Insurance Suitability: It's back-to-basics time!
Suitability is a perennial issue in financial services. It’s based on a presumably elementary and unobjectionable concept: that advisors shouldn’t sell a product to anyone who doesn’t have a need for it and whose financial resources and risk profile make buying such a product inappropriate.
Yet in violation of common sense — and business ethics — advisors in the past have made millions selling annuities to people who were unlikely to survive the product’s surrender period. And securities-licensed reps continued to sell highly speculative offerings to conservative clients who had no clue about the high-risk securities they were buying.
Gross abuses such as these led to the development of the National Association of Insurance Commissioners (NAIC) Suitability in Annuity Transactions Model Regulation and its subsequent adoption in a majority of states. Plus, FINRA cracked down on securities suitability violations with its FINRA Rule 2111.
End of problem? Hardly. The North American Securities Administrators Association (NASAA) recently released a report suggesting advisors are dropping the ball when it comes to documenting the discussions they have with prospects about risk tolerance, goals, needs, and financial status. “It just ... blows our minds that we still see the No. 1 books and records issue (being) client suitability documentation,” Michael Huggs, director of the Mississippi Securities division and head of NASAA’s Investment Advisor Operations committee, told InsuranceNewsNet.
Unless advisors do this, they won’t have a leg to stand on if a client files a complaint or errors-and-omissions insurance claim in the future. Without profiling data, advisors won’t be able to prove the product they sold was appropriate. Since investment advisors and presumably insurance- and securities-licensed professionals are still having trouble with documenting suitability, perhaps it’s time for the industry to redouble its efforts to sell only suitable products to its customers.
To that end, here’s a quick refresher on basic suitability concepts. In this article, we’ll focus on insurance (primarily, annuity) pointers. In the next two articles, we’ll provide guidance on investment advisor and then securities broker suitability.
1. What is suitability?
It’s the process of assuring that clients buy a life insurance or annuity product for the appropriate reasons. That means they fully understand its features, benefits, conditions, and limitations. This doesn’t happen automatically or easily. It requires an advisor to diligently uncover client information and preferences and to apply professional analysis and judgment. It also requires a structured approach for uncovering, documenting, and saving client information so that it can be easily recalled in the event of a future dispute.
2. Why is suitability important?
Suitability is crucial because it ensures that every product sold is consistent with customer needs, resources, and risk profile. It also builds a strong relationship between customers and their advisors and insurance companies, not just today, but for decades to come. It also prevents customer complaints and errors-and-omissions insurance claims, reduces the likelihood of regulator inquiries and sanctions, and enhances the industry’s overall reputation with the public.
3. What is the suitability determination process?
At its highest level, this process typically involves five distinct steps:
• Reviewing the prospect’s income and expenses, net worth, and liquidity.
• Knowing the person’s short- and long-term goals, especially the prospect’s potential needs and plans to withdraw funds from the product in the future.
• Discussing the prospect’s appetite for risk.
• Determining the person’s marginal tax rate.
• Being clear on the prospect’s life stage and the stability of his or her income stream.
4. What type of suitability documentation is required?
As discussed earlier, it’s important to record information about the client’s situation, resources, appetite for risk, as well as specific comparisons between an existing client product and a proposed replacement. Most companies require or prefer that advisors use their suitability form, but they may allow the use of a homegrown form if it collects the same data.
5. How long should suitability records be retained?
It’s a good idea to retain suitability worksheets and other documents related to product analyses and client discussions for at least 10 years. But check state rules because some require even longer holding periods in certain cases.
Next page: What red flags are regulators looking for?
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