Chapter 2
Chapter Two:  The Legal Framework of Compliance& Ethics


Important Lesson Points

The important points addressed in this lesson are:

Although principally a function of the states, insurance regulation is a responsibility shared by federal and state government
The concept of agency-by virtue of which a principal is bound by the actions of its agent-grew out of English common law
Authority enjoyed by agents may be express, implied or apparent
Ratification by a principal will make it liable for the unauthorized actions of its agent
Various legal concepts developed out of common law that affect liability between buyers and sellers and their agents, including custom, waiver, estoppel and election
Over the years, courts have extended sellers' liability and have effectively changed the concept of caveat emptor to caveat vendor


Federal Government Role

The regulation of the insurance industry is done principally by the state insurance departments.  These departments license agents and insurers, and they supervise agent and company sales practices.  As a result of this pervasive state presence, few people give much thought to the role the federal government plays in the regulation of the insurance industry.  

Despite this predominance of state regulators, the federal government exerts regulating control over the insurance industry in four principal ways.  Federal government influence in the insurance industry is wielded through:

the powers reserved to it under the McCarran-Ferguson Act
the Internal Revenue Code and its tax provisions applying to insurers and insurance products
health insurance and pension legislation
SEC regulation of insurance products considered securities

The federal government retains the power to control the insurance industry under the McCarran-Ferguson Act to the extent that the issues involved are deemed to be national in character.  Overseeing state regulation of the insurance industry is a power reserved to the federal government.  Although the states are specifically charged with the responsibility of regulating matters relating to ethical conduct of insurance agents, the federal government could consider it to be of sufficient national concern to step in.  There has been little federal interest up to this point, however, in taking over the job of supervising agent conduct.

The role of the federal taxing authority is very familiar to those practitioners whose career is principally on the life insurance side of the industry.  The tax treatment given to products sold by life insurers, particularly the tax-favored cash value growth and income tax-free death benefits, often play an important role in the sale of substantial amounts of life insurance.  Furthermore, the Internal Revenue Code also contains specific provisions concerning the taxation of mutual and stock insurance companies.  Since taxation can significantly affect any product or industry, it becomes clearer just how important this area of regulatory influence is.

The third area of federal influence concerns its ability to legislate in the areas of health insurance and pensions.  In the area of health insurance, the federal government created standards for Medicare supplement policies first and then established criteria for qualified long term care policies.  Subsequently, the passage of the Health Insurance Portability and Accountability Act (HIPAA), further defined the health insurance playing field.  Recently, the Economic Growth and Tax Relief Reconciliation Act of 2001 made significant changes to pension regulation and contribution limits to qualified plans. Some observers expect that the federal government's move towards standardization will eventually apply to basic health care plans.  

The federal government, through the SEC, exerts considerable influence in both licensing and product registration of securities products, and that influence is increasing in the insurance industry due to the many new insurance products that have a dual character as insurance products and investment products.  Although the federal government has considerable power to affect the insurance industry through regulation, the major burden of insurance regulation falls to the states.  
State Government Role

Generally, when agents think about insurance regulation and their initial interaction with insurance regulators, they think about state insurance licensing requirements and the general requirement for continuing education.  In addition to agent licensing, the state insurance departments' main responsibilities include the oversight of insurers' operations and marketing practices.  Those marketing practices are our principal focus.

Despite their lack of uniformity, state insurance laws contain common themes.  Through their laws and regulations, the states establish rules of practice that provide compliance and ethical guidelines by spelling out what an agent is permitted to do or prohibited from doing.  Some of the more common rules deal with the:

requirement that only approved policies may be sold
prohibition against misrepresentation
guidelines that must be followed in the replacement of coverage
returning of premiums or other consideration to a client, i.e. rebating and
requirement that agents perform their duties in a timely way

See below for a discussion of specific Florida regulations.

If these federal and state regulations were the only rules that applied to agent and insurer marketing practices and conduct, they would be sufficient to hold both agents and their companies liable for errors and omissions.  Insurers, however, have liability for agent conduct that pre-dates these laws.  That liability derives from the common law and its concept of agency.  

Common Law & the Concept of Agency

Common law is that body of English law and concepts that grew out of the English judicial system.  It was this law-based principally on the decisions and opinions of law courts-that became the law in the English colonies.  Augmented by legislation, that common law constitutes much of our current system of laws.  An important concept derived from common law is the concept of agency.

It is the law of agency and the agent's contract with represented insurers that determine whether the individual is an agent of the company.  The law of agency binds a principal by the authorized actions of the agent.  Since only authorized acts of the agent can bind the company, it is important to gain an understanding of how this authority is conferred on the agent.  The three types of authority that may be given to agents are:  

Express authority
Implied authority
Apparent authority  

The methods by which the agent gains these types of authority are different from one another.

