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.