Suitability, Best Interests and Fiduciary Explained
This post is part of a series sponsored by AgentSync.
Insurers must meet different standards of care when it comes to serving their customers. While deception and fraud are never acceptable, depending on the situation, simply being honest about an insurance product is not enough.
For most of the history of insurance regulation in the United States, insurance producers have been held to a similar standard of care as other retail industries. Basically, don’t be a scammer.
Insurers are the experts when it comes to helping individuals protect just about everything, from their homes and cars to their pets and family members. But some types of coverage have a different risk and impact than others.
Consider business fire coverage. You have coverage in mind and a rate you want to pay, and your insurer can help you find the intersection of the two that works for your business budget. You probably don’t expect the producer to talk about in-depth long-term visions of your company’s future, or read the ins and outs of politics. Of course, provisions and disclaimers are important, but ultimately you’re more concerned with having a product in place than with it being the best and most perfect. It’s simply because the chances of a fire are low in the scheme of all the risks your business will face.
However, policies that will almost certainly be used, such as annuities or permanent life insurance, for example, are a bit more critical on a personal level. And when it comes to choosing the right types and amounts of coverage for these complex policies, people are relying even more on their agents to guide them — not just to put an old plan in place.
In these examples, it is understandable that an insurance producer selling a commercial fire insurance policy would be held to different standards than those selling a permanent life insurance policy. Insurers are generally expected to meet a “standard of care” for their customers, but what does that really mean? Let’s discuss some of the standards that insurers are held to and what those standards mean for their customers.
The vast majority of insurance agents are held to the fitness standard. This means that agents should only recommend products that fit their client’s goals, budget, and schedule. The insurance provider must thoroughly investigate their customer’s suitability information before making any suggestions, and there must be a reasonable basis to believe that the consumer has been informed of all policy features and transaction results.
When does adequacy apply?
The suitability standard governs most insurance sales, but in recent years life insurance producers selling annuity products have been driven to adopt somewhat stricter standards. Aside from that, suitability standards pretty much apply the rest of the time. Basic transactional agreements, producers, adjusters, brokers – all must operate knowing that they cannot recommend products outside of a client’s means and goals. A customer with a stated insurance need of $5 million should not be insured for a $20 million policy, even if he can afford a higher premium. On the other hand, an insurance producer should not recommend a low-cost policy to someone who clearly needs more coverage than it provides.
How is the fitness standard regulated?
The fitness standard is largely regulated by state courts. Much of the standard includes court rulings and a common law understanding of what is fair and expected.
Brokers: Brokers often present themselves as impartial trustees, acting in the best interest of the client. Yet, depending on the state they’re in and very specific nuances, that may or may not be true.
For example, court decisions from Texas make it clear that producers are only ever held to a standard of fitness.
2. Best interest
The term “best interests” is used in many fields, including the medical, legal and financial sectors. When it comes to the financial industry, the 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 relatively new standard for the insurance industry, and we have decided to put it in its own category based on the NAIC Model Annuity Transaction Adequacy Rules, the latest draft of which was adopted in 2020. Don’t let the name fool you: the most recent version of the NAIC’s regulations call for a higher standard than propriety.
The NAIC Model Rules require insurance agents selling annuity products to act in the best interests of their customers to effectively meet all customer needs at the time of the transaction. This means ensuring that the benefit to the customer is a higher priority than the benefit to the producer.
For an overview of 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 interests standard brings into the picture:
- Producers must mitigate conflicts of interest
- Producers need to find not just a “fit” product, but the one that works best
- Producers must provide continuous services to customers
- Producers should carefully document why they recommended a specific annuity product
When does the best interests standard apply?
The best interest standard applies to agents who sell annuities, as these transactions could serve the financial interests of the insurer rather than those of the client. With respect to annuities, the best interests standard provides consumers with additional protection.
How is the best interest standard regulated?
The NAIC’s regulatory model is being adopted in waves by states across the country, quickly becoming the law of the land. Additionally, the Department of Labor (DOL) fiduciary rule may also apply here, but this is actually an area of intense debate and interest, so hold your breath and we’ll dive into the fiduciary section.
The last standard we will discuss is the fiduciary standard. Although there is some confusion about the difference between the fiduciary standard and the best interests standard, most regulators agree that the fiduciary standard goes beyond the adequacy and best interests standard. , making it the highest standard of care.
In a fiduciary standard, you make decisions for your client as if you were the client. You take responsibility for their well-being and personal circumstances as if they were your own.
DOL’s Fiduciary Rule, or, if you prefer the proper name, Prohibited Transaction Exemption 2020-02, Improving Investment Advice for Workers and Retirees, requires insurance producers to a fiduciary standard when they sell annuities. This is, however, an important area of disagreement. Both 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 explicitly state that a best interests standard is not 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 are a fiduciary, you are still a fiduciary. Their view is that if an interest standard only applies to a certain set of products or situations, then it is 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 is right? In classic American style, we’ll probably know if the case goes to the Supreme Court. In the meantime, if we were producers of insurance, we wouldn’t test it to find out.
When operating under the fiduciary standard, professionals not only recommend appropriate products and in the best interest of the client, but there is also the question “would you buy this product if it was your own money?” “. Basically, the insurance professional would only suggest products that they would buy themselves if they were the customer.
When does the fiduciary standard apply?
According to the DOL, the fiduciary standard applies to producers selling annuity products.
If you are looking for more reading on the subject, Plaintiff’s magazine featured an interesting column with quotes from states that each handle it differentlywith rulings from Louisiana, Illinois and New Jersey all stating that brokers must follow a fiduciary standard.
Another twist: Dual-licensed insurance professionals can also hold a Series 65 license, which binds them to a securities fiduciary duty. If a client who consults this professional for securities advice also asks him questions about insurance, when does he cease to be a fiduciary? The DOL fiduciary rule is a step forward, but these situations still have a lot of gray areas to explore.
How is the fiduciary standard regulated?
The DOL’s fiduciary rule and judicial concern regulates the fiduciary standard and its implementation among insurance producers across the states.
Agents owe clients a degree of care
The bottom line is that sometimes insurance is purely transactional, but the more impact it can have on a customer, the higher the standard of care the insurance producer must consider.
Annuities in particular are an area to watch in the future, and brokers should be particularly concerned about regional variations in standards of care.
Do you know what standard you are held to? If you don’t, check with a regulator or lawyer. You don’t want to use what we call the “trick and find out” method.
In addition to the responsibility to customers, insurance professionals have a responsibility to operate in compliance with a host of different rules and regulations. AgentSync can help prevent regulatory violations before they happen. If you want to reduce compliance costs and risk in your agency, see AgentSync in action today.