Express Authority

Express authority is contractual-given authority.  It is given to the agent through his or her contract with the insurer and any amendments made by the company to that contract.  It is specific to the extent that it details the authority of the agent and outlines his or her duties.  Clearly, if the agent does only what he or she is given express authority to do, those actions would bind the company.  As a result of this specificity, few compliance problems arise out of express authority.

Implied Authority

Implied authority is quite a different matter.  Authority is implied when it:

Is intended to be given by the insurer
Usually relates to the general customs of the business
Is not contractually provided
Is not specifically delineated

Unlike express authority, implied authority comes from the powers that the company customarily gives its agents rather than from the contract between the agent and the insurer.  An example of implied authority can be seen in the insurer's giving the agent the express authority to solicit applications for life insurance on its behalf; by giving the agent that express authority, it also gave the agent the implied authority to telephone prospects on its behalf to arrange sales appointments.  

It isn't this kind of implied authority, however, that generally turns into significant insurer liability.  Instead, it is the insurer's liability for agents' behavior if the company knowingly or negligently permitted its agents to engage in unethical sales practices.  By the insurer's failure to stop the agents' unethical sales practices, a plaintiff could maintain that the company gave the agents implied authority to act in that fashion.  To the extent that the insurer authorized that conduct-in this case through implied authority-it is responsible for it just as though it had specified that activity in the agent contract.  If the insurer is deemed to have conferred that implied authority, the company could be held liable for any damages resulting from those acts.  Implied authority has provided the legal basis for some of the successfully-maintained lawsuits alleging unethical marketing practices.

Insurers, in order to limit their liability, generally provide considerable direction to their field force as to permitted sales practices and advertising.  Although implied authority creates many of the insurer's liability concerns, the type of authority that causes most of the compliance problems is the last type: apparent authority.  

Apparent Authority

Apparent authority is authority that:

is not provided by contract
is not intended by the insurer
appears to the client to be given to the agent based upon the agent's believable statements

Apparent authority reasonably appears to the client to be given to the agent, and this apparent authority may make the company liable for the agent's unauthorized acts.  Not unexpectedly, it is apparent authority that causes the majority of the liability for life insurers.

Even if the agent has none of those three types of authority, it is still possible for an insurer to be liable for the agent's acts.  That outcome may result from the insurer's ratification of the agent's acts.  

Ratification

Ratification is the confirmation or approval of an agent's actions by the principal.  The four elements necessary for ratification are as follows:

The agent must have represented himself as an agent acting on behalf of the insurer;
The customer must have believed the agent's representations;
The insurer must subsequently have validated the agent's actions by ratifying them in some fashion; and
The insurer must have ratified the entire agent transaction.

It should be clear that agent actions may create both personal liability and insurer liability. It is principally the mitigation of that insurer liability that has caused much of the current emphasis that insurance companies have placed on compliance.  Despite the fairly clear concepts that may result in liability, the issue of liability is anything but straightforward.  In fact, there are a number of other elements that affect liability.


Legal Concepts That Impact Liability

There are four concepts that often affect liability that are used by courts to determine which party in a malpractice suit should prevail.  These concepts also developed out of English common law.  They are:

Course of Conduct and Custom Doctrine
Waiver
Estoppel and
Election

The legal concept known as the Course of Conduct and Custom Doctrine considers the way that people have previously done business.  It simply takes into account the manner in which the parties to the transaction had handled their dealings together over a period of time to determine what is reasonable.

Let's consider an example to clarify the concept.  Suppose that an agent has handled a client's insurance needs for years.  As each policy expired, the client would initiate a meeting with the agent to add new coverage, increase limits, etc.  At no time had the agent ever notified the client when a policy expired.  

The inevitable happens, and the client's building burns to the ground right after the fire insurance policy expires.  Stating that the agent had a duty to inform the client of the policy's expiration, the client sues the agent. Although it could be modified by statute or regulation, the court would apply the doctrine of "Course of Conduct and Custom" to the facts.  Since it was customary for the agent not to inform the client of the expiration of coverage, the court could hold that the agent had no duty to inform the client.  Although the prudent client would probably avoid this kind of agent, it illustrates the concept of Course of Conduct and Custom Doctrine.

Waiver is a defense that involves the voluntary and intentional giving up of a right the individual knows he or she has.  If we go back to the unhappy client with the uninsured, destroyed building and change the facts slightly, we can illustrate the concept.  In these changed facts, the client informs the agent that a notification from the agency every time the coverage approaches its expiry date is unnecessary and unwanted.  Perhaps the client has risk managers that he employs to handle the details of the coverage.

