- How do I know if a policy is suitable for me?
- July 30, 2013
Suitability is a term, which basically means that a certain policy is appropriate for a certain individual. However, the difficult part of life insurance suitability is that there are no clear-cut answers for either consumers or professional advisers.
Currently, there are suitability regulations for the sale of variable insurance policies as they are under the review of the FINRA/SEC. In reviewing suitability regulations from the perspective of (non-variable) life insurance, there are significant differences.
State suitability rules exist in only a small percentage of the states and vary in term of requirements, terms and enforcements.
It has also been taught by insurers and passed from agent-to-agent that life insurance is a unique financial product, which can be a one-size-fits-all solution. Life insurance, for the most part, has never been viewed as a part of an overall financial plan – rather it has been viewed plan in and of itself.
We need to recognize that life insurance is a financial asset, which needs to be measure as such.
It is important to look at the history of how field representatives have determined life insurance needs. The word “agent” is important here, since agents act on behalf of a principle, in this case, a life insurance company.
Over the years, life insurance companies have been seeking to distance themselves from their agents (i.e., their distributors) and claim to bear no responsibility for the abuses carried out by their agents.
Suitability necessitates that agents and brokers fully understand their policies. If sellers do not understand what they are selling, they cannot make a reasonable recommendation.
For years, agents were asked to distribute products that were to some degree “black boxes”. Meaning, the agents had no idea what they were really distributing. The components of the products were a mystery in terms of mortality costs, dividends and overhead expenses.
Another factor in determining suitability is the recognition that life insurance is indeed a financial asset and that it must stand up as such. A number of life insurance policies inherently do not.
For example, the goal of a policyholder was to use life insurance to increase the future wealth of the beneficiaries. The client’s trust owned a $2 million; second-to-die policy (i.e., pays a death benefit at the second death) life insurance and the insured were, at the time, 72-years-old.
The policy had a planned annual premium of $50,000 for life. The rate of return at age 100 is only 2.4% (i.e., estate and income tax free), which is low considering there is a 20% chance that at least one person lives that long.
Under FINRA regulations, this would most likely not be a suitable investment, due to the low rate of return. However, based on the risk factor, there could always be an argument that, if the client were to die early, it would be a good investment.
An example like this shows how mixing life insurance into the planning process can make it a complex topic.
Due in part to the history of abusive life insurance industry practices; a majority of households remain underinsured. For some of these people, it has been the author’s experience that they are turned off by the thought of life insurance, due to prior negative experiences.
One of the major issues in enforcing a suitability regulation is the long-term nature of life insurance. Often by the time a customer realizes he has been sold an unsuitable policy, many years have passed and the statute of limitations has expired.
For this reason, it is essential that a life insurance regulation contain a discovery rule to toll the statute of limitations. This ensures that customers will be protected from abuses that many take years to unfold.
Under current state laws, life insurance agents and brokers have a duty of good faith and fair dealing. They do not currently have a duty to advise, which needs to be recognized.
With all this being said, it is still advised to consider your adviser’s background before purchasing a policy. Majorities of agents/producers do have their client’s best interests at heart.
About Tony Steuer
Noted insurance author Tony Steuer has spent over 25 years in the life insurance industry. Steuer’s leadership roles include serving on the California Department of Insurance Curriculum board and the National Financial Educator's Council Curriculum Advisory Panel as well as having served as President of the San Francisco Chapter of the American Society of CLU & ChFC, President of the leading Life Insurance Producers of Northern California, and as a board member of the San Francisco Life Underwriters Association. Mr. Steuer is the author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, The Questions and Answers on Life Insurance Workbook and The Questions and Answers on Disability Insurance Workbook - the first two were awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy. Steuer holds a Chartered Life Underwriter (CLU) designation and also holds the Life and Disability Insurance Analyst License, a designation that is held by less than thirty people in California.
Questions & Answers on Life Insurance by Tony Steuer, CLU, LA, CPFFE is licensed under a Creative Commons Attribution 3.0 Unported License.