How Life Insurance Policy Reviews Trip Up Fiduciary Advisors

What You Need to Know

A shifting regulatory landscape has put a spotlight on the inconsistency in CFP conduct standards.
Annuities and life insurance policies have their own quirks to consider during the evaluation process.
Several cost-influencing factors need to be understood to help clients weigh policy options.

The Certified Financial Planner Board of Standards recently published a new guide highlighting key areas in which state-based annuity sales rules fall short of the organization’s own fiduciary standards.

The guide’s publication quickly sparked conversation among insurance sales professionals and financial advisors about the significant murkiness of the regulatory waters when it comes to advisors and insurance.

Writing to ThinkAdvisor about the issue, Michelle Richter-Gordon, an annuity researcher and consultant leading the Institutional Retirement Income Council, posited that “advisors selling insurance” is itself a “logically unsupportable sentence,” and that the entire conversation in this domain remains rife with contradictory information that misleads advisors and clients alike.

“Advisors are service providers,” Richter-Gordon argues. Therefore, they “sell verbs” — processes and pieces of insight about how to select and compare investments, how to structure retirement income, how to mitigate key risks and more.

As Richter-Gordon points out, insurance policies are products — “not verbs” — and so the effort to square financial advisors’ compliance duties with those applying to pure insurance sales professionals is inherently messy. This is true with respect to annuities, Richter-Gordon says, as well as with other types of insurance.

“RIAs do not sell products,” Richter-Gordon continues. “They can introduce and advise upon products, but they cannot sell them. Selling products is what agents and brokers do.”

Similar comments were shared via LinkedIn by Barry Flagg, a certified financial planner and founder of Veralytic, a tech-focused firm that helps financial professionals conduct objective and transparent evaluations of client suitability for life insurance policies.

According to Flagg, the CFP Board’s conduct standards and the model annuity suitability regulations being widely adopted by the states to better align themselves with Securities and Exchange Commission standards under Regulation Best Interest differ even more than the original ThinkAdvisor article spells out. There are also “really big” inconsistencies between the states’ NAIC-based life insurance sales rules and the CFP conduct standards, he warns.

As such, Flagg urges advisors to revisit separate resources put out several years ago by the Financial Planning Association in partnership with himself and several other CFP experts, including Paul Auslander and Ray Ferrara. The reporting shows other important ways the state-based standards created by the National Association of Insurance Commissioners can lead unwary advisors to breach their fiduciary duty.

Life Insurance Policies Are Financial Assets

Following updates made in 2019, the CFP Board’s practice standards require that CFP professionals, when providing financial advice to a client, “must act as a fiduciary and, therefore, act in the best interests of the client.”

The updated standards also define “financial advice” as a communication that would “reasonably be viewed as a recommendation that the client take or refrain from taking a particular course of action with respect to … purchasing, holding, gifting or selling financial assets.”

As the FPA analysis points out, the definition of “financial assets” here includes “instruments that convey a contractual right to receive cash.”

Because life insurance policy contracts include contractual rights to receive a cash death benefit or a cash surrender value, they satisfy the definition of a financial asset. As such, CFP professionals must act in the best interests of the client when advising about purchasing, holding, gifting or selling life insurance.

Policy Illustrations Are Particularly Fraught

According to the FPA report, the NAIC Life Insurance Illustrations Model Regulation was originally promulgated in 1995 with the intent to “ensure that illustrations do not mislead purchasers of life insurance and to make illustrations more understandable.”

“With this goal, it’s plausible that supposed apples-to-apples illustration comparisons would be used as due diligence for product recommendations,” the analysis explains. “However, the NAIC subsequently concluded that, in the absence of uniform guidance, two illustrations that use the same index and crediting method often illustrated different credited rates.”

Deeper Analysis Needed

According to the FPA report, because insurance costs vary from year to year, comparing costs becomes more practical when the amounts are “normalized” to account for differences in amounts and timing of the charges in different policies.

Normalized values, provided by services such as Veralytic, can then be compared with industry benchmarks for each of the life insurance policy’s pricing components.

“This practice of benchmarking is well-established in the financial services industry, where a financial product’s performance is compared to a standard, independent point of reference,” the authors explain.

For example, the performance of a mutual fund is often compared with the Dow Jones Industrial Average, the S&P 500, the Nasdaq or the Wilshire 5000, depending on the fund’s investment objective.

“Likewise, comparing [insurance features] and expenses for a given life insurance product to industry standard mortality tables and industry aggregate expense ratios reveals actual cost competitiveness or excessiveness,” the report argues.

The authors go on to dissect several cost-influencing factors that advisors should understand if they want to truly help their clients weigh and select life insurance policies, including fixed administrative expenses, premium loads and cash-value-based wrap fees, among others.

Ultimately, the authors conclude, due diligence for life insurance product recommendations should consider whether expected cost of insurance charges are consistent with mortality experience, whether expected policy expenses are consistent with operating experience, and whether expected policy interest and earnings are consistent with historical performance of both invested assets underlying policy cash values and corresponding asset class benchmarks.

“The NAIC Life Insurance Illustrations Model Regulation generally ignores these risks,” the authors warn, “instead permitting both mortality improvements and operating gains (albeit with disclosures in footnotes not often read by planners or clients), as well as a wide range of interest/earnings assumptions that have too often proven to be unreasonable.”