Chapter 5
An Ethical Insurance Practice


The important points addressed in this lesson are:

Success of the sales process can be attributed more to ethical treatment of client than any particular sales technique that might be employed by the agent
The approach step of the sales process is designed to create trust and rapport
Agents must disclose that they are sellers of financial products no later than the opening interview
The only ethical recommendation an agent can make is one that is suitable for the client
Any supporting materials used in the sales process by the agent must be sufficiently clear to be able to stand alone without misleading the reader


The sales process is the heart of any company's distribution system.  Its ultimate success is based on the salesperson's ability to develop trust and create rapport with a prospect.  The salesperson's ethics and values contribute more to the process' success than any specific technique or strategy the agent might use.  For a professional, selling is not a one-way transaction; instead, it is a collaborative process in which the professional and the buyer work together to achieve an exchange of value.


The Approach

"You never get a second chance to make a first impression" the old saying goes.  The initial meeting with a prospective client -- the so-called "approach" -- is a critical one.    Whether the salesperson is an agent, stockbroker or other financial services agent, he or she must be viewed as both competent and credible before the prospective client will trust the salesperson with the client's personal financial information.    

The purpose of the approach step of the sales process is to cause the prospective client to come to the understanding that the agent is someone with whom he or she may want to do business as a result of the rapport that has been created.  The approach may be accomplished in any number of environments -- in person, on the phone, etc. --  but to be ethical, any information imparted to the prospect in the approach step must be balanced and complete.  

This step of the sales process allows the agent to present him- or herself to the prospective client,  the most serious ethical issue in the approach step has to do with the agent's stating or implying that he or she has skills, experience or credentials that are not possessed.   Consider, for example, the declaration that the agent is a financial planner or financial adviser when, in fact, the agent is a life insurance agent or registered representative.  Such a statement could suggest to the prospective client that the agent was in the business of providing unbiased analyses of client financial situations while having no inherent conflict of interest.  Of course, the agent's selling of financial products clearly creates such a conflict and makes that kind of statement misleading and a breach of ethics.  

If the agent was a registered investment adviser (RIA), use of those titles would be appropriate since the RIA that sells financial products is required to disclose to the prospective client in a client brochure that a conflict of interest exists in his or her offering financial products for sale.  Without that statement concerning the conflict of interest, however, appropriating these titles is misleading and presents ethical problems; furthermore, their use in that situation would be illegal in certain jurisdictions.  

The manner in which the agent holds him- or herself out to the prospective client could also impact the client's reasonable expectations and the agent's liability.  The reason for that heightened liability may be obvious; if the agent represents or implies that he or she has certain skills, the client may have every right to expect the agent to provide service at a level that one possessing those skills could be expected to provide.  Failure to provide that expected level of service could make the agent liable for damages the client sustains as a result.  Certainly any implication by the agent that he or she is affiliated with the government or any governmental agency in an attempt to suggest governmental approval of the agent or products is unethical.  

Some agents may choose to use a trade name.  While using a trade name is certainly acceptable, its use by the agent as a way of identifying him- or herself without also identifying the company being represented would be misleading.  To the extent that it misleads, it is unethical.  Consider, for example, the life insurance agent who identifies himself as a member of the "First Houston Group" in order to disguise his affiliation with a life insurance company.  There should be no question about the ethical value of that deception.  The agent is clearly attempting to mislead his prospective client, an obviously unethical act.

Discussion in the approach step of the products being offered presents another area that could create ethical concerns.  As in the other areas we've discussed, the ethical requirement is for full and fair disclosure.  Any product discussion should have as its objective a complete understanding by the listener.  Here are some practical examples of the meaning of full and fair disclosure:

If the agent states or implies that the products offered involve tax advantages, it should also be stated that only a thorough review of the client's situation would determine if those advantages apply to him.

The real nature of the product should not be obscured through the use of unfamiliar names.  Any product should be identified by its common name.  As an example, the use of the terms "plan" or "private pension" when referring to a life insurance policy could be unethical since those terms would tend to obscure the true life insurance nature of the product.

Using highly technical information about the products being offered that could be expected to mislead the person(s) receiving the information is unethical even if the information is true in every regard.  If the initial approach is made by telephone, as is normally the case, the agent should usually avoid discussion of specific products since adequate explanation in the relatively short space of time on the telephone is difficult.  An attempt to discuss a complex financial product in this setting often results in misunderstandings.  Unless the prospect is highly knowledgeable with respect to the product, a complete explanation is more likely to cause confusion rather than understanding.

