Insurance Suitability Regulation Is At The Crossroads

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Tremendous progress has been made by the National Association of Insurance Commissioners on suitability requirements for fixed insurance products. But those efforts hang precariously in the balance.

While much good work has gone into drafting model suitability legislation, its prospects for adoption turn on a few key issues, and perhaps none will be more critical than private right of action.

In some respects, it would be a shame if the NAIC’s work on suitability proved to be for naught. Insurance regulators have worked earnestly to create rules similar to suitability requirements for securities brokers. Rosanne Mead of the Iowa Insurance Department, as chair of the NAIC working group finds herself now in the middle of an increasingly difficult task– bridging differences among regulators, insurers, agents, financial planners and consumer groups.

Possibly because suitability is such a nebulous concept, the NAIC initiative has evoked strong emotions and become a lightning rod for market conduct issues. The debate has unleashed sharp criticism by regulators and consumer groups of certain insurance products and sales practices–most notably credit insurance. It also has stirred deep-seated industry fears of potential class action lawsuits.

One might ask what’s all the fuss, given six states already have adopted insurance suitability regulations, securities brokers have lived with suitability requirements for the past 40 years, and class action lawsuits today routinely allege breach of fiduciary duty or improper sales practices anyway.

But such a question misses the point. A widely adopted and accepted suitability standard for the insurance industry would fundamentally shift the role of the insurance agent from sales representative to client advisor, and just as importantly, for the first time in effect impose supervision responsibilities upon insurance companies.

Suitability places an affirmative obligation on the agent to recommend only products that meet the customer’s insurance or financial needs. It requires an agent to know his or her customer and to document the basis for any recommendation.

While better agents have always conducted sales this way, elevating such practices to a legal requirement–overseen by the agent’s firm or insurance company–would have profound and lasting effects on industry sales practices.

The NAIC working group’s current suitability proposal is a worthy piece of legislative drafting. Its key provisions are thoughtful and balanced:

“Suitability” is defined sensibly as a recommendation that “assists a consumer in meeting the consumer’s insurable needs or financial objectives.”

A duty is imposed on agents to obtain “relevant information” from a consumer such as income and insurance needs, but discretion is given to the agent to determine what information is necessary for sale of a given product.

Appropriate exemptions are created to focus the rule on sales by agents to non-sophisticated consumers where protection is needed.

Oversight responsibilities are placed on insurers–but insurers have the ability to delegate those duties to responsible third parties such as brokerage firms, provided the insurer remains ultimately liable for compliance.

Suitability of a sale is judged by the circumstances at time of the recommendation and such recommendations are given the benefit of the doubt if the agent can provide appropriate documentation and explanation of the sale.

As currently drafted, the NAIC’s suitability proposal is a careful blend of pragmatism and consumer protection, to some extent reflecting the give-and-take of drafting model legislation, but also reflecting the purposeful pursuit by the NAIC working group of a workable bill designed to enhance market conduct without creating needless litigation.

But regulators may now be at a crossroads, especially as they begin to grapple with one of the toughest remaining issues, penalties for non-compliance. In particular, private right of action–the consumer right to enforcement through lawsuits–has been a dormant issue awaiting resolution. But its time has come and this forces the question of whether suitability will be a tool of regulation or litigation.

Industry opposes private right of action not because it wants to foreclose legitimate grievances but because it is wary of a litigation trap built on inexact suitability requirements and the inevitable customer complaints inherent in a complex business like insurance. Industry worries that claims of unsuitability could easily become the answer to every customer disappointment, a source of meritless complaints, and ultimately the basis for class action litigation.

For an industry that has felt the sharp sting of class action lawsuits, fear of litigation is real and colors its perception of any proposed law, especially one that creates subjective legal standards like suitability.

Industry believes enforcement by regulators should suffice. After all, the real benefit of suitability lies not in some guarantee that every sale will be perfect, but rather in the discipline it imposes on companies and agents to demonstrate and document suitability for each transaction, thereby elevating the sales process as a whole for the benefit of consumers. Seen this way, as a process rather than a result, suitability can best be enforced by regulators familiar with company procedures and practices.

Some argue that private right of action exists against securities firms, so why not against insurance companies? But unlike the realm of securities, suitability in the insurance context is uncharted territory, and there are not the procedural safeguards found in the brokerage industry, such as NASD arbitration to prevent runaway judgments.

Until suitability standards and practices have had time to evolve, insurers and agents cannot be blamed for wanting to proceed cautiously.

In a sense what industry fears most is that suitability could become to the sales process what “bad faith” has been for claims practices. Whatever one’s view of insurance claims practices, all can agree that bad faith has spawned endless litigation, creating a patchwork of state law, costly court battles, and to some extent supplanting regulation with litigation.

Although bad faith is a common law concept, industry knows any private right of action arising out of suitability, express or implied, could potentially create another legal stampede for damages.

Suitability is a good concept and the NAIC working group has done a commendable job translating that concept into a regulation. But industrys support for the regulation may depend on assurance that suitability is not simply a “set-up” for litigation. The best way to provide that assurance is to expressly bar any private right of action in the regulation.

There is an old proverb that says “Do not fear going forward slowly, fear only standing still.” Perhaps this is a time when regulators, industry, and consumer representatives should go forward “slowly”–in other words, give suitability a chance to work away from the shadow of lawsuits–rather than standing still and missing a real opportunity to improve insurance sales practices.

, formerly vice president of regulatory and industry affairs for American Express Financial Advisors, practices law in Minneapolis. He served previously as chair of the ACLI committee on suitability. He can be reached at Belconin@aol.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, March 11, 2002. Copyright 2002 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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