Tier One Interview: Michael DeFillipo

In this month’s interview, Jay catches up with top tier producer and Lion Street, Inc. firm principal Michael DeFillipo, CLU®, ChFC®.  The pair discuss how to best position life insurance with clients, Michael’s short-lived collegiate athletic career and where to find the best rabbit pie in the Philadelphia area.

JAY:  Perhaps the greatest professional compliment I have for you, Michael, is that you are a top-notch writer.  You have a rare ability to take complex planning ideas and make them easily digestible for folks outside of the life insurance industry.  After reading this interview, I would encourage our readers to head to your company’s website to check out all the subject matter pieces you have authored.  I am always looking out on LinkedIn for your latest article.

Let’s get rolling.  Tell me about your firm, 1847 Private Client Group, and your role with the organization.

MICHAEL:  It’s my great pleasure and honor to invited to part of the Tier One Interview series, Jay.  As a regular reader, it’s a bit overwhelming to be considered, given the industry luminaries and leaders that have been interview subjects in the past.

The 1847 Private Client Group – the “PCG” – formed in 2016 when several industry veterans brought their respective practices and expertise together in an effort to bring the highest quality service to high- and ultra-high-net-worth clients and their professional advisors.  By combining our backgrounds in wealth transfer life insurance, asset location and investment management, holistic financial planning, and business succession strategies, we can bring integrated solutions to meet all our clients’ needs.

One of the PCG’s core philosophies, no matter which area of practice, is to provide unrelentingly high touch service; three of our team members are dedicated to responding to any inquiry in a timely and thorough fashion and, in a best-case scenario, answering a question before it’s even asked.

The PCG became a member firm of Lion Street in December of 2019.  The relationship with a highly regarded producer group has been a critical component of our growth over the past five years and was nothing short of vital during the first wave of the pandemic. It isn’t a stretch to say that our relationship with Lion Street is a key to our sustainability. There is incredible value in having deep relationships with our partner life insurance companies and having a community of top producers united in the enthusiastic sharing of ideas.

Our team’s primary location is in Conshohocken, one of the Philadelphia suburbs, and we also have a presence in South Florida. We have clients in over 25 different states, generally with some connection or nexus to the Philadelphia area.

My practice is entirely focused on the design, implementation and management of sophisticated life insurance strategies. Much of my work involves working collaboratively with a family’s professional advisory team that likely includes their attorney, wealth planner, accountant, trust officer, and other professionals to determine if, and how, life insurance can play a role in their planning. Within the PCG, I work with my partners and associates as a product specialist and Advanced Markets proxy...which mostly means I know who to call when we have a question. 

JAY:  I guess I should not be surprised by your writing and technical capabilities because you have a background in science. As a result, you are not a stranger to technical processes. I want to hear more about this. Where did you grow up and how did you end up where you are today in the top tier of the life insurance industry?

MICHAEL:  To answer the last part of the question first, I ended up in the life insurance industry just over 20 years ago completely and utterly by accident. Now for the origin story…  I was born in Westchester County, New York and grew up in southwest Connecticut. Education was always paramount, and while I was raised in a very financially literate household, I did not have any family members directly involved in financial services. My mother raised four children, and my father worked as an executive in the local newspaper industry. Medicine was the family vocation, with both of my mother’s parents being dentists and my uncle a well-established dermatologist; from a young age, I assumed my path would inevitably head in that direction. Incidentally, my grandmother was one of the first practicing female dentists in the country!

After moving to New Jersey halfway through high school, I was recruited to play football at Swarthmore College. In a shocking and still painful decision, the College eliminated the program after my freshman year. My contributions to scout team punt coverage will live on in college football lore. I also had a very short and unspectacular collegiate relief pitching season before turning to club rugby to stay out of trouble. Results varied.

