By Dennis M. Groner

One of the current issues that regulators, the industry, critics and supporters are dealing with is who is responsible for determining and evaluating suitability. Is it the agent when he makes a recommendation or the company when it underwrites the risk and offers a contract, i.e., the “sale”?

This is an important issue, since many people see it as the basis for assigning accountability and liability. Their reasoning goes something like this: If the agents recommendation is the basis for determining responsibility for suitability, then it seems likely the agent will bear the majority of the liability for an error in suitability.

On the other hand, if the companys offer of a contract is seen as the basis for determining liability, the company will likely bear the majority of the accountability.

Part of this issue reflects the assumed level of control by the company. For captive agents, the assumption is made that the company can require that the agent provide the client information needed to assess suitability. For independent producers, the assumption is made that such requirements can not easily be made.

Although who will be seen as liable for suitability errors is an important part of the overall suitability puzzle, the fundamental issue, regardless of who will be seen as responsible, is what standards will be used to determine suitability. Determining if a sale is suitable is ultimately a standards issue.

What are Potential Suitability Standards?

There are many possible aspects to suitability standards, but five seem to be key and thus bear closer analysis:

–Scope of the analysis;

–Defining what is in the clients best interest;

–Type and documentation of analysis;

–Time frame; and

–Full disclosure and client responsibility.

How regulators, companies and agents deal with these aspects of suitability standards will be the key to understanding the impact of suitability on the regulatory landscape as well as in the practical application of the concept.

Scope of the Analysis

The first issue to deal with is how extensive the analysis of a client’s need should be. Should it consider all possible client needs, e.g., health, disability, retirement, last expenses, cash needs, etc.?

It seems reasonable that if the client is willing to provide the information, then the analysis should be as complete as possible. However, the broader and more complete the analysis, the more likely there will be multiple needs that should be satisfied.

And, if there are competing needs, how do we evaluate which one is paramount? If a client has a need for life insurance, disability insurance and health insurance, how do we determine which need should be met first? What is the standard that should be used to determine priorities among a clients needs?

One way of dealing with this difficult issue is to require the client to choose the need she feels is most important and to document that choice. However, that will likely require the agent to educate the client regarding the implications of each of her needs, so that the clients decision has a sound basis. This may be a difficult task since it will hinge on projections of likely outcomes and the severity of their negative impact on the client and her dependents.

How should one estimate the impact of not having disability insurance vs. not having life insurance? Is there a sound actuarial basis for estimating the cost and the likelihood of the occurrence?

Another approach to prioritizing needs is to create a “need” profiling method conceptually similar to the risk profiling methods used when considering which investments match the clients experience and risk tolerance.

Agents who do not sell a full range of products to meet the potential range of client needs may be faced with the ethical challenge of losing a sale because of the scope of the analysis. They may identify needs they cannot fulfill and be tempted to direct the sale toward needs they can fulfill.

Companies, regulators and agents will need to wrestle with how to determine the priority of needs and the methodology that should be used to determine the highest priority need in determining a standard for evaluating the scope of analysis.

Defining what Product is in the Clients “Best” Interest

Once the clients highest priority need is identified, the issue of suitability turns to the product recommended to satisfy that need. Shouldnt the product that is recommended be the one that is in the clients “best interest”? Doesnt this concept seem to define the essence of what is suitable?

This is the simplest conceptual way to define suitability. However, must the product that is recommended or sold be the “best” possible product to meet the clients needs, or can it be one of several equally suitable alternatives? What standards will be used to determine if a specific product is in the “clients best interest”?

Once a priority need is determined, it is likely that determining what is the single “best” product solution to the clients needs is futile and impossible. In most cases, there are too many variations in products, too many factors in most clients’ financial plans and situation and too few benchmarks to identify the single product that is in the clients best interest.

Instead, the likely standard will be “equally good” product alternatives vs. clearly inappropriate or “bad” alternatives. “Equally good” alternatives are those that have a logical basis for meeting the clients needs. Some alternatives may be better than others on one factor or another, but overall the differences between them are not quantifiable or are equivocal.

If a variable life insurance product meets the clients needs, which variable life insurance product is recommended or sold is probably a secondary issue.

Picking “bad” alternatives tends to be easy since they stand out as inappropriate based on the clients needs or situation. For example, recommending or selling a product that the client cant afford to keep in force during the second year of the contract is likely not in the clients best interest. That of course does not fully solve the problem of where along the continuum of alternatives the evaluation goes from “good” to “bad”.

The challenge to regulators and companies is to develop standards for clearly differentiating “good” from “bad” alternatives. The National Association of Insurance Commissioners’ Model Replacement Regulation provides insight on the possible direction regulation may take. That model provides a list of questions that must be reviewed with the client to identify potential reasons why a replacement is unsuitable.

