The financial services industry is attempting to move away from harmful sales practices toward more customer-friendly standards. Much has been written about the Securities and Exchange Commission's Regulation Best Interest adopted in June 2019 that governs the sale of investments. In the annuity and life insurance markets, New York Department of Financial Services (NYDFS) Regulation 187 (Reg. 187) establishes for the first time best interest standards for the sale of annuities (effective Aug. 1, 2019) and life insurance (effective Feb. 1, 2020). As the NYDFS is often a “first mover” in the oversight of insurance markets, it’s likely that other states will follow its lead.
Reg. 187 covers three broad areas—sales practices, disclosure and documentation, and policy recommendations.
The recommendation to buy or not to buy must be in the customers’ best interest. Prior to Reg. 187, a suitability or best interest standard didn’t apply to the sellers of life insurance, but now both standards apply. For suitability, a producer should have reasonable grounds for believing the recommendation is suitable for the customer on the basis of relevant facts disclosed as to the customer’s financial situation. For best interest, a producer should act in the best interest of the customer. This standard reflects the care, skill, prudence and diligence that a prudent person acting in a like capacity and familiar with such matters would use under the same circumstances. The receipt of compensation can’t influence the recommendation. The customer must be informed of various features of the insurance contract, including favorable and unfavorable consequences of the sales transaction, including surrender charges, availability of cash values, tax implications of policy changes or termination, policy fees, expenses, performance and risks, and the manner in which the producer is compensated for the sale and service of a policy.
Disclosure and Documentation
Enhanced disclosure and documentation will be required of the producer and insurance carrier. Disclosures must be made to the customer in a reasonable summary format, including all relevant suitability considerations and product information, both favorable and unfavorable, that provide the basis for any recommendations. This includes disclosing the limited universe and arrangement with selected carriers the producer has. The producer should provide fee comparisons to the customer when similar products from the same carrier are available. Producers should also disclose their compensation structures. Any recommendation made should be documented, subject to the facts and analysis in support of that recommendation. Forms requiring customer acknowledgment of these disclosures will become part of the documentation file.
Policy recommendations must reflect the customers’ best interest in terms of costs, performance and risks related to benefits. Costs that can be justified include cost of insurance, mortality and expense charges, investment advisory fees and surrender charges; performance that’s reasonable to expect includes the availability of cash values, equity index features and limitations on interest returns; and risk must be appropriate for the circumstances, including market risk and interest rate risk.
It will be interesting to see how the industry responds to the new requirements for policy due diligence given that the traditional tool for making insurance sales—the life insurance illustration—seems headed for a major downgrade. Some observers feel an approach similar to that followed in the due diligence of investments—comparing costs, performance and risks to benchmarks—will be the best path to pursue for insurance policies.
Effect on Advisors
What will Reg. 187 and its likely followers in other states mean for CPAs, attorneys, trustees and others who aren’t selling life insurance but are often involved in the recommendation and servicing of policies? Three areas come to mind.
First, should they seek out a New York nexus for an irrevocable life insurance trust (ILIT) to enable their clients to benefit from the stronger life insurance protections available here? Reg. 187 applies to any transaction or recommendation to purchase or replace an insurance or annuity contract issued or delivered in New York state (new or in-force). This would include residents of New York (with or without ILITs), former residents of New York but with ILITs domiciled in New York, ILIT trustees in New York even if the ILIT is domiciled elsewhere and producers in New York if they’re delivering a policy there. Advisors choose certain states for asset protection and other benefits for other types of trusts. Why not choose New York for life insurance protections?
Second, they should be skeptical when a producer uses only life insurance illustrations as a means to compare policies to make a sale. They should ask producers to provide additional information as required by the regulation. That should apply now to any state.
Finally, for current trustees, the documentation file should contain more than just an updated illustration to demonstrate that the policy is optimal for the situation. As above, the information available to satisfy this requirement will evolve.
Advisors of all types need to be aware of the changing regulatory landscape in insurance sales, service and products to serve their clients, expand their practices and mitigate liability risks.
Richard B. Freeman, CFP® is Senior Director, Wealth Advisor with Round Table Wealth Management. www.roundtablewealth.com