My barely Division III athleticism opened a window to attend a prestigious and highly competitive academic institution, where I majored and received my degree in Biology. I took one general economics course, and the grade was unimpressive. During my time in college, I completed all the premed requirements and was preparing to take the MCATs and get ready to be a doctor.

That is the point where my journey in the insurance industry begins. During my senior year, in the middle of debating if I wanted to go “all in” on medicine or enroll in grad school to pursue further study in botany, two of my close friends and old teammates asked me for a favor. They had recently graduated and were looking for help for their company in arranging a mini-job fair for some of the undergraduates that might be interested in a career in finance. The firm had a very strong and direct pipeline to Swarthmore, dating back to its founder in 1934. 

For the price of a steak dinner – which was incredibly valuable to a college student -  I agreed to gather up some prospects and waited in the back of the room until we could go get a ribeye. Two weeks later, I decided that I hadn’t made any decision about my future, so I asked if I could throw my hat in the ring for what was, at the time, an intern-to-full time position. The timing was perfect for my very transitory time period and it started as a six-week trial.

At that firm, I started my career with the glamorous roles of faxing beneficiary change requests and filing annual statement paperwork. Even as a young guy who didn’t know what a premium was, my mentor and friend, Tim Malarkey, took an inordinate amount of time out of running the practice to teach me the foundations of life insurance. An actuary by training, Tim spent many Friday mornings with graph lined paper showing me how life insurance products function and how they fit within the structure of an estate plan.  

Essentially, I learned from the bottom up: customer service to inforce policy analyst to case design. After the one advisor in our then-fledgling asset management part of the business went back to actuarial consulting, I jumped into that role. It was 2008 and not fun. 

I became a partner and shareholder in M Financial after a few years and, after a merger with a P&C firm, I shifted back to focusing more on the life insurance side of the business.  At the 10-year mark, I took an opportunity to slightly change direction and joined a start-up captive insurance manager with Swathmore alumni connections. I spent 20 months as a regional VP of sales, working with benefit brokers to implement self-funded employee benefit plans. The 20-month mark is important, since we can park our securities licenses for 24 months before losing them. That was a great experience in more of a sales-oriented role and I felt that I had gained an understanding of what I was proposing and a more refined way of positioning the solution.

I didn’t have much production responsibility during the formative part of my career, so had the freedom to learn the technical aspects of the business, how life insurance policies are built and what makes them work. That training and experience shaped the way I built my practice and continues to inform the work I do today.   

JAY:  You have an approach to placing life insurance with which I am totally on-board. In most instances, life insurance is sold to fund a tax liability at a date in future. From what you and I have previously discussed, that approach demonstrates how life insurance is commonly misunderstood. Please elaborate on what this means.

MICHAEL:  The traditional approach of positioning life insurance in this manner makes sense given the core tax treatment of death benefit, which is that the proceeds are received income tax free and can be removed from the taxable estate. In general, the funds in the form of cash arrive within a matter of days without the need for valuation or the need to sell assets. It’s an excellent solution to fund a future estate tax need.

While this is all true and permanent life insurance should be considered an important part of estate tax planning, it is incredibly limiting to think of it as a solution to only one problem.

Backing up a step, let’s outline the “solve” of this equation: we want to know the life insurance amount to fund a future liability. In its simplest form, the amount of life insurance required to fund the liability is the applicable tax rate applied to the taxable estate. I think it’s important to remind ourselves of the recent history of the Federal Wealth Transfer Basic Exclusion Amount. In 2000, the individual exemption amount was $675,000; that was only 25 years ago! While it’s true that nothing is certain except death and taxes, it’s also been true that we don’t know what the tax is going to be when you die. To me, there is a serious flaw in the logic of using a formula to determine the amount and need of life insurance when one of the key variables is so, well, variable.

The narrow perspective of using life insurance only as a tax offset also confuses the issue between “needing” and “should consider having.” Very few clients need life insurance unless compelled by some agreement or contract. When a wealth advisor tells me a client doesn’t need insurance because they have enough liquidity, I wonder if another recommendation to the client was to move all their assets to cash. If the client has enough money, why do they still need an asset manager?