More likely, companies will try to develop guidelines for agents to help them sort out the “good” from “bad” alternatives. For captive agents who can only sell one “product line”, these guidelines may be very helpful. However, it seems that agents who can sell the products of many companies may well be challenged to apply any one companys guidelines.

Type and Documentation of Analysis

How much client information must be gathered to have enough on which to base a recommendation or sale? What needs to be known about clients and their financial objectives, goals, current insurance and investment holdings, family situation, etc., to be able to make a suitable recommendation or sale?

Another way to ask this question is, how much information must we have to know what the clients priority needs are and which product is in the clients “best” interest?

The answer is that it depends on the clients needs, financial situation and the willingness of the client to share information and the product being recommended.

For example, a recommendation or sale to a client with a single, simple need and a simple financial situation should be based on much less of a needs analysis than a client with complex needs and financial situation. There is less information to collect and assess in one case than in the other.

For both, however, there should be a documented process that collects and records the appropriate information. There should also be a documented analysis that demonstrates the information used to logically reach the recommendation or sale of the product. The amount of information needed should be enough to defend the recommendation or sale if it is questioned.

The standard for the type of analysis and the documentation most likely depends on the clients needs and financial situation and on the type of product. Is there, then, one best way to collect, record or analyze client information and needs?

What is needed is a definition of the minimum amount of information that should be collected depending on the situation. Deciding what this minimum amount is will pose another challenge to regulators, companies and agents.

Finally, we must balance the clients responsibility for providing full information with her right to privacy.

Time Frame

Must a recommendation or sale be suitable forever, or is there a reasonable time frame after which the agent and company are no longer responsible for suitability? Is it enough that a recommendation or sale is suitable today, even if it is unsuitable tomorrow?

Clearly a time frame must be included in suitability standards since the clients needs and financial situation change over time, as well as the products that are available to meet those needs. In addition, product performance in terms of dividends, costs, investment returns, etc., change over time.

For example, a client whose needs increase over a three-year period may no longer have enough life insurance coverage to meet those needs. Is the product sold three years ago now “unsuitable”? Based on a retrospective review, it may be. If over a three-year period the investment performance of a variable annuity is outstanding in one investment option, the client may find that there is a need to re-balance her asset allocations. Again, based on a retrospective review, are those original allocations now “unsuitable”?

The industry and regulators have attempted to address this issue by saying that the agent should periodically review the clients sale to identify changes and adjust, if possible, the clients various products and plans to assure they remain suitable.

Balanced against the agents responsibility to review the clients situation, is the clients own responsibility for alerting the agent of changes in her situation. This assumes a long-term relationship between the client and agent and that the products sold are flexible enough to allow modification. These are assumptions that may not be totally true.

Time frame standards are an issue that will require regulators and the industry to wrestle over the commonly held notion that life insurance is sold for the long term. We may find that only highly flexible products which can be modified over time, such as variable universal life products, can be re-tailored to meet a clients changing needs and remain suitable long-term. One can envision the time when assuring ongoing suitability might lead to periodic replacements.

Full Disclosure and Client Responsibility

In a perfect world, the client would be held responsible for the suitability of the recommendation or sale. Her decision about what to purchase would demonstrate that she confirmed the suitability of the agents recommendation. Logically, the client should only be held responsible if she has had full disclosure of all of the features, benefits, costs, etc., of the products that may be suitable to her needs and situation.

Responsibility, therefore, seems to be a function of knowledge and understanding of not only the recommended alternative, but of other possible alternatives. Thus, the agent and company will likely have to develop ways to provide “full disclosure”, i.e.:

–Educate the client regarding her needs;

–Profile the various alternative ways to fulfill those needs;

–Provide details about the costs, benefits, features, etc., of those alternatives; and

–Explain the reason why one of those alternatives is better suited for the client than others.

Once all of this information has been disclosed and the client understands it, it would seem that the clients decision would then show confirmation of the suitability of the sale.

For registered products, an important aspect of this standard is predominantly based on clients’ acknowledgement that they have received a prospectus. But, do clients really understand all of the information in the prospectus?

There are other questions: Could an acceptable standard be providing a similar type of document that focuses on the clients needs? Could the clients signature on a form be sufficient to demonstrate full disclosure? How would we know that the client understood the differences in the alternatives presented? Would the client have to pass a test?

In addition, would the requirement to provide information on all alternative recommendations reduce the number of alternatives proposed by the agent and thus be self-defeating? It may be that the biggest challenge will be to provide understandable information on the various alternative ways to fulfill the clients needs without confusing the client or deterring the agent from proposing alternatives.

The standards for full disclosure must be sensitive to these issues. Agents and companies may need to develop methods for providing and then documenting “full disclosure” as a first step in developing standards. Once workable methods are developed, they can be evaluated in how well they meet regulators goals.


Reproduced from National Underwriter Life & Health/Financial Services Edition, September 10, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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