Even providing the prospect with a prospectus -- without a discussion of the various costs of the product with the prospect -- could be unethical if the agent believed the prospectus would not be read.  A failure to discuss costs would be less than full and fair disclosure.


Interviews

Usually, the first substantive step in the sale process is the opening interview.  The principal function of the opening interview is to continue to develop the rapport created in the approach step.  The opening interview is typically followed by  the fact-finding interview.  As was mentioned in an earlier Module, insurance agents have a fiduciary responsibility to the insurers they represent (we'll explore fiduciary responsibility in greater detail later in the course).  The ethical principles governing full disclosure require that the prospective client be fully apprised of the agent's status as an advocate for a financial product or products.  

To be ethical, agents must share identifying information with the client.  This includes the agent's status as a stock broker, a property and casualty or life insurance agent.  If the agent represents a particular company, the status as a representative of that company needs to be disclosed, as well as any other relevant business arrangements.   For example, if the salesperson is a registered representative he or she should identify the company and broker/dealer and provide home office addresses and telephone numbers.  

Unless the agent is an RIA the agent should not represent him- or herself as a financial planner, investment planner, consultant or adviser.  It is ethically responsible to describe what you do and the results you seek as long as you also state that the results are accomplished through the purchase of stocks, bonds, mutual funds, life insurance, annuities, or whatever other product you sell to achieve the desired results.

Often the prospect needs to be disturbed about his or her present situation before taking any steps to improve it.  There is a fine line, though, between rousing a client's interest and scaring them.  Any effort to outline risks (premature death, outliving one income, etc.) should be balanced and represent realistic scenarios. In order to disturb the prospective client, the opening interview will sometimes include graphics; typically, these graphics will depict marginal income tax brackets through the years or some other relevant statistics.  When using these graphics, it's important to make sure that they do not mislead the prospect when presented without accompanying descriptive text and that the material match the prospective client's level of understanding.  In addition to graphics, agents also use testimonial letters from satisfied clients.  If you choose to use testimonials or endorsements, they must be genuine and reflect the endorser's current opinion, and any financial interest held by the endorser -- for example, that it is a paid endorsement -- must be disclosed.  

 Sometimes a fact-finding interview is scheduled as a separate meeting; but just as often, it flows as a natural extension from the opening interview.  The object of the fact-finding interview is to gather sufficient information to analyze the client's needs and support a recommendation that is suitable to the client's situation -- consistent with his or her objectives and tolerance for risk.    

Usually, the fact-finding step of the sales process presents few specific ethical issues that have not already been considered. The agent has an ethical and legal duty to make a diligent effort to determine all of the client's circumstances that are relevant to his financial situation.  For the financial services agent seeking to make a suitable recommendation, these circumstances include the prospect's current finances as well as his or her hopes and dreams.  

Whenever interacting with the prospect, care must be taken to ensure that your questions don't inadvertently lead the prospect to believe that you are in the business of providing services not actually provided.  For example, a life insurance agent's questions regarding the prospect's investment portfolio could cause the prospect to conclude that the agent is in the business of providing investment advice apart from his business of selling financial products.  Unless the agent was an RIA, such a conclusion would be incorrect.  

Similarly, the tools that the agent uses could lead the prospect to erroneous conclusions.  For example, suppose the data-gathering form shown to the prospect is titled Financial Planning Form.  A similar conclusion -- that the agent is in the business of providing financial advice for a fee -- could be drawn by the prospect.  As a financial agent, you have the responsibility to avoid anything that could reasonably be expected to mislead the prospect.  Additionally, you have the ethical responsibility to correct any misperception of which you become aware.


Recommendations

A critical step in the sales process is the presentation of the agent's recommended course of action.  The purpose of this step is to present to the prospect a solution to a need that he or she has admitted having.  Often it includes a recommendation or presentation of insurance products.  Two primary ethical considerations of this step are suitability of the recommendation to the client's needs and a balanced disclosure of risks and benefits.   

