Chapter 5

Chapter Five:  Common Ethical and Compliance Problems

Important Lesson Points

The important points addressed in this lesson are:

The agency agreement establishes a fiduciary relationship between an insurer and its agent
An agent has a duty to solicit profitable business and to act with reasonable care in the performance of his or her duties
An agent must make full disclosure to his or her insurer of all pertinent information in the placement of a policy
Churning is the unethical excessive trading in a customer's account for the purpose of generating commissions
Rebating is the illegal giving of a gift as an inducement to an applicant to purchase an insurance policy
Replacement of insurance places a duty on an insurance agent to make a complete comparison of proposed coverage with existing coverage
A customer's expectations concerning a practitioner's acts, if reasonable, may affect the practitioner's liability for those acts
Certain terms, because of their propensity to mislead, cannot ethically be used in connection with life insurance products


The ethical and legal issues that have been examined to this point have principally involved the practitioner's interaction with prospects and clients.  However, as we noted earlier in our discussion of the law of agency, there is another important relationship that may give rise to ethical and compliance issues-the practitioner's relationship with represented companies.

Earlier, it was noted that the concept of caveat emptor had been replaced by caveat vendor; in other words, "let the buyer beware" was judicially replaced by "let the seller beware."  This change in prevailing attitude may have far more impact on the financial services practitioner than is obvious.  Just as the practitioner is the seller with respect to his or her prospect or client, the practitioner may be seen as the seller with respect to his or her companies.  As a result of this change in perspective, the practitioner may find that he or she bears a significantly enhanced requirement for fair dealing when it comes to represented companies.  This is the case even without the common law concept of agency which places a fiduciary duty on the practitioner.  

Breach of Fiduciary Duty

The agency agreement between an insurer and an agent establishes a fiduciary relationship between the two parties.  Arising out of this relationship is the agent's duty to act in the best interests of the insurer.  Although this duty extends to every act in which the insurer's interest is at stake, we can develop a list of principles to use as a guide in our dealings with these companies.

Since so much of the agent's job involves the solicitation of insurance, it is a reasonable place to begin our discussion.  In the solicitation of insurance, the ethical principle involved is an agent's duty to solicit business that will be profitable to the insurer.  In more concrete terms, what that means to the agent is that his or her solicitation should be for business that is likely to result in a reasonable claims ratio.  For the life insurance agent, that means selecting prospects who are in reasonably good health and who are in a position to pay both the initial premium and future premiums.  Although insurers are unlikely to expect agents to act as home office underwriters, this requirement, nonetheless, places a burden of care on agents not to present unsuitable applicants to them.

Consistent with the solicitation of profitable business is another agent obligation to carry out authorized activities with reasonable care.  An example of this principle is the requirement that we not attempt to engage in business in which we are not capable of performing with a level of skill possessed by others that are similarly engaged.  In other words, if the practitioner is not familiar with the area, he or she should seek the assistance of another agent that is.  That may involve working with your company's pension specialist, disability expert or someone else that has particular skill in the area.  

What we disclose to our companies is the next ethical area we will deal with.  The ethical principle involved is one that requires the agent to make a full disclosure to the insurer of all pertinent information that bears on the placement of an insurance policy.  The agent that decides not to list an applicant's illness on an application because he or she felt it was not important may have violated this part of the fiduciary and ethical obligation.  Not surprisingly, the important word is "pertinent."  Unless the agent is certain that the information is not pertinent and is in a position to adequately judge its pertinence, the agent should not fail to note it on the application.  

Another important but common situation involving an insurer that requires full disclosure is in the completion of claim forms.   Claim form completion may be somewhat less of an issue in the case of a life insurance claim since health department regulations impose a certain standardization where death is involved.  In the case of health insurance or property & casualty claims, however, it is extremely important.  

An ethical issue that surfaces with some regularity relates to conflicts of interest.  As agents of an insurer, life insurance agents have a duty to avoid conflicts of interest.  The standard applied to an agent's actions with respect to this principle depends upon whether the agent is a captive agent or an independent agent.   Not unexpectedly, a captive agent is held to a higher ethical standard in this regard than an independent agent.  We can see an example of that differing standard in the products sold.  Although an independent agent may represent multiple companies, each offering identical products that compete with one another, a captive agent's representing the same companies would constitute a breach of fiduciary duty.

