What is the difference between a life insurance review and a life insurance audit? In this episode, Steve Herlihy at Wellspring Associates sheds some light on why it might be time for your family to consider a life insurance audit, and outlines some life insurance basics that younger-generation family members should know.

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Below is a transcript from the conversation:

KC: So, life insurance. I know a recent conversation that FOX had with Wellspring touched on the difference between a life insurance review and a life insurance audit, and that families should know the difference. So it's great that we have you here to shed some light. I wasn't aware until recently that there was a difference. So please tell us, what is the difference between a life insurance review and a life insurance audit?

Steve Herlihy: Well, certainly. You know, it's funny because we work in the family office space, have for years, and we have lots of conversations with family office executives and family members. And what we find is that most of them are completely unfamiliar that there even is a difference. And so, let's just define them. Obviously, a life insurance review is simply performed by the person who placed the coverage. And they mainly focus on the performance of the policy or the carrier and it's completely life-insurance focused, as you would expect.

But differently, a life insurance audit is actually performed by somebody that has dual experience in both advanced planning and life insurance. So, it's kind of like if the person who crafted all of your complex planning was also the most knowledgeable life insurance expert in the country. And they were reviewing your life insurance plan with the knowledge that they have from a planning perspective. That gives them an opportunity to look for missed opportunities. It also gives them a way to look for ways to simplify how it fit in to the overall planning. And so what we find is that they’re just completely different and most people weren't even aware there was a difference.

KC: Oh man, yeah. That seems really important. So have you found that this is a big deal? Are families surprised?

SC: You know? Yes. It's interesting because most families, going in, they’re not even sure there really is much of a difference, so they're not even sure what to expect. But maybe, I could just give you a couple of quick examples that might sort of illustrate what we're talking about.

KC: Yeah, that’d be great.

SH: I was working with the family and we were actually hired to do all their advanced planning, and so in the course of that we were reviewing their life insurance. And the family had three policies and they added up to $70 million.  And so, there was a $30 million second-to-die policy of mom and dad and it was owned in her trust. And it was a non-generation skipping trust. And then they had $20 million policies on their children, and those were owned in generation-skipping trusts. So, why did this really matter?

So the first thing we did look at, just like a life insurance agent would do in a review, we looked at the policies and they were the best. They had premier companies, they had a premier product—they were just fantastic and there was really no opportunity to help them improve the life insurance policies. But, based on the net worth of the family, what we figured out is that when you have $30 million in a non-generation skipping trust, that's $30 million that's going to be taxed in the kids’ taxable estate. And with a 40% tax rate, that's a $12 million tax that's completely avoidable. And also, which is even more interesting to me, is that it sounded like the kids had gotten it right because they put their $40 million of insurance in a generation-skipping trust.

But again, because as an audit, we’re looking at all the details. So, I had asked the family to let me talk to the CPA to get a copy of the gift-tax return so I could make sure the proper allocations were made so that everything was done properly. And, KC, you probably won't be surprised, but the reason we're giving this as an example is that there was no allocation of generation-skipping exemption. So, the long and the short of it is, that was $40 million that was also going to be taxed at 40%. So, you take $12 million and $16 million—that's $28 million of tax savings on a $70 million portfolio that had nothing to do with the life insurance policies. So that’s just one example, but it is a big deal.

Imagine being the trustee of a trust, and let's just say it had $30 million of insurance in it, just to pick a number. And imagine that you’ve been doing reviews every year. And 20 years later, people pass away and the policy pays out and the beneficiary is going, “golly, KC, I thought we had a lot more coverage than that.”

“No, no that’s what your mom and dad bought. They bought $30 million of coverage.”

“See, I was talking to a friend of mine and they found out that their parents doubled their insurance for no more premium. I mean, just because policies have changed. Did you ever look at that?"

“Uhm, no.”

You know, that's the kind of thing … you wouldn't want to be in that position. There's a lot of liability that people just aren't even aware of.

The second thing I would say is that, everyone that I deal with, they always wants to maximize their investment. Just like I do when I invest. You know, whatever money I put in, I'd like if I could get twice as much out. I mean, obviously. That's a pretty obvious thing. And so, it's not uncommon for policies that are 10-years or older, when people still have relatively the same health, that they could have significantly more coverage or lower their premiums for the same coverage.

KC: How many years have you been working with Wellspring and doing these life insurance audits?

SH: This is my 26th year in the business and our firm was founded in ’81. So, I think that was about 38 years ago. So, we've been at this for quite a while.

KC: And after doing so many life insurance audits and working with families, what has surprised you the most?

SH: You know, I think it's probably two things. One, is I was surprised that people thought that just reviewing it was enough. And I think it was kind of that old adage of “what you don't know can hurt you.” I think people just didn't know there was a difference.

And then the second thing is, we literally have had opportunities to work with some of the wealthiest, most sophisticated families in the country over the last several years. And you always kind of wonder … You would think those families would have it all buttoned-up, but maybe not the other family. And after so many where that wasn't the case, I guess I'm to the point where I'm not really surprised anymore.

KC: Fair enough. Can we zoom out a little bit and talk about life insurance more simply? I recently had a baby boy—he's 9 months old—and my husband and I purchased life insurance—definitely not as much as one of the families you work with need to get—but with that said, it's kind of a confusing process. What should people know, of any personal wealth level, that you find most people don't know?