The only ethical recommendation an agent can make is one that is "suitable" for the client.  The overriding ethical issue with respect to product selection is that it must be suitable to the prospect's particular circumstances and the produce meets the client's needs.  The National Association of Security Dealer's "Rules of Fair Practice" -- which apply directly to sales of variable insurance products (as they are considered "securities") -- require that any recommended securities transaction be suitable in light of the prospect's financial situation and needs.  This same suitability standard should also be applied  to all financial transactions involving the agent and client -- regardless of whether the recommendation involves a "security" or other financial products, such as insurance and annuities.  

The second ethical consideration in the presentation step concerns how the product being presented is communicated to the prospect.  Obviously, the product must be properly identified.  Regardless of the nature of the recommended product, it needs to be referred to in terms that offer understanding.  Agents should use general terminology to identify the recommended product.  Annuities should be called annuities, not as a "retirement plans" or "or savings plans".  Separate accounts of variable products should be identified as such, not as "mutual funds".    Insurance products should be described as a means of protection, not as an investment vehicle.   Calling the product by a name that is unfamiliar to the prospect may result in its true nature being disguised.  To do so intentionally is unethical.

Selling often involves educating the prospect has to how a the recommended product functions.  When the client possesses only a rudimentary knowledge of financial products, this process is frequently done by explaining the unknown in terms of what the client already knows.  While educating the client is a necessary step in the presentation, using analogies with other products to explain the recommendation may mislead the prospect.    The ethical risk of an analogy is that it often leaves out more important information than it imparts.  As a result, the prospect may have an incomplete and erroneous understanding of the product.  For example, referring to the cash value of a whole life policy as a "savings account", overlooks the role of the cash value in determining the death benefits under the policy.  

Another ethical concern is when terms used reference to insurance products have a different meaning when applied to non-insurance products.  For example, a dividend on a participating insurance policy is in reality a rebate or refund of premiums paid by the policyholder.  In other contexts, dividends are a return of profits earned by a corporation.  To state that policy dividends are an "investment return" or to allow a client to believe that are misleading and unethical, for a couple of reasons:  It misstates what a policy dividend truly is, and it mistakenly draws a parallel between insurance and securities.

 All comparisons of insurance to alternative investment or savings vehicles must be approached carefully.  Rarely are simple comparisons of past returns indicative of the differences between the products.  To compare the rate of return on stocks to CDs, or taxable corporate bonds with tax-free municipal bonds is to see only part of the picture. To be balanced, comparisons should note the all of significant differences between the products -- such as risks, guarantees, insurance coverage, tax feature --  and not simply rates of return.   A comparison that overlooks these features is, at best, misleading.  The purpose of a comparison is to educate a client, so that he or she is better able to  make a fully-informed decision.  A fair and balanced comparison that details the pros and cons of each product along with a detailed examination of their similarities and differences is the only ethical way to do that.

Rarely does an agent represent the full range of insurance or investment products available in the marketplace.  Clients may be approached by agents of competing insurers.  Agents will often present the relative merits of competing products or sponsoring companies.  The ethical imperative in such a comparison is that it must be balanced and complete.  A "balanced" comparison is one that compares all of the important features of the products and examines the advantages and disadvantages of both products. It is obvious that the intentional misstatement of fact concerning a competing company or product would be unethical; it may be less obvious that the intentional omission of material information would also be unethical.  The guiding ethical principal is that a comparison must include a comparison of all of the important features.   Statistics are often necessary and helpful when comparing products or companies; they must be substantiated and referenced whenever they are used.

During the early phases of the sales process, agents should inquire as to the prospect's tolerance for risk -- financially and psychologically.  Prospects will vary substantially from one to the other in their risk-comfort levels.  While many will avoid risky planning strategies, others will try to push the envelope as much as they can. When discussing the possible use of strategies or products that involve risk, the key ethical consideration for the agent is appropriate risk disclosure.  The competent agent will understand the risk being taken by the prospect that implements a proposed strategy; often, however, the prospect's awareness level is far below that of the agent.  The agent's failure to advise the prospect of the risks inherent in the adoption of any recommended strategy is unethical and likely to expose the agent to the risk of a malpractice claim.


