Trustees have what is called “joint and several liability” with the trust company, meaning that all trustees—individual and institutional—may have some or all the liability. The difference between an institution and an individual trustee is that an institution has the protection of a corporate veil, while an individual is risking their personal assets in the event of litigation.

Independent Trustees Are at Particular Risk

Next, let’s examine what will happen in the event of a claim from the independent co-trustee lens. First, trust companies have their own insurance.

There is often misinformation concerning this topic, and although I have heard trust officers say the trust company will cover the trustee, it rarely happens. The institution’s insurance policy only covers employees and not independent trustees. In the event of a claim, the trust company will bifurcate the defense, meaning it will defend itself and its employee but not the independent trustee.

If the defense is aligned, the institution may provide minimal amounts of protection, but as soon as interests are not aligned, the trustee must engage their own defense attorney. In this scenario, the trust company may choose to not approve trust expense, leaving the co-trustee without trust assets; the judge may end up making that decision.

When it comes to finding a lawyer, the trust company most likely already engaged the most competent defense counsel, leaving the co-trustee to canvas the lawyers that do not have a conflict of interest. As a result, they might end up with less experienced counsel.

Secondly, protection afforded to the trustee may be in the form of an indemnification agreement. Two issues will likely arise:

• Will the institutional trustee approve the reimbursement of legal fees and settlements?
• If there are allegations of intentional misconduct or gross negligence, a judge may be asked to rule on using trust assets to defend a trustee for an action that generally is against public policy.

Who Pays the Cost of Trustee Liability Insurance?

Most jurisdictions allow for trustee liability insurance to be purchased using trust assets, especially if the trust document specifically states that insurance is an allowable expense. A few states don’t allow for payment of the premium, but they do allow for trustee fees, which can be increased and used to pay the premium. The key is agreement by the grantor and disclosure to the beneficiaries.

The trust company might view trustee insurance as an unnecessary administrative burden or an additional layer of complexity that does not align with their risk management approach.

However, the grantor and beneficiaries should want to attract the best trustees to carry out these vital fiduciary duties. Part of attracting trustees is ensuring they will be protected when making complex decisions. All trustees should participate in an onboarding process of trusts that incorporates the same risk analysis that institutional trustees use. Trustees should know their roles and responsibilities, have a thorough understanding of the information and programs they need to manage, and review their fiduciary roles.

Grantors should want the trustee to be protected by both an indemnification agreement and an insurance policy just like members of a board of directors. In the 1980s, it was uncommon to purchase directors and officers (D&O) insurance. However, today no one would agree to a position on a for-profit or non-profit board without D&O coverage. Trustees require and should demand the same protection.