An ethical issue that we considered briefly in relation to the agent-prospect interaction has to do with the implementation phase of the sales process.  The agent is required to follow through on business transactions within a reasonable time.  However, the definition of a "reasonable time" is fluid and often seems to depend more on the courts than on the facts of the situation.  

For example, a court held a property & casualty insurance agent liable for not obtaining coverage only two days after commencing the search for it, while another held that three weeks was a reasonable time to spend searching for coverage.  In the case of life insurance or health insurance, an insurer may be placed at risk if an insurance application is not submitted on a timely basis.  In such cases, the controlling ethical principle is that applications should be completed and business submitted within the earliest possible period of time.  Applications and premiums for life and health insurance should be submitted within one business day of being taken, while applications for property & casualty insurance should be submitted within one business day of locating the market.

A fiduciary duty with which agents are generally familiar is the duty to account for premiums.  Premiums must be submitted on a timely basis, must not be commingled with personal funds and must not be used for personal expenses.  If the agent banks the applicant's premiums, he or she must be sure to maintain a separate bank account for that purpose.  Failing to maintain a separate bank account for applicants' premiums inherently suggests impropriety.

Considerably broader in scope than the duties that we have considered thus far, the final fiduciary duties are duties of loyalty and obedience to the represented insurer.  In plain terms, agents owe a legal and ethical duty of loyalty to their represented insurers.  Loyalty to our insurers manifests itself in our acting in good faith and with integrity in our dealings with them.  

Agents also have an obligation to follow their carriers' lawful and reasonable instructions.  Because of the litigious environment, especially where the deep pockets of insurance companies are concerned, this obligation is of particular importance.  Partly in reaction to the legal environment, many insurers are providing thorough instructions regarding the solicitation of business and the type of illustrations that agents can use.  

Instructions like these are designed both to limit the insurer's liability and provide a minimum standard against which agent conduct may be measured.  Agents that choose to ignore the instructions from their insurers may find their contracts terminated, and, if sued, they may be required to face the lawsuit entirely on our own.  Clearly, the agent that disobeys his or her carrier's compliance requirements does so at considerable risk.  

Unethical and Illegal Acts

Unlike the issues that have been examined thus far that were unethical largely because of the situations in which they occurred, we are now going to examine practices that are illegal and unethical in all cases, irrespective of the situation.  The unethical practices that we will consider are:

Twisting & Churning
Abuse of the Free-Look provision, and

Twisting is the act of replacing insurance coverage of one insurer with that of another based on misrepresenations.  Churning is in effect "twisting" of policies by the existing insurer.  While replacement of existing coverage is a perfectly legitimate practice, inducing changes in coverage based on misrepresentation or deception is unethical and illegal.  

"Churning" has a second connotation, that of "overtrading."  Churning is the practice of excessive trading in a client's securities account for the primary purpose of generating commissions for the practitioner.  The practice holds no benefit for the client and is forbidden.  There are no established standards for determining when excessive trading is being done.  However, the practitioner needs to be guided by the client's interest with respect to his objectives and financial situation.  

In more straightforward terms, it means that when the practitioner is making trades with the intention of generating commissions rather than improving the client's situation he or she is guilty of churning.  Furthermore, since mutual funds are long-term investments, when substantial trading is being done in a client's mutual funds the likelihood is great that the practitioner is churning.

Another practice that is unethical-and which is illegal in most states-is rebating.  While the giving of gifts to customers takes place in many industries, this practice is generally forbidden in the insurance business.  Rebating involves the giving or promising of a valuable consideration intended to be an inducement to the buyer to purchase an insurance policy.  The inducement may be cash or any other item of value.  Generally, any gift greater than a nominal one could be considered a valuable consideration and a violation of rebating rules.

Another practice that is considered unethical is the lack of full disclosure of specific policyowner rights.  One of those important rights has to do with what is known as the "Free Look" provision.  The Free-Look period is a cooling off period after the purchase of a life insurance policy that gives the applicant an opportunity to recover his initial premium for any reason-or for no reason.  An unethical practice involving this provision is the abuse of the Free-Look rules.  The agent's failure to advise the policyowner of his or her rights under the free look provision or to explain the details of the provision constitute unethical behavior.