I also think that when presented this way, we are misunderstanding the ultimate objective, which is not to find a way to pay estate taxes, but how do we transfer as much wealth as possible to the people or places that we decide? 

Michael with Jay

With that framing, we can now consider the unique characteristics of life insurance as it relates to an overall portfolio. Here is the pandering section of the interview:  the “Life Insurance: A Valuable Contingent Asset Class” article you authored with Michael Fontanini for Trusts & Estates in 2020 was the Leonardo-DiCaprio-pointing-at-the-screen meme for me. Life insurance is a vehicle where we can measure expected risk, expected return, correlation to other assets and liquidity - it is another asset class. The math done by you and other very accomplished people shows that adding insurance to a diversified portfolio increases the overall expected return while reducing expected risk. These findings were reinforced by two studies conducted by Ernst & Young. The results are beneficial to a client regardless of whatever the exemption is the future.

JAY:  Let’s stay on this topic for a second – not necessarily pandering to me by mentioning my past academic glory but positioning life insurance in a client’s full financial picture.  What if I bought a $3 million policy many years ago when the federal estate tax exemption was not as large as it is today. That policy is held in an irrevocable trust outside of my estate and now I really don’t need the death benefit because the exemption takes care of my federal tax exposure. How should I be thinking about that $3 million policy?

MICHAEL:  This is exciting. We have an asset no longer limited to addressing a liability, and now the goal is to optimize the existing value and potential future investment in a manner that best fits our new objectives. By the way, how is your health right now?

The first thing we want to do is get our arms around the status of the existing policy through a thorough review and analysis of an inforce illustration. In fairly short order, we have a good idea of the policy’s current value and expected performance, but only in a vacuum.

You told me in your article that life insurance is a contingent asset class where the return on investment for the life insurance is calculated at life expectancy, so the performance is dependent on when death occurs. I asked about your health earlier because that determines how we should evaluate the data received through the policy review. A policy that is illustrated to remain inforce for 15 years with no more premiums is a more attractive asset to maintain that a policy where the client has a 30-year life expectancy. 

Assuming favorable insurability, we now want to think about ways we can maximize our return on past and future investment into the policy, including whether or not repositioning the cash value via a tax-free exchange to a new strategy.

Here is an example of that in practice. I was referred a situation a bit different the hypothetical client you used in your article. A 77-year-old female had set up three Irrevocable Life Insurance Trusts for the benefit of her children with life insurance in the 1990’s as means to fund a potential estate tax exposure. The corporate Trustee would send a review each year of the coverage and submit premium payments, however the coverage itself and the options available were not understood. The objective had changed, but the process and path did not. Since there was no longer an estate tax issue, the primary goal was to maximize the cash value or previous cash flow while minimizing, or preferably eliminating, future premiums. 

Utilizing informal underwriting, we conducted a two-pronged analysis of mortality and inforce policy projections to review the options: keep the life insurance in place and fund to keep the policies inforce to an updated life expectancy, stop funding and hope that mortality occurs before the policies lapses, sell the policies on the secondary marketplace where there could be negative tax consequences, surrender the policies for cash value or exchange the policies to a new product designed for today’s objective. 

We were able to secure favorable underwriting and replace the existing coverage with smaller variable universal life policies guaranteed to Age 100 and no future premiums due. 

The result - we knocked down the death benefit a substantial amount in exchange for guarantees and no future premiums. By using a product that functions both through protection mechanisms such as the death benefit guarantee and upside potential via the cash value and death benefit growth tied to the market, we were able to lock-in the established value of past premiums with a baseline death benefit that under reasonable assumptions will continue to grow over time. 

The client and their advisors were very happy with the result; we were able to take a problem of “not needing” the insurance for its original intended purpose and turning it into a tax-efficient legacy transfer device.