Illustrations & Exhibits

One of the best ways to explain policies clearly and completely is to use policy illustrations.  In the past, fixed-value policies could be explained with one or two pages showing guaranteed valued.  With the development of interest-sensitive and variable policies, however, that is no longer possible.  As a result, computer-generated policy illustrations, detailing policy performance under a handful of scenarios, were developed.  Many agents use these illustrations as the center of their sales presentation.  Unfortunately, the use of illustrations provide opportunities for ethical lapses.  The illustration may be intended to show the possible growth of cash values, dividends and death benefits of a life insurance policy, or it may show the historic growth of a security.  Regardless of its intent, the important ethical principle is the same: the information provided must be such as to enable the prospect to make an informed decision.  Agents should be sure that the illustrations used in their presentations are complete and balanced, so the prospect can properly assess the product and its suitability for meeting his or her need.  

Policy illustrations simply show how the policy would perform under a given set of hypothetical financial assumptions.  A copy of any product illustrations shown to a prospect should be provided to the prospect for his or her file -- and it should be made completely clear that the assumptions upon which the illustration is based may not prove to be correct.  Life insurance dividends, costs and interest rates will almost certainly not be as illustrated and may be higher or lower than shown.  

Life insurance product illustrations require special care to ensure that the prospect is properly informed.  Consider, for example, the illustration of a life insurance policy in which shows policy dividends paying all of the premium at some point in the future.  It is possible that future dividend payments will not meet the hypothetical assumptions of the illustration, and be insufficient to fully offset future premium payments. If a life insurance agent proposes such a life insurance policy, he or she should illustrate how the policy would perform if the policy dividends actually credited were lower than illustrated.  To do that, the agent would be required to re-run the illustration and use a dividend scale that is lower than the current scale.    

While the possibility of "vanishing premiums", that is dividends or rising cash values will offset future premium payments, exists --  the agent would be ethically required to explain that the premiums do not really stop -- nor is the policy paid-up.  Instead, premiums continue but are simply paid by policy-generated dividends, whose use in that way will reduce the policy's total cash value.  Furthermore, the agent would need to explain that a resumption of out-of pocket premium payments might be required if the declared dividends were lower than the dividends illustrated.  For all of these reasons, the term "vanishing premiums" has fallen into disuse -- the term simply generates more misconceptions than it explains -- and is avoided by ethical agents.  

The tax-advantaged nature of insurance and annuities also raises ethical concerns.  Most clients would prefer to pay less in taxes.  Insurance and annuities do offer significant tax benefits -- but any discussion the tax-advantages of insurance products should come with a disclaimer.  Agents should disclose how those tax advantages will benefit the particular client's situation and a full explanation of the conditions required to be met to qualify for those tax advantages.  The explanation would need to include information about the tax advantages of the illustrated policy if it were to become a modified endowment contract.  The general statement that a life insurance policy has income and estate tax advantages could easily mislead the prospect.

Insurer-provided product illustrations normally present few ethical problems principally because they are insurer-provided.  The significant ethical issues generally arise when the illustration is not insurer-provided but is created by an outside vendor or by the agent.  Insurers often prohibit the use of illustrations created by their agents unless the illustrations have been approved by the sponsoring company.  The obvious reason for the prohibition is that company-created illustrations contain important information that helps provide a balanced and complete presentation of the product to the prospect.  

While an agent should only present illustrations provided by the sponsoring companies, sometimes it may be desirable to present supporting or ancillary information to the prospect.  These supporting illustrations present a large area of ethical concern.  In order to comply with ethical requirements, and agent should be sure these supporting illustrations are accurate,  balanced and complete, and presented in a manner that enables the client to understand the situation as it truly is.   For example, an illustration that presents only the benefits of an offering without consideration of the attendant costs would be unbalanced, misleading and unethical.  

Any sales literature used by the agent -- including agent-created supporting illustrations -- should be submitted to the companies whose products are illustrated for their input and approval.  While many companies require submission of sales literature, the agent should submit the point-of-sale supporting information used to all of the companies represented, whether or not they require such submission.  Insurers are generally better equipped to assess the ethical and legal pitfalls inherent in the literature.  And, we shouldn't forget that the agent has an ethical and legal duty to those companies that could be held liable for his acts by virtue of the law of agency.  For more on Florida's advertising rules, including use of statistics, disparaging comments about insurers, introductory or special offers.


Follow-through

While ethical problems and compliance issues can occur during the sales process, many ethical issues arise out of the agent's conduct following the sales interviews.  Keep in mind, ethical lapses can occur from things the agent does (errors of commission) as well as what an agent fails to do (errors of omission). Two critical problem areas are:

failure to obtain proper coverage, and
failure to maintain proper coverage.