SH: Sure, one of the things I find a lot of people don't know is that medical underwriting is actually a negotiated item. So, think about it this way: Your policy is going to get priced on your age, your gender, and your health—or somebody's opinion of your health is really a better way to say it. No one can help you with your age or your gender. But, medical underwriting is negotiated. And that's a really important point, because imagine if you're healthy and have a standard offer, that's really good. But if someone was able to negotiate a super-preferred offer for you, and lower your premium 17%, depending on how much you …. I guess it doesn't matter how much you're paying, everyone percentage-wise wants to save money. So, that's something that I find a lot of people don't know. I've had people tell me, “well, I have this or I have that, or I'm not insurable, or I'm not healthy …” And really, in reality, it's negotiated. And so, who you work with really matters in that way. And there's a lot of folks out there that do enough business to where they can actually help in that area, So, I would say that's really important. Which is kind of interesting.

And then there's one other thing which is kind of new, that some people just haven't heard about yet. Four years ago, one insurance company, John Hancock, just kind of flipped the industry on their head. And they decided that they would try to figure out a way to help people live longer and healthier lives, which sounds kind of interesting. You know, your life insurance provider should probably care about your health. But they partnered with the firm that really had a behavioral-change model that actually works. And a lot of their folks are living six to seven years longer and healthier. And, so that's kind of exciting. It's a little bit different. I think some people just haven't heard about that. But, a lot of the younger people that I talk to—some of the G 3’s in some of the families that I talk to—are kind of interested to know there's something a little more innovative and fun out there.

KC: Right, for such an old industry, that’s revolutionary.

SH: Not known for innovation. Never would be accused of being very innovative.

KC: OK, so zooming back in to the families that Wellspring works with, straight-up, what does a life-insurance audit cost?

SH: Oh, it's interesting, because generally what we do is we price it—and I think a lot of people do it this way—we generally price it per-policy. So, you know, it could be between $500 to $1000 per-policy, but that really depends on the facts and circumstances of the case. And so, what you find is that for a lot of folks, what you uncover clearly just dwarfs the nominal cost to have somebody really drill down and look at it. And it's interesting because, regardless of what somebody finds, you know that with the right process, and an in-depth process, you know you're going to reduce your liability. And that's something that most trustees, once they hear that, are very, very interested in figuring out what they need to do to make sure that they have done everything that they could to make sure the policies are doing exactly what they were designed to do. And that they’re going to be taxed properly or avoid tax properly. And that they've got the best situation for their family.

KC: How often do you recommend a life insurance audit?

SH: You know, every three to five years is probably a good rule of thumb. But then sometimes, think about major life changes. If there was a major change, maybe someone's net worth dramatically changed, or somebody had a divorce, or somebody had bought a couple of companies … If there's something dramatic that changes, obviously that's a trigger you ought to consider if it's appropriate. Because, what happens when there's life events, is that sometimes the need changes. And so when the need changes, potentially, that's an opportunity that should be reviewed. Because, potentially, ownership might need to be changed. The policy could be completely fine, but you might need to change the ownership or change something else, because the needs have changed. So, every three to five years is probably good rule of thumb, but when there's a major event and a need could have changed, that’s a good time to put another set of eyes on it.

KC: If somebody listening thinks that they need in audit, how could they get in touch with you?

SH: Pretty simply. Wellspring Associates, you know on the web, is pretty easy to find. For FOX members, you know, a lot of your listeners are probably FOX members and they probably know Karen Rush. We spend a lot of time back-and-forth and she could certainly help put us together.

KC: Wellspring is also featured on our website, www.familyoffice.com.

SH: Wonderful. And so, between your website and our website, probably pretty easy to find.

KC: Are there any observations that we let fly by? Anything else about life insurance? I think this is a topic a lot of people really don't know enough about.

SH: Well, I would say that if they can really just kind of drill down and just kind of think about the difference between only looking at the policies themselves, but taking a broader look to how they fit into why they were purchased, I just think that is critical.

The last thing I would say is that the liability is real. Our society, unfortunately, is not getting any less litigious. Unfortunately, that's just what we live in. So, I just think people should really kind of think through making sure that they're very thoughtful and they have a very good process. Whoever they decide to partner with, that they can really have a very thoughtful way to look at everything that's involved around life insurance. So, it's not just the policies. It's really how it fits into the planning. And things do change. We all know that. Life changes, it’s fast. And so, just looking at revisiting the need: Is this exactly the same need? Did it change? Is the ownership doing exactly what we think we're going to do? Can someone go back and look at the details just make sure we dotted our “i’s” and crossed our “t’s?” That type of thing.

And I think when people do that, KC, they'll be so happy. You know, one of two things are going to happen: (1) You're going to find nothing and just get confirmation that everything's great. That ought to be exciting. Or (2), you're going to find something, and then you can fix it. And that's the great thing about life insurance—just fix it before the policies pay out. You know, and then you're fine. That's the last thing that I would say is probably pretty important.

KC: Oh gosh, it's been so awesome just to learn a little bit today. I, for one, have learned a lot. Steve Herlihy, senior partner at Wellspring Associates, thank you so much again for joining us today.

SH: Well, thanks for having me. It's been a pleasure speaking with you, and hopefully some of this information will really help some families. That's the whole idea—to help families improve where they are.