How insurers can mitigate their exposure when it comes to beneficiary designations

By Richard Miller

One of the biggest myths and misconceptions of estate planning is that a will controls the disposition of all one’s assets at death. This is not the case. Failing to distinguish the difference between probate and non-probate assets could lead to unintended and costly consequences not only for the person who owns the asset, but also for life insurers that serve as custodians of the assets.

A will only controls assets in a person’s individual name – not assets that have a joint owner or are controlled by beneficiary designation. Joint accounts and beneficiary designations supersede the will and often pass directly to the surviving joint owner or beneficiary even if the will directs otherwise. “Non-probate” assets pass outside the will. “Probate” assets are controlled by and distributed pursuant to the terms of the will.

The importance of understanding how an asset passes at death cannot be underestimated. For example, testamentary trusts are routinely established in wills, so assets do not pass outright to certain beneficiaries such as minors, people receiving government benefits, spouses with children from a prior relationship, spendthrifts and mentally incapacitated individuals. To ensure assets are distributed to the testamentary trust (or as otherwise intended under the will) it is critical for the insurer to identify how one’s accounts are titled and know the manner in which the account will pass at death.

For example, it is not uncommon for individuals to name their spouse or children as beneficiaries of a life insurance policy. Likewise, under the governing instrument, a policy might default to a spouse or children if a contingent beneficiary is not named. Such an outcome could circumvent the provisions of a will and cause assets to inadvertently pass to an unintended recipient.

As blended families have become more common, estate disputes have increased, underscoring the issues associated with life insurance policy beneficiary designations. By way of illustration, it is not unusual for one or both partners in a second marriage to have children from a prior relationship. In this scenario, an individual’s will typically establishes a lifetime trust for the surviving spouse. At the death of the surviving spouse, any remaining trust assets would revert to the children of the first decedent.

If, however, the surviving spouse is the designated beneficiary of the first decedent’s life insurance policy, the death benefit would be paid outright to the surviving spouse, and they could use the proceeds without restriction – potentially excluding the first decedent’s children.

These types of situations often lead to litigation among family members. Allegations of undue influence and lack of capacity are routinely asserted when disgruntled heirs attempt to set aside beneficiary designations. These actions often include claims against the insurance company that was involved in the beneficiary designation process.

Insurers must be more aware of these risks, and establish and implement protocols in connection with the beneficiary designation process to mitigate the risks associated with this lack of clarity.

Beneficiary designations have significant legal implications. As a result, it is imperative that individuals who complete the beneficiary designation forms receive independent and professional advice from their estate planning attorney. These forms should visibly and clearly state that it could potentially supersede one’s will before the insured signs any documents.

As technology evolves, personal communications with clients will continue to diminish, thereby creating more opportunities for fraud and exploitation, especially against vulnerable older adults. Financial institutions have a duty to minimize these risks.

For example, as electronic filing of beneficiary forms becomes more common, insurers should assess the protocols that are in place to ensure that the owner of the policy is the one actually completing or submitting the document - particularly if everything is processed exclusively online. For example, they might consider instituting policies requiring follow-up calls to the account owner to validate the document.

Likewise, before beneficiary designation forms are processed, multi-verification and authentication methods should be considered to ensure that the owner of the policy or account is the one submitting the form, understands the implications of the form and has been advised to seek independent legal counsel before submitting the form.

Although these efforts create additional work and more responsibility for the insurer, they mitigate the risk of lawsuits against agents and companies that manage non-probate assets such as life insurance policies, retirement accounts, annuities and transfer on death accounts.

In recent years, we have noted an increase in cases in which financial institutions have been named as a defendant in matters involving contested beneficiary designation forms. Although it is impossible to eliminate exposure, steps can be taken to minimize the threat. Understanding the significance of beneficiary designations as they relate to a client’s global estate plan is a critical first step. Implementing policies and procedures to ensure the client’s testamentary intent is memorialized and effectuated as to the disposition of non-probate assets is equally essential. Insurance agents and institutions are encouraged to examine and evaluate their policies and procedures involving beneficiary designations and take the action necessary to confirm best practices are being followed.

Richard Miller is a partner in the trusts and estates practice at Mandelbaum Barrett in Roseland, NJ. Contact him at [email protected].