One of the substantial problems that has seemed to plague the insurance industry is misrepresentation.  The misrepresentation may be either oral or written and is the basis of many of the legal problems the industry has encountered.  Although in most cases misrepresentations appear to happen unintentionally-the misrepresenting agents believing that they are being truthful-the agent's ignorance is not a defense against liability arising out of this unintentional misrepresentation.  The existing laws that hold agents responsible for misrepresentation are generally based on the premise that agents have an ethical duty to know what they are selling and to present policies in a truthful manner.   

See below for Florida laws governing these activities.

Special Issues in Insurance Replacement

The inappropriate replacement of insurance contracts is a practice that has created serious industry problems.  Although the replacement of existing life insurance may certainly be appropriate, it often is not.  However, irrespective of its suitability, the agent must make certain that the comparison of the proposed policy with the existing policy is complete and accurate.  

A complete comparison with respect to a life insurance policy replacement requires that the consequences of any replacement be made clear to the policyowner.  For example, it must be explained that:

the suicide and incontestable provisions begin anew
the previous policy's cost basis may be lost, and
adverse tax consequences could result  

Furthermore, if a replacement form is required by the state in which the transaction is taking place, the agent must provide it.  

Legislation has recently been adopted in certain states concerning life insurance replacement requirements that is expected to be endorsed by the National Association of Insurance Commissioners (NAIC) as model legislation for other states.  The legislation is a significant departure from existing replacement regulations that have been on the books for many years.  Pursuant to this new insurance replacement legislation the following steps must be taken for every life insurance policy replaced:

Insurers must have internal procedures in place to handle replacements and a company officer responsible for monitoring and enforcing them

Applicants are given a 60-day period following the replacement sale during which they can change their mind and have their initial premium returned.  It is during this 60-day cooling-off period that replacing companies must implement additional disclosure requirements.

Agents are required to obtain a list of all of the applicant's existing life insurance and annuity contracts and must provide the applicant with a form that defines the scope of a life insurance replacement.  The form must be signed by both the agent and the applicant.

If replacement occurs or is likely to occur, the replacing agent must complete a statement disclosing specified information about the new policy and submit it with the life insurance application.  An insurer whose agent is replacing existing life insurance must reject any application received that isn't accompanied by the necessary disclosure forms.

Replacing insurers have increased disclosure responsibilities that they are expected to implement during the 60-day period, including:  
supplying the replaced company with copies of the sales materials and proposals used in the new sale and
sending the disclosure statement to the insurer whose coverage is being replaced to complete the information concerning the policy being replaced.

The insurer whose life insurance is being replaced must forward the disclosure statement with both the new and existing policy information to its agent of record and to the new agent for delivery to the policyowner.

The applicant is given the completed disclosure statement containing the comparative data concerning the existing and replacement policies which should enable him or her to make an informed decision concerning the replacement.

A failure by a replacing agent to make a full and fair disclosure of all of the relevant information is a practice known as twisting.  It is illegal and unethical and, if the steps of this legislation are followed, it will be virtually impossible.  

See below for Florida laws governing replacement.

Reasonable Client Expectations

It isn't only the actions of a practitioner that determine his or her liability under errors and omissions coverage for ethical breaches; the customer's viewpoint is frequently considered.  Customer expectations often affect agents' liability as long as those expectations are reasonable.  

The agent's failure to obtain agreed-upon coverage is one of the areas that often results in liability.  Consider the following example: a customer signed an application for flood insurance, and the agent sent it to the insurance company along with the first premium.  At the time that the application was forwarded, the agent assured the applicant that he had coverage.  The insurance company subsequently rejected the application, but the agent failed to notify the applicant.  The result was that the applicant's claim for a flood-related loss was upheld.  The agent was held liable for it, rather than the insurance company.

