The insurance industry isn’t alone in this challenge, as financial advisors who receive commissions are also being held to a higher standard thanks, in part, to Reg BI (Regulation Best Interest). The purpose of this article is to focus specifically on the insurance space as it relates to a fiduciary approach and to do so from a practical perspective. We will get into the more technical and legal aspects of what it means to be a fiduciary with regard to insurance in later articles.
For years, many financial advisors and insurance professionals have operated under a suitability approach. This standard of care requires that all recommendations made by advisors and insurance professionals to their clients must be suitable. Google tells us that for something to be suitable, it must be “right or appropriate for a particular person, purpose or situation.” While that sounds nice, in this context, it doesn’t mean that it would be in the client’s best interest. For example, let’s assume two insurance products, product A and product B, are identical in all areas other than commission. While both are suitable for the client, product A is priced 10% higher and pays a higher commission to the advisor. Technically, an insurance advisor could recommend product A to the client and still abide by the suitability standard of care. The recommendation by the advisor may still be appropriate, but there’s something very uncomfortable about this transaction. While there are many factors that should weigh into the selection of a particular insurance product—and it is certainly not the case that less expensive is always better—in this basic fact scenario, assuming everything else is equal, the advisor is simply making more money at the expense of the client.
Some have tried to combat this issue through the use of low-load or “commission-free” insurance. The argument for these types of products is that because the compensation is stripped out, they are cheaper and better for the client. But we must ask, cheaper than what? There are hundreds of life insurance companies in the market providing hundreds of options. Just because a product pays a lower commission doesn’t automatically mean it’s cheaper for the client or, more importantly, better for the client. While these types of products are a step in the right direction, we can’t focus only on the compensation structure. We must take into consideration all factors when providing recommendations that are in the best interest of the client.
So how do we arrive at insurance solutions that go beyond those that are simply “suitable” (or, on their face, the least expensive), are truly in a client’s best interest, and fit within their comprehensive financial plans? Implementing a fiduciary approach to insurance planning goes well beyond the product. It’s critical that we, as insurance professionals, understand the client’s situation in much greater detail so we can recommend the proper insurance policy with the right carrier and for the right reasons. We are involved in insurance discussions every day and can often suggest to an advisor a different approach or strategy to accomplish the same thing in a more efficient manner. Because we’re exclusively focused on insurance, we can provide expertise to an advisor and client in our domain, much like an attorney or CPA can provide legal and tax advice in theirs. This allows a financial advisor to remain focused on the client’s financial portfolio without the distraction of insurance planning, and it ultimately serves the client’s best interest.
From a practical and philosophical perspective, a fiduciary approach to insurance planning consists of three main components:
- Planning-focused v. product-focused
- Comprehensive fee compression
- Comprehensive product portfolio
Planning-Focused v. Product-Focused
It’s critical that we understand all aspects of the client’s situation—financial, personal, and medical—before we even begin discussing solutions. A financial advisor wouldn’t recommend an investment strategy without gathering facts, data, opinions, and goals from the client. Bringing a similar approach to insurance planning will ensure recommendations are made in the best interest of the client. I like to use the example of long-term care insurance: Just because someone is 65 years old doesn’t mean he or she needs long-term care insurance. While it may be suitable to “sell” LTC insurance to this particular individual, it doesn’t mean it’s in their best interest.
Comprehensive Fee Compression
As previously discussed, reviewing the commissions paid on a particular product is important, but this isn’t the only fee that should be considered. An insurance product may also contain administrative fees, surrender charges, rider charges, and of course, cost of insurance charges. Each one of these must be considered as you look to find the most efficient vehicle for your client. Often, the cost of insurance charges in an insurance policy is the largest expense to the client, so it’s incredibly important to find the best underwriting offer for the client to ensure they’re not overpaying for their coverage. A common situation that we encounter is a client who is paying tobacco rates because they smoke a cigar or chew tobacco. There are a handful of carriers who will consider this type of tobacco use as non-tobacco and will therefore reduce the overall premium by 20, 30, or even 40 percent. By gathering medical information up front and taking a comprehensive approach to analyzing the fees within the policy, we can ensure that the client is paying the appropriate premium for the coverage that is being implemented.
Comprehensive Product Portfolio
Once we are able to understand the goals of the financial plan and have a handle on the client’s medical history, we can then turn to product solutions. It is important for insurance professionals to work with enough quality insurance companies to be able to handle the unique circumstances of various clients. It’s extremely important to review the financial stability, quality of ongoing customer service, and overall underwriting capability of the carriers. While it may be natural for insurance professionals to place the majority of business through a handful of carriers that solve for routine situations, they also should have available alternative carrier options and relationships when the regularly used carriers can’t get the job done. A limited portfolio of insurance companies could imply a fair amount of bias on the part of the insurance professional. Also, be wary of captive insurance agents representing one company. This signals that the insurance agent has an obligation to the insurance company, not the client. Whether it is a captive agent or an insurance professional with limited access to insurance companies, the likelihood of the client owning an inferior product increases. At Palladium Group, we work with over 80 insurance companies to help ensure there is a fiduciary solution for your client.
Finally, it’s critical to consider the depth of expertise of any insurance professional with whom you work. Are they capable of engaging in more sophisticated planning for ultra-high net worth clients and business owners? Do they have the ability to provide solutions for life, disability, long-term care, and income planning? Do they monitor the underwriting cycle time in order to make sure long delays don’t negatively impact a client’s ability to obtain coverage? These are important and practical considerations when implementing a fiduciary-based approach to insurance planning. Palladium Group can help with all of this and more. If you have questions, please reach out to a member of our team.