JAY:  It is safe to say that day in and day out, I am inundated with marketing about ways to fund life insurance. Premium financing, split dollar, synthetic reinsurance…the list goes on. Are consumers confusing these funding mechanisms for reasons to buy life insurance?

MICHAEL:  I experience with increased frequency conversations that start with a prospective client or a non-insurance financial professional telling me that they were brought an idea about how to use one of these funding mechanisms with life insurance. I think there is a danger of misrepresenting how these methods to pay premium are just that and not the impetus to acquire coverage.  When used appropriately and monitored and re-evaluated routinely in the future, these are powerful tools for sophisticated clients.

A critical component to all the math we’ve discussed is that the power of life insurance within a diversified portfolio isn’t the expected return, but the low risk. Actuaries are smart people, so one would expect a properly priced product should have an expected IRR at life expectancy similar to a high-quality corporate bond. The year-to-year change in IRR around life expectancy is very small as are the chances of death, so we assume a relatively predictable outcome. Extreme outliers in timing tend to be premature deaths, which vastly improve the return on investment…but most folks don’t volunteer for that. 

Techniques, like those you listed and more, are used by professionals and consumers to try to improve the expected rate of return by limiting the cash flow into the policy. The offset to paying lower premiums is introducing some other risk - external interest rates, for example.  In an effort to improve the expected return, we’ve created additional expected risk. It would follow that we should adjust our expectations to allow for a wider spectrum of outcomes.

What I’ve also heard with increasing frequency is that when one of these strategies goes sideways, it is the life insurance policy’s fault. I would venture that in most cases the life insurance policy did exactly or close to exactly what it was supposed to do. It was a change in the other moving parts of the strategy that caused a strain on the system. As an industry, I think we need to be very conscious of how the marketplace perceives these strategies and understand that the bad news gets reported much louder and faster than the success stories.

A good reason to buy life insurance is if a consumer wants to transfer wealth, do so in a tax-efficient manner and in a financial product that offers predictable returns at low risk that is not directly correlated to the market. From there, there can be discussions around how to best fund the desire.

JAY:  You are on the board of the Philadelphia Estate Planning Council, and I was thrilled you invited me to speak this past March. I spoke about the hockey stick growth in the purchase of private placement life insurance. PPLI, at its core, is just a version of a life insurance policy used for cash value accumulation. You recently told me you are seeing an uptick in accumulation products. What do you think is going on?

MICHAEL:  It was great to have join us … your talk was excellent!  Designing a life insurance product for asset accumulation, rather than death benefit, focus certainly isn’t a new idea. The concept goes back decades using traditional whole life as a fixed income alternative; in the last 20-ish years, we’ve been using overfunded variable universal life products as the “wrapper” around what would otherwise be taxable equity assets. The accumulation discussion boils down to trading insurance costs and liquidity for taxes. 

I think the growth is catalyzed by a combination of recent tax changes, an immediate concern around future unfavorable income tax rates and the perception of control.

A substantial favorable change occurred in 2020 when Congress enacted the Consolidated Appropriations Act, 2021, which included a revision to the underlying crediting interest rate applied within life insurance pricing under IRC Section7702. This reason to reduce the rate was as a solution to older traditional whole life policies that were unable to accept additional premium to stay inforce without jeopardizing the foundational tax-free nature of the death benefit. Going forward, this change would allow more money to go into the contracts given the historically low ambient interest rate market. 

A side effect of this was that it allowed a significant higher contribution into a life insurance policy for an analogous face amount. By supercharging the overfunding of the contract, the life insurance charges were further mitigated because of the smaller net amount on the contract. All of this further tilted the math towards the underlying insurance costs, on an average annual basis over the long term, to be less friction than the taxes on a taxable portfolio. Insurance carriers quickly moved to reprice or start new products to take advantage of this opportunity.