These problems frequently occur on the property & casualty side of the business; however, they can occur on the life and health insurance side as well.  

Failing to obtain coverage is usually caused by one or more of the following:  improper analysis of the client's needs, failure to request the proper form of coverage from the insurer, or delays in obtaining the necessary coverage.

Failing to maintain coverage usually occurs because of a failure to notify the insured of non-renewal or internal agency problems in renewing coverage.

Since many life policies are permanent, renewal situations are less frequent than in health coverage or P&C business.  According to industry surveys, renewal-related complaints account for more than one-third of all errors and omissions claims for property & casualty agents.  



SPECIFIC FLORIDA LAWS AND RULES


To minimize the opportunities for misrepresentation of life insurance policies, the legislature passed the General Life Insurance Solicitation Law. Florida Statute 626.99  This act requires insurance companies to provide prospective purchasers with information regarding coverage, rates, and suitability to the purchaser's needs. Insurance companies, and their agents, must deliver disclosure documents to clients when soliciting ordinary (individual) life insurance or fixed annuities. This law does not apply to variable annuities, variable life insurance, group life, credit life or policies issued to qualified retirement plans such as pensions, Keoghs, etc.

Insurance companies must provide life insurance applicants with a "Buyer's Guide" and a "Policy Summary" either:
(1) before accepting an initial premium deposit, or
(2) upon delivery of the policy, if the policy can be unconditionally canceled by the applicant within 10 days, with full refund of premium.

Purchasers of fixed annuities receive a "Buyer's Guide" and a "Contract Summary". Fixed annuities must contain a provision for an unconditional refund for at least 10 days.

 The Policy Summary titled "Statement of Policy Cost and Benefit Information" must contain, at a minimum:

name and address of the agent soliciting the application (or if no agent is involved, a means for the applicant to contact the company),
full name and address of insurer (or administrative office),
a short descriptive title of the premium and benefits of the policy, e.g., "single premium whole life", "five-year renewable term", etc.,
annual premium payable for the basic policy and each rider (listed separately) for at least the first 5 years,
guaranteed death benefits,
cash surrender values and other policy benefits,
effective interest rate on policy loans,
projected dividend payments (and a statement that dividends are not guaranteed), and
insurance cost index comparisons.

"Buyer's Guides" must be presented in a format similar to the model guide adopted by the National Association of Insurance Commissioners.


 Testimonials and endorsements.

Florida regulations require testimonials and endorsement by third parties to "be genuine, represent the current opinion of the author, be applicable to the policy advertised and be accurately reproduced"  Is the person endorsing the insurance product is considered a "spokesperson"", the spokesman most likely must be licensed as an insurance agent.  A spokesperson is anyone who has a financial interest in the insurer, is in a policy-making position or is in any way directly or indirectly compensated for making a testimonial or endorsement. The financial interest of the spokesperson, or  his or her capacity as a representative of the insurer must be disclosed.  If the spokesperson is compensated for the testimonial or endorsement the  phrase "Paid Endorsement" must also be included.  When a testimonial refers to benefits received under a policy for a specific claim, the specific claim data, including claim number, date of loss, and other pertinent information shall be retained by the insurer for inspection for a period of four years.   


 Privacy of Client Information

Federal law requires financial institutions, including insurance companies, banks, brokerage firms, etc., to safeguard the privacy of client financial information.  The Financial Modernization Act of 2002, also known as the Gramm-Leach-Blily Act, limits the ability of financial institutions to share non-public financial information.  This federal law requires state regulatory authorities to enforce restrictions on the use of client information -- Florida's Department of Financial Services complies with this federal mandate.  In general, the rules require insurers to notify policyholders and other customers of their privacy rights (what type of information is collected and disclosed, the types of affiliates and other third parties with who information might be shared, etc.) when the relationship is established, and an annual notification thereafter.  Customers must be given the opportunity to "opt-out" of information sharing for marketing and other purposes not related to the execution of the contract.  Non-public information may be disclosed to the extent it is necessary to implement the contract.  This rule also extends the policyholder's privacy rights to health information collected by the insurer.  Agents should be aware that information collected during the fact-finding interview is "privileged" and of the consequences of unauthorized disclosure of financial and medical information.