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Life Health > Life Insurance

Life Carrier Selection: A New Approach

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Most investment managers have a well articulated methodology for why they recommend a particular stock, bond, or fund out of the universe of offerings.

Insurance brokers, however, have traditionally not had their own formal methodology to explain their carrier selection to clients. This needs to change, and there is a way to do that.

First, here is some background that bears on this issue. The recently decided Cochran vs. Keybank case shows that irrevocable life insurance trust beneficiaries can and do question trust management of life insurance policies, and they do seek to have the trustees held accountable for the carrier and product selections the trustees make. [See In re Stuart Cochran Irrevocable Trust, 901 N.E.2d 1128 (Indiana Court of Appeals, March 2, 2009.)]

The court did rule in favor of the trustee for life policy decisions the trustee made, but the decision also signaled that the trustee had done only the bare minimum. Given current efforts in Washington to require investment brokers and broker-dealers to operate under the fiduciary standards that now apply to registered investment advisors, it may be that future courts will not be so lenient with trustees and other fiduciaries.

Meanwhile, the Uniform Prudent Investors Act or similar state legislation has been adopted in many states, with more to come. This has exponentially increased the potential for more liability on trustees and fiduciaries in the management of trust-owned life insurance.

Such activity suggests that developing a systematic approach for carrier selection is not only a sound business practice; it will also assist insurance brokers in limiting exposure to professional liability and future errors-and-omissions claims.

An immediate reaction may be to say that the broker’s practice already uses the prevailing insurance carrier ratings system as the benchmark for selecting a policy for the client. However, the existing system raises a few questions.

For instance, has the system been captured in writing and communicated with clients, trustees, and staff?

Also, do the ratings in and of themselves provide enough information for carrier selections? This may not always be the case, and often is not, because company ratings do not necessarily take into account such factors as size, new business written, or limited/select distribution. Neither do they reflect whether the carrier is a subsidiary of a larger carrier–an important factor when the two have potentially different ratings.

Finally, Congress is currently considering whether the current model of having the insurers pay the rating services for their ratings creates a conflict of interest.

A potential outlet would be for the broker to use an independent third-party rating company. These firms operate under a user-pay model in order to avoid potential conflicts of interest.

However, this alternative presents problems for the broker, as well. For instance, if the broker is not part of a brokerage general agency or other marketing affiliation group, this could become an expensive proposition or one that, by virtue of economy, does not capture the whole marketplace.

Also, since these third-party rating services use a user-pay model, the services do not necessarily have the same access to senior management or financials that is granted to the four primary ratings agencies.

Furthermore, the speed by which these third-party vendors update their ratings information can, in some instances, lag the release of updated financial statements.

A last concern is that some third-party rating services do not wish to see their ratings used for the solicitation of new business. This restriction hampers the broker’s ability to bring clients all of the available information.

How about going in a new direction and devising a proprietary rating system that incorporates different key elements that mirror the business’s practice? In such an approach, the firm analyzes a company based on three main criteria (financial, underwriting, and service) after it puts the carrier through an initial screen.

A proprietary system decreases the firm’s reliance on rating agencies even as it applies a defined methodology that further differentiates highly rated carriers. By employing such a methodology, the system can easily define the firm’s top tier or core carriers from ancillary carriers.

Thus, carrier selection becomes objective. This contrasts with the practices at some firms where carrier selection is done according to subjective factors and business relationships.

Another advantage: Having a defined system for carrier selection–one that is written, actually governs business practice, and is easy to communicate–will decrease the insurance broker’s liability in the future. It will also increase the broker’s value proposition to trustees or other fiduciaries involved in trust-owned life insurance as well as to any purchaser of life insurance.

Not only will this serve as a competitive differentiator, it may also limit competition. When the client and/or trustee see that the broker has studied the market and, through a quantitative process, has selected a set of carriers for the need, why would the client consult with any other advisor?

Kenneth J. Masters, CLU, ChFC, is director-research and development, Financial Architects Partners, Boston, Mass. His e-mail address is [email protected].


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