Insurance producers have to follow different standards of care when it comes to serving their clients. While deception and fraud are never OK, depending on the situation, simply being honest about an insurance product doesn’t cut it.
For most of U.S. insurance regulatory history, insurance producers have been held to a similar standard of care as other retail industries. Basically, don’t be a shyster.
Insurance producers are the experts when it comes to helping individuals protect just about everything from their home and car to their pets and family members. But some types of coverage have a different risk and impact than others.
Consider a business’s fire coverage. You have a coverage range in mind, and a rate you want to pay, and your insurance producer can help you find the intersection of the two that works for your business’s budget. You don’t probably expect the producer to talk through long-term, in-depth visions of your business’s future, or read through the ins and outs of the policy. Sure, the provisions and exclusions are important, but at the end of the day, you’re more concerned that you have a product in place than you are that it’s the most bestest perfect one. This is simply because the chances of a fire are small in the scheme of all the risks your business will face.
Policies that will almost certainly be used, though, like annuities or permanent life insurance, for instance, are a little more critical at a personal level. And when it comes to choosing the right types and amounts of coverage for these complex policies, people rely even more deeply on their agents to give them guidance – not simply to put any old plan into place.
In these examples, it’s understandable that an insurance producer selling a business fire policy will be held to different standards than one selling a permanent life insurance policy. Insurance producers are generally expected to meet a “standard of care” for their clients, but what does that really mean? Let’s discuss a few of the standards insurance producers are held to, and what these standards mean for their clients.
The vast majority of insurance agents are held to the suitability standard. This means agents are expected to only recommend the products that are suitable to their client’s objectives, budget, and timeline. The insurance producer must conduct a thorough investigation of their client’s suitability information before making any suggestions, and there must be a reasonable basis to believe the consumer has been informed of all policy features and transaction outcomes.
When does suitability apply?
The suitability standard governs most insurance sales, but in the last few years, life insurance producers selling annuity products have been moved to somewhat stricter standards. Setting those aside, suitability standards apply pretty much the rest of the time. Basic transactional deals, producers, adjusters, brokers – all should be operating with the understanding that they can’t recommend products outside of a client’s means and objectives. A client with a stated insurance need of $5 million shouldn’t be insured for a $20 million policy, even if they can afford a higher premium. On the other hand, an insurance producer shouldn’t recommend a low-cost policy to someone who clearly needs more coverage than it provides.
How is the suitability standard regulated?
The suitability standard is largely regulated by state courts. Much of the standard comprises judicial rulings and common law understanding of what is fair and expected.
Brokers: Brokers often hold themselves out as being impartial fiduciaries, acting in a client’s best interest. Yet, depending on what state they’re in and very specific nuances, that might be true … or not.
For instance, Texas judicial rulings make it clear that producers are only ever held to a suitability standard.
2. Best interest
The term “best interest” is used in multiple fields including the medical, legal, and financial industries. When it comes to the financial industry, best interest means that agents will set aside their own personal beliefs and biases for the good of the client at all times.
This is a fairly new standard for the insurance industry, and one we’ve decided to put in its own category based on the NAIC’s Suitability in Annuity Transactions Model Regulation, the newest draft of which was adopted in 2020. Don’t let the name fool you: The most recent draft of the NAIC’s regulation advocates a higher standard than suitability.
The NAIC Model Regulation requires insurance agents selling annuities products to act in the best interest of their clients in order to effectively address all client needs at the time of the transaction. That means making sure that the benefit to the client is a higher priority than the benefit to the producer.
For a peek at what this standard looks like in practical application, go ahead and check out our breakdown of Mississippi’s adoption of the NAIC model. Some of the key differences that the best interest standard brings into the picture:
- Producers have to mitigate conflicts of interest
- Producers have to find not just a “suitable” product, but one that is the best fit
- Producers have to provide ongoing services to the customers
- Producers have to thoroughly document why they have recommended a specific annuity product
When does the best interest standard apply?
The best interest standard is for agents selling annuities, because these transactions could serve the insurer’s financial interests over those of the customer. When it comes to annuities, the best interest standard provides consumers with an extra layer of protection.
How is the best interest standard regulated?
The NAIC’s model regulation is being adopted in waves by states across the country, quickly becoming the law of the land. Additionally, the Department of Labor (DOL)’s fiduciary rule might also apply here, but it’s actually an area of intense debate and interest, so, hold your breath and we’ll dive into that in the fiduciary section.
The last standard we’ll cover is the fiduciary standard. While there is some confusion over the difference between the fiduciary and best interest standard, most regulatory bodies agree the fiduciary standard goes above and beyond both the suitability and best interest standard, making it the highest standard of care.
In a fiduciary standard, you make the decisions for your client as if you were the client. You assume responsibility for their well-being and personal circumstances as if they were your own.
The DOL fiduciary rule, or, if you prefer the proper name, the Prohibited Transaction Exemption 2020-02, Improving Investment Advice for Workers & Retirees, holds insurance producers to a fiduciary standard when they sell annuities. This is a strong area of disagreement, though. The Securities and Exchange Commission (or, the SEC, which has a standard similar to the NAIC model, but from the securities side of the industry) and the NAIC both explicitly state that a best interest standard isn’t a fiduciary standard. The DOL explicitly disagrees.
So, what gives? The NAIC and SEC argue that a fiduciary duty is a standard that is fixed – once you’re a fiduciary, you’re always a fiduciary. Their standpoint is that, if a best interest standard holds only for a certain set of products or situations, then it’s not the same as a fiduciary standard. The DOL argues that this is a circumstantial use of the fiduciary standard.
How will we know who’s right? In classic American style, probably we’ll find out if it ever goes to the Supreme Court. In the meantime, if we were insurance producers, we wouldn’t test it to find out.
When operating under the fiduciary standard, professionals not only recommend products that are appropriate and in the customer’s best interest, but there is also the question of “would you buy this product if it was your own money?”. Basically, the insurance professional would only suggest products that they themselves would purchase were they in the customer’s position.
When does the fiduciary standard apply?
According to the DOL, the fiduciary standard applies to producers selling annuity products. Brokers: According to the state of California, the fiduciary standard also applies to brokers.
If you’re looking for more reading on the subject, Plaintiff Magazine featured an interesting column with citations from states that each handle it differently, with decisions from Louisiana, Illinois, and New Jersey all pointing to brokers needing to follow a fiduciary standard.
Another twist: Dually licensed insurance professionals might also hold a Series 65 license, which obligates them to a fiduciary duty in securities matters. If a client who sees that professional for securities advice also asks them about insurance, at what point do they stop being a fiduciary? The DOL fiduciary rule is a forward step, but these situations still have plenty of gray areas to explore.
How is the fiduciary standard regulated?
The DOL’s fiduciary rule and judicial concern regulate the fiduciary standard and its implementation across insurance producers across states.
Agents owe customers a certain standard of care
The bottom line is that sometimes insurance is purely transactional, but the more of an impact it might have on a client, the higher the standard of care the insurance producer should consider.
Annuities in particular are an area to watch moving forward, and brokers should be particularly concerned about regional variations in standards of care.
Do you know which standard you’re being held to? If you don’t, check with a regulator or lawyer. You don’t want to use what we call the “fool around and find out” method.
Along with responsibility to clients, insurance professionals have a responsibility to operate in compliance with a whole host of different rules and regulations. AgentSync can help prevent regulatory violations before they happen. If you’re interested in reducing costs and compliance risks at your agency, see AgentSync in action today.