Because of the client's wishes, the agent informs his staff that policy status notices are not to be sent to the client.  The client voluntarily and intentionally gave up the right to receive policy status notices, even though the client had a right to receive them.  In legal terms, he waived his right to receive a notice of cancellation.

Estoppel is somewhat similar to waiver.  Both concepts involve the giving up of a right.  However, in the case of estoppel, the client gives up a right without intending to give it up.  It is that lack of intent that is the principal difference.  Estoppel limits an individual's right to change his or her mind.  The test of whether the individual ought to be permitted to change his mind is whether another person has acted reasonably in reliance on another person's promises.  In simple terms, estoppel involves the legal inability to abandon a decision or action.  

Suppose that an insurer believes it is on a particular risk and acts in a manner that lets the client believe coverage is in force.  The insurance company might be unable to deny that coverage was in force if the client's position would be jeopardized by it.  If the client had forgone the opportunity to secure a particular additional coverage because the insurer's actions indicated the risk was already covered, the insurer could not subsequently deny coverage when the claim was submitted.  This would be the case even though the in-force policy did not provide the coverage.

The last defense we noted is called "election."  The concept works in the following fashion.  When a party to an insurance contract has a choice of actions and chooses one, he cannot subsequently change his choice if the change would be detrimental to the other party.  If a client agrees to repairs of damaged property but later attempts to change the choice to a cash settlement after repairs are started, the court might say that the client had elected the repair option, and he would be held to that position.  To do otherwise would injure the other party-the insurance company.

Judicial Extension of Liability

In a sense, the law is like language.  It is a dynamic, living thing that changes over time.  In no area is that more true than in the areas of product and professional liability.  As time has passed, the courts have generally increased a person's liability for his professional actions.

Caveat emptor is a term that encapsulated the judicial approach to product liability in the first half of the 20th century.  The term translates to "let the buyer beware."  It was a clear acknowledgment that the buyer of goods or services was expected to watch out for himself, and it was the prevailing common law doctrine regarding the transaction between buyers and sellers.  It informed the buyer not to rely on the legal system to protect him from sellers that might not treat him fairly.  Over time this doctrine has fallen out of favor and has been effectively replaced by a doctrine of caveat vendor.  

Caveat vendor translates to "let the seller beware."   It characterizes an environment that goes so far as to permit lawsuits against sellers of high-calorie meals in which plaintiffs seek damages because they have become obese.  This is the environment in which agents are selling their products and one in which they are at great risk of professional liability.  

One of the benefits of acting ethically is its beneficial effect on the likelihood of being held liable for professional actions.  Accordingly, in the next chapter, we will begin to examine the sales tools that agents use in order to develop appropriate ethical guidelines to minimize our exposure to that liability.  





SPECIFIC FLORIDA LAWS AND RULES

Like all other states, Florida regulations prohibit deceptive sales practices.  Only policies offered by approved (authorized) insurers may be offered to residents of the state.  Florida Rule 4-230 requires agents who are aware of unauthorized insurers operating in the state to notify the Department of Financial Services of such unauthorized activity.

 Replacement of coverage is regulated under Rule 4-151.  Replacement of life insurance is defined as the sale of a new policy while allowing existing coverage to lapse, be reduced in value through the use of non-forfeiture options, amended to reduce policy benefits, reissue the policy with a reduced cash value, or borrowing 25% or more of the policy's loan value.  The replacement rule requires agents to ask prospects if an existing policy's coverage is reduced as part of the application process.  If the agent knows -- or should have known -- that such reduction in an existing policy's value occurs when solicting new coverage, the agent must complete a replacement form (Form DI4-312).  The applicant may request a comparison of the existing policy's benefits to the proposed coverage -- the replacing insurer must provide a comparison, if requested.  

Twisting -- inducing a client to replace coverage through the use of misrepresentations or deception -- is prohibited under Florida law (see Code of Ethics below).  Twisting (and replacement) applies when the replacing policy is issued by a different company than issued the lapsing policy, e.g., Company B replaces Company A's policy.  In the past, some insurers induced existing clients -- using mesrepresentations -- to letting existing coverage lapse or reduce benefits and sell those clients another policy (Company A replaces Company A's coverage).  Florida law defines this as "churning".  Churning is prohibited under Florida statutes 626.9541(1)(aa) and Rule 4-151 Part III.  If a company "replaces" its coverage with another policy, the agent must disclose this to the policyholder on Form DI4-1180.