The second recent impactful change was the passing of the SECURE Act and SECURE 2.0, which essentially ended the ability for a beneficiary to stretch inherited IRAs over their lifetime. Under current law, those assets must be liquidated and taxed at normal income rates, from dollar one within a 10-year window. The practical result of this was that qualified dollars were the worst kind to inherit. Now, we can use an overfunded accumulation product to mimic a synthetized ROTH, without any income testing or contribution limits.  The owner/insured can allow these assets to grow tax-deferred and distribute tax-free later in life to support living needs. The remaining assets are passed as a tax-free death benefit to the beneficiaries. Yes, there is not the upfront advantage to tax-deferral, but the backend advantages make the strategy something worth considering.

The previous two examples are based on current legislative. The second driver to the growth in accumulation products is anticipating where income taxes are going to go in the near term. We started the meat of this interview discussing the estate tax and why it is difficult to aim at that moving target, so far into the future. The annual deficit was 1.8 trillion dollars at the end of 2024. The Congressional Budget Office released a score estimating the pending signature bill of the Trump Administration would add $3 trillion billion to the national debt over the next 10 years. The average highest marginal federal income tax rate is 57%. I think it is a reasonable assumption to plan that an increase in income tax sometime in the foreseeable future. And a lot more people pay income tax than are subject to federal estate tax.

The final piece of my hypothesis is that good old-fashioned selfishness plays a part. There is psychology to consider where some clients do not want to overindulge their heirs; perhaps it’s a negative response to idea that they are giving money away; some, no matter the wealth, fear they will run out of money; others might not yet know where they want their legacy to go. The accumulation design may allow for more flexibility, both in terms of funding requirements and in multiple avenues to use the policy when the time comes.  From a product standpoint, there is an interesting analysis around the effectiveness of using an accumulation product for legacy purposes and the favorable comparison to more protection style designs. There is more control and optionality with these types of policies, which is attractive to a wider marketplace.

JAY:  Fortunately, I know you have a few passions outside of the life insurance industry, so I feel safe in asking how you spend your time outside of helping your clients?

MICHAEL:  Athletics have always been a big part of my life, so much of my free time is spent thinking about how I would run the major New York sports franchises. My favorite sport is baseball, and we follow the Yankees year-round; I am also hopeless dedicated to my fantasy baseball team where the league I play in is over 20-years-old and full of other uncomfortably intense people. When I’m not watching baseball, I’m usually studying numbers and being a big nerd about it. I no longer play organized sports but I do weight training regularly and am convinced I could still run a few routes if needed. Mainly, I am looking forward to coaching my daughter when she starts playing.

Passing on the Yankees Pride

Along with the Philadelphia Estate Planning Council, I am also on the Board of Directors for Living Beyond Breast Cancer, a nonprofit that connects people with trusted information and a community of support. Breast cancer continues to impact my family, so I very much appreciate and believe in the work we are doing for patients and their caregivers.

My wife and I enjoy cooking and working on our property when we’re not chasing around the little one. I was introduced to craft beer in the mid-2010’s and became an investor in a local brewery in 2018. I have catalogued over 3,400 different beers from across the United States and several spots in Europe.  Beer is a great compliment to cooking and yard work!

JAY:   Thank you for participating in the Tier One Interview Series, Michael.  As I expected, you did a great job.  We have reached the restaurant question where, without naming a steakhouse or a steak dish, I want to hear your recommendations for some of your favorite spots as well as what you order when you visit.  A caveat just for you, you are allowed to bring up beverages in your answer!

MICHAEL:  It’s been a great joy doing this, Jay, thank you!  Here are a few key spots in Philadelphia:

• Monk’s Café: Best mussels in town to pair with a world-class Belgian beer list.  They also always have Russian River beers on tap.

• The Dandelion: Rabbit pie with whatever English Special Bitter is in the cask.

• Conshohocken Brewing Company (Conshohocken): A bag of chips with fresh MC-5 from the tap.

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Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at www.lifeinsurancestrategiesgroup.com.

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