Chapter 6
Other Ethical Issues


The important points addressed in this lesson are:

Agents owe a fiduciary duty to the insurers they represent.
Agents have a duty to act with reasonable care in the performance of his or her duties, including the duty to solicit profitable business for the insurers they represent.
Agents must fully disclose all pertinent information when placing a policy with an insurer.
A customer's reasonable expectations of agent's acts can affect the agent's liability.
Certain terms, because of their propensity to mislead, cannot ethically be used
Certain acts -- rebating and replacement -- while legal, are prone to ethical abuses and should be approached carefully by an agent


The ethical and legal issues that have been examined to this point have focused on the agent'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 agent's relationship with represented companies.  Furthermore, as courts have shifted their legal reasoning from caveat emptor to caveat vendor,  sellers in the marketplace are under increasing scrutiny.  Agents, as salespersons, should be aware of this increased scrutiny of their actions and deal with both client and insurers in an ethical manner.


Fiduciary Responsibilities

A "contract of agency" establishes a fiduciary relationship between an insurer and an agent.  One central tenet of this contract is the agent's duty to act in the best interests of the insurer.  This duty extends through all actions the agent takes in which the insurer's interest is at stake, especially proper handling of premiums, solicitation of business, full disclosure of pertinent facts related to applicants, following insurer directives and exercising due care in their dealings.  

 The most obvious fiduciary duty -- one with which agents are generally familiar -- is the duty to account for premiums.  Premiums must not be commingled with personal funds nor may they be used (in legal jargon, "converted") for personal expenses.  Agents who do so are guilty of "embezzlement" -- a criminal offense ranging from a misdemeanor if the amount is $300 or less, to a felony, if more.     If the agent deposits the applicant's premiums in a bank account, the agent should be sure to maintain a separate bank account for that purpose to avoid the appearance of impropriety.  (If the agent collects premiums on behalf of an insurer for which the agent is not appointed (most likely, excess or rejected business), the funds must be held in a separate account).  Florida law requires that agents maintain records of premium payments for at least three years.  Lastly, premiums accepted by the agent must be submitted to the insurer on a timely basis.

In the solicitation of insurance, the agent has an ethical and fiduciary responsibility to solicit business that will be profitable to the insurer.  Agents should focus their solicitation efforts on 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.

Agents must be sure to make a full disclosure to the insurer of all pertinent information that bears on the placement of an insurance policy.  The agent report, attached as part of the application should note, the agent's pertinent first-hand observations and knowledge of the insured (for example, did the applicant smoke cigarettes while answering "nonsmoker on the application).  The important word is in these statements 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.    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.  

Likewise, agents who assist policyholders in submitting claims forms must keep the insurer's best interest in mind.   Again, full disclosure of pertinent facts is required.  Claim form completion may be somewhat less of an issue in the case of a life insurance claim since a death certificate must accompany the claim form -- although there may be discrepancies in the insured's true age, which may have a bearing on the level of the policy's coverage (less common are cases of impersonation, lack of insurable interest or intent to murder which could void the policy.)  In the case of health insurance or property & casualty insurance claims administration is extremely important, as there is the possibility of multiple claims under a single policy.    Filing false applications or claims forms is considered "fraud" under Florida law; a felony.    

As was mentioned earlier,  one ethical issue that arises in implementation phase of the sales process is following through on business transactions within a reasonable time.  The definition of a "reasonable time" is ultimately left to the courts based on the facts of the situation.    Some courts have 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, 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 an insurer willing to accept the application.  The standard boilerplate in most contracts reads: "Time is of the essence" -- agents should realize that such language exists for a reason.

Another fiduciary duty is that 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 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.  

Along similar lines, an agent has an 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 agent 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.  

Lastly, agents frequently face 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.  


Replacement, Twisting & Churning

Replacement is defined as changes in existing coverage, usually with coverage from one insurer being "replaced" with coverage from another.  It is, however,  a practice that can lead to ethical lapses.  Agents should be aware that replacement of coverage can, in some cases, be inappropriate and therefore unethical.  That said, it can also be argued that failure to replace coverage that no longer meets the client's current needs may be just as unethical.   Because of the problems arising from unethical sales practices, state law imposes restrictions and additional duties on agents who seek to replace coverage.  

In Florida, replacement is defined as a purchase of new coverage accompanied by a substantial reduction in the benefits available under an existing policy, such as:

termination of the existing policy,
use of the non-forfeiture options such as reduced paid-up or extended term,
reissuance of a policy with reduced in cash values, or
borrowing more than 25% of an existing policy's cash value for purchase of new coverage.  

In these circumstances, the new coverage is said to replace the existing coverage -- and the agent has additional responsibilities.   Agents proposing a replacement policy, must provide the prospect with a "Notice to Applicant Regarding Replacement of Life Insurance".   This notice gives the policyholder the option to request a written comparison between the existing policy and the proposed coverage.   The agent must indicate on the application that the proposed policy will replace existing coverage -- thus notifying the proposed insurer that new coverage is a "replacement policy". If the prospect requests a written comparison of coverages, the replacing insurer will provide a comparison and notify the existing carrier of the proposed replacement.  Insurers must maintain a log of replacement business, which will be reviewed by state regulators as part of the insurer's periodic audit process.  