 Rebating -- returning a portion of a commission as an inducement to apply for insurance -- is permitted in Florida in very limited circumstances under Florida Statute 626.572:

(1) No agent shall rebate any portion of his or her commission except as follows:
(a) The rebate shall be available to all insureds in the same actuarial class.
(b) The rebate shall be in accordance with a rebating schedule filed by the agent with the insurer issuing the policy to which the rebate applies.
(c) The rebating schedule shall be uniformly applied in that all insureds who purchase the same policy through the agent for the same amount of insurance receive the same percentage rebate.
(d) Rebates shall not be given to an insured with respect to a policy purchased from an insurer that prohibits its agents from rebating commissions.
(e) The rebate schedule is prominently displayed in public view in the agent's place of doing business and a copy is available to insureds on request at no charge.
(f) The age, sex, place of residence, race, nationality, ethnic origin, marital status, or occupation of the insured or location of the risk is not utilized in determining the percentage of the rebate or whether a rebate is available.
(2) The agent shall maintain a copy of all rebate schedules for the most recent 5 years and their effective dates.
(3) No rebate shall be withheld or limited in amount based on factors which are unfairly discriminatory.
(4) No rebate shall be given which is not reflected on the rebate schedule.
(5) No rebate shall be refused or granted based upon the purchase or failure of the insured or applicant to purchase collateral business.

Agents and companies may, for advertising purposes, provide applicants with gifts valued up to $25. Department rules define gifts as "articles of merchandise". The Department does not recognize gift certificates, memberships or other services as "merchandise". Consequently, agents who give away auto club memberships, gift certificates or cash violate the Insurance Code.
Florida regulations also prohibit defamation.  Defamation is defined under Statute 626.9541(1)(c) as: "Knowingly making, publishing, disseminating or circulating, directly or indirectly, or aiding, abetting, or encouraging the making, publishing, disseminating or circulating of, any oral or written statement, or pamphlet, circular, article or literature which is false or maliciously critical of or derogatory to any person and which is calculated to injure such person.  Defamation is a tort that includes both libel (written) and slander (spoken) of a person.



FLORIDA ADMINISTRATIVE CODE
CODE OF ETHICS -- LIFE UNDERWRITERS

4-215.210 Scope. The Business of Life Insurance is hereby declared to be a public trust in which service all agents of all companies have a common obligation to work together in serving the best interests of the insuring public, by understanding and observing the laws governing Life Insurance in letter and in spirit by presenting accurately and completely every fact essential to a client's decision, and by being fair in all relations with colleagues and competitors always placing the policyholder's interests first.

4-215.215 Twisting. Twisting is declared to be unethical. No person shall make any misleading representations or incomplete or fraudulent comparison of any insurance policies or insurers for the purpose of inducing, or tending to induce, any person to lapse, forfeit, surrender, terminate, retain, or convert any insurance policy, or to take out a policy of insurance in another insurer.

4-215.220 Rebating. Rebating is declared to be unethical. Except as otherwise expressly provided by law, no person shall knowingly permit or offer to make or make any contract of life insurance, life annuity or disability insurance, or agreement as to such contract other than as plainly expressed in the contract issued thereon, or pay or allow, or give or offer to pay, allow, or give, directly or indirectly as an inducement to such insurance, or annuity, any rebate of premiums payable on the contract, or any special favor or advantage in the dividends or other benefits thereon, or any valuable consideration or inducement whatever not specified in the contract.

4-215.225 Defamation. Defamation is declared to be unethical and defined as making, publishing or circulating any oral, written or printed statement which is false, or maliciously critical of or derogatory to the financial condition of any insurance company, or which is calculated to injure any person engaged in the business of life insurance, and this practice is declared to be unethical.

4-215.230 Misrepresentations.
(I) Misrepresentations are declared to be unethical. No person shall make, issue, circulate, or cause to be made, issued, or circulated, any estimate, circular, or statement misrepresenting the terms of any policy issued or to be issued or the benefits or advantages promised thereby or the dividends or share of the surplus to be received thereon, or make any false or misleading statement as to the dividends or share of surplus previously paid on similar policies, or make any misleading representation or any misrepresentation as to the financial condition of any insurer, or as to the legal reserve system upon which any life insurer operates, or use any name or title of any policy or class of policies misrepresenting the true nature thereof.
(2) No person shall make, publish, disseminate, circulate, or place before the public, or cause, directly or indirectly, to be made, published, disseminated, circulated, or placed before the public, in a newspaper, magazine, or other publication, or in the form of a notice, circular, pamphlet, letter or poster, or over any radio or television station, or in any other way, any advertisement, announcement or statement containing any assertion, representation or statement with respect to the business of insurance or with respect to any person in the conduct of his insurance business, which is untrue, deceptive or misleading.

4-215.235 Proposals and Requirements. Wherever a Life Insurance agent submits a written proposal or program for any prospective client, such proposal should contain the following information: the Company whose policy is proposed to issue, the date of the proposal, and the signature and address of the agent submitting it.