The agent's failure to maintain proper coverage is another area in which agent liability is often based on the client's reasonable expectations.  Consider another example: although the insurance contract did not require it, an insurance company mailed a renewal notice to the insured as his contract was ending.  The insured claimed he did not receive the notice, and the coverage lapsed.  Unfortunately, the customer suffered what would have been a covered loss if the coverage had been in force.  The court reasoned, in holding for the customer, that since the agent had told the customer he would receive a premium notice, the insurance company was liable.  Clearly, what agents say that their customers rely on may be central to their liability.  

Misleading Terms

As we noted earlier, a fundamental teaching technique uses concepts that are understood to the individual to explain concepts that aren't.  Using that teaching technique, we might use phrases like "similar to" or "very much like."  Since selling involves a teaching element, we may sometimes use this same technique when we are selling insurance-particularly since insurance tends to be a somewhat complicated subject for many customers.  However, this intention to make insurance clearer and its benefits more obvious to our prospects may have unintended and serious adverse consequences.  

In many cases, the customer remembers only the analogy and may believe the insurance product is identical to the product to which it was compared.  Eventually, the customer may discover that the insurance is not identical to the product used in the analogy.  Frequently the customer then feels that the insurance product has been misrepresented and that he or she has been misled.  

Since the ethical requirement in the insurance business calls for the full and candid disclosure of everything that is material to the sale, the agent needs to avoid any terms that might tend to obscure the facts.  It is both ironic and unfortunate that the terms that might have been used to help clarify the insurance product at the time of the sale are often viewed as obscuring those facts the agent hoped to make clear.  

Since certain terms have a high likelihood of ultimately being misleading when used to describe the features of insurance products, the ethical agent will take pains to avoid them.  These misleading terms are terms that have been used to describe the features of life insurance policies or, sometimes, have been applied to the policies themselves.  

That communication needs to aid the customers' understanding of the facts as they are and not disguise them is the guiding ethical and compliance principle.  Some of the terms that are most likely to get in the way of properly communicating with customers are:

Account, plan, private pension, program or strategy when the agent  means policy
Contribution, deposit, investment or payment when the agent means premium
Earnings, profit or return when the agent means dividends
Account or savings when the agent means cash value
Mutual funds when the agent means separate accounts
Vanishing premiums when the agent means using dividends to pay premiums
Tax-free when the agent means tax-deferred

A phrase that is often the cause of customers' claiming unethical sales practices involves the payment of life insurance premiums through the use of policy dividends.  The concept has frequently been called "vanishing premiums."  Since premiums really don't vanish in this concept, but are simply being paid by dividends and the cash value of surrendered dividend additions, the use of the phrase has been characterized as misleading.  To make matters worse, there is a tendency of premiums to again be required out-of-pocket when dividend scales are reduced.  The ethical agent will avoid using the term "vanishing premium."

The term "private pension," used when referring to a life insurance policy, is one that has also come under serious criticism.  In a fairly recent lawsuit, a company was sued for unethical sales practices because its agents were selling life insurance policies and calling them "private pension plans."  The settlement in this class action suit amounted to several hundred million dollars.  The problem in the use of the phrase may be obvious once we look more closely at it.  The phrase "private pension" obscured the true nature of the product.  Since the product being sold was a life insurance policy rather than a pension plan, the court considered use of the term to be inherently misleading.  

A word that is intimately associated with insurance is "premium."  An unethical practitioner that wished to disguise the fact that the product was life insurance might choose to refer to premium in some other way.  Some of the other terms that have been used in the past to refer to premiums include:  


Unfortunately, the use of these terms tends to reduce the clarity of communication and may be unethical.  The heightened awareness of compliance and ethical considerations makes these terms unacceptable.  Instead of illuminating the agent-customer conversation, these terms obscure it.


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.  Rule 4-150.

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.

The Free Look provision in Florida is a minimum of 10 days for all forms of life insurance.  For most health policies issued in Florida, the Free Look provision is 10 days -- with two notable exceptions:  Medicare Supplement (Medigap) and Long Term Care policies.  In both of these cases, the Free Look provision is 30 days.  Insurers may extend these timeframes for their policies, but may not shorten them.  

Florida's current 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.  

As mentioned earlier, twisting is the practice of replacement based on misrepresentations.  Churning is the practice of an insurer replacing existing coverage with a new policy based on misrepresenations.  Both practices are illegal in Florida.