The law requires the agent to ask about existing coverage and note possible replacements on the application.  This is a minimal standard of conduct.  To be ethical, the agent must also provide a complete and accurate disclosure of the proposed replacement.  To do less, would be unethical.  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 new policy may impose a new suicide and contestability period
the policyholder's cost basis in the policy may be lost,
possible adverse tax consequences could result, and  
in the case annuities, new surrender charges may be imposed.


Twisting is the act of replacing insurance coverage of one insurer with that of another based on misrepresentations.  Churning is in effect "twisting" of policies by an 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.  

Please note: "churning" has another meaning in the securities industry, that of "trades of excessive size or frequency."  The primary purpose of such trades is to generating commissions for the registered representatives.  As there is no benefit for the client and is unethical, and prohibited by the National Association of Securities Dealers.  There are no established standards for determining when excessive trading is being done.  However, the agent needs to be guided by the client's interest with respect to his objectives and financial situation. ]


Proposed Legislation

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.  


Rebating & Gifts

While giving gifts to customers is customary in many industries, this practice can lead to ethical problems.  For this reason, gift-giving or rebating 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.  

In Florida, any rebates must be uniformly offered to all prospects in the same actuarial class -- that is to say, the agent may not "pick and choose" which clients will be offered the rebates.  If offered, the size of the rebate must also be uniform among those receiving the rebate -- again, no "picking and choosing", although the rebate schedule may allow for differences between policies of different sizes or members of different actuarial classes, so long as factors such as race, age, sex, marital status, residence, or occupation are not used to distinguish the classes.  Nor may agents require clients to purchase other ("collateral")  products in order to obtain the rebate. Agents who choose to rebate must prominently display their rebating schedules at their place of business and make copies of the schedule available to members of the public.  Such schedules must be retained for five years.  

Agents must file a copy of the rebating schedule with the the carrier prior to offering rebates on policies issued by that carrier.  All rebates given to customers must be consistent with the schedule that is filed with the insurer.  Insurers may deny agent permission to offer rebates -- and most do.  If an insurer prohibits rebating on policies it underwrites, the agent may not rebate any portion of his or her commission earned from that company.    

Gifts of nominal value are permitted under Florida law, with some restrictions.   Agents and companies may, for advertising purposes, provide applicants with gifts valued up to $25. Rules of the Department of Financial Services 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.



Client Expectations

While agents can find themselves in breach of their ethical responsibilities by the actions they take -- their failures to act can also result in liability.  In legalese, they are liable for there "acts of commission", as well as "acts of omission".  Customers have a reasonable expectation that the agent they deal with is a professional.  As such,  they can expect that the agent will exercise due care in representing insurers to the public and be competent in servicing of that business once it is placed.   Failing to do so, in the eyes of many courts, exposes the agent to personal liability.    

For example, an agent forwards a customer's signed application and first premium payment for flood insurance to the insurer.  The agent assures the client that coverage will be underwritten. The insurance company, however, rejects the application, and notifies the agent -- but the agent fails to notify the applicant. A flood strikes and the client learns he is uninsured.  Courts have held, in circumstances like these, that the agent was held liable for the flood-related losses.   

Similarly, agents who fail to exercise "due diligence" may be personally liable for their failure.  As we discussed in an earlier chapter, agents who represent unlicensed insurance entities are personally liable for losses their clients believed would be covered under the fraudulent contract.  In addition to the personal liability, the agent is also guilty of a felony by representing an "unauthorized entity".  Good intentions are not enough......agents must exercise due care in their business.  

While no substitute for due diligence and competent business practices, Error and Omission Insurance  (E&O) is a type of "malpractice" insurance available to insurance agents who may unwittingly be caught up in such circumstances.  As our society becomes ever more litigious, agents will want to seriously consider such coverage.

Most agents will take the time to describe to an applicant the full range of rights the policy will confer -- non-forfeiture options, policy loans, assignment, etc.  There is one right, however, that could adversely affect the agent: the so-called Free Look provision.  This provision gives the applicant a short period of time to reconsider the purchase and an opportunity to recover his initial premium for any reason he or she feels is important -- or for no reason at all.   In Florida, state law requires a minimum 10-day Free Look period on all life insurance and most health insurance policies ( two notable exceptions:  Medicare Supplement (Medigap) and Long Term Care policies must have a minimum 30-day Free Look).  Insurers may extend these timeframes for their policies, but may not shorten them.    If the applicant cancels the policy within the policy's timeframe, the agent will not earn his or her commission.  This creates a conflict of interest between the best interests of the client and the interests of the agent, and this conflict must be disclosed.    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.  


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
premium

Earnings, profit or return

dividends

Account or savings

cash value

Mutual funds

separate accounts

Vanishing premiums

using dividends to pay premiums

Tax-free

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 agent 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:  

Investment
Deposit
Contribution

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.


In summary, misrepresentations, whether deliberate or unintentional, are the root cause of may ethical lapses.  The misrepresentation may be in writing, but is more often verbal.  In most cases misrepresentations are unintentional -- the agent believes that he or she is being truthful -- but the agent's ignorance is not a defense against liability arising out of 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.   



SPECIFIC FLORIDA LAWS AND RULES

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 69B-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 soliciting new coverage, the agent must complete a replacement form (OIR-B2-312 "Notice to Applicant Regarding Replacement of Life Insurance").  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. (OIR-B2-313 "Comparative Information Form")

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 misrepresentations.  Both practices are illegal in Florida.