Life Insurance Regulations and Contract Law

By and large, life insurance regulations are handled by the fifty state insurance departments and is based on contract law rather than any duty an agent has to the client. Currently, those who sell general account life or annuity contracts, must pass a relatively simple exam after forty hours of classroom or on-line learning. Under the law of agency, the agent who sells insurance does not work for the client but is technically an agent for the life insurance company in the transaction and places the policy on behalf of the company. Thus, the agent represents the insurance company in the transaction not the client. Under current standards, the life agent owes few legal duties to the clients and those limited duties terminate when the policy is placed.

If there is a dispute on how a policy was supposed to work or the benefits that were to be provided, it is the policy contract language that controls it, not sales materials or representations by the agent. This language on how policy earnings are actually credited and the policy charges are often at odds with expectations the client may have had based on the sales proposals or illustrations used by agents. Illustrations are supposed to show prospects how the product will work under certain premium payments and under certain conditions, but they are often inappropriately used to compare contracts. This has been a persistent and seemingly intractable problem for the better part of the last thirty years.

In our experience, most life agents really do seek to serve their clients and deliver a quality recommendation, but they are hampered by some of the same complexity of products that plagues clients. Few agents have the sophistication to look past the illustration to study the contract language from the products being recommended to make more informed recommendations. Fewer still have built a business model that monitors policies past placement and provides ongoing advice on how those policies should be managed over time. Any of these services, while beneficial to clients, are outliers to the very low minimum regulatory standards.

New York is the first state to significantly raise this low minimum standard for agents and insurance companies and has created a higher standard for life insurance recommendations. Under the NYDFS Regulation 187, the agent and the company will be held to a standard where recommendations concerning life and annuity contracts must be “exclusively in the client’s best interest” and must also be suitable for this client based on understanding the client’s goals and thirteen specific suitability elements that agents must gather as part of a recommendation.

To understand the significance of these changes, one must understand that for the last 150 years, life insurance has operated on what has been basically a “caveat emptor” or “buyer beware” regulatory model for the purchase of life insurance, based primarily on the contractual terms of the policy. Under current state insurance law, the purchaser of a life insurance or annuity contract is presumed to have read, understood and consented to the terms of the life insurance contract that is delivered after they have tendered premium. In actual practice, the client is often shown illustrations by the agent about how the policy will work and promised benefits based on a number of elements that will change over the life of the contract and are oftentimes not guaranteed. The actual cost and benefits may vary greatly from these “illustrations”.

At the very end of the sales process, after being shown illustrations and after the client has gone through the underwriting process and actually paid a premium on the policy, it is only then that the actual contract from the company is delivered to the policyholder. It is the contract language, not the illustration that is controlling how the policy values are credited and how charges are deducted from the policy. The client then has a limited time period to read and fully understand the terms of the contract and either keep or reject the contract (rescind the policy during the free look period for a refund of premium).

Understanding state life insurance regulations and contract law helps consumers make a wiser financial decision.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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