The purpose of this chapter is to review the regulation of the business of insurance by federal and state law. We will also discuss the ethical standards mandated by most states. Finally, we will focus on the ethical standards of financial planning and the federal regulation applicable to many agents, the Investment Adviser Act.
The Constitution of the United States allows the federal government the power "to regulate commerce with foreign nations and among the several states." This power has seldom been used with regards to insurance.
Federal regulation of the insurance industry is accomplished in five ways:
1. Through the powers reserved to the federal government under the McCarran-Ferguson Act.
2. Through special tax provisions that apply to insurance companies and the products they offer. These provisions can be found in the Internal Revenue Code.
3. Through legislation regulating the health insurance industry.
4. Through legislation of securities and various insurance products.
5. Through pension regulation.
Congress enacted this act in 1948, which spelled out the role of the federal government in regard to the regulation of the insurance industry.
Basically this law states that the federal government retained the power to control insurance matters that were considered national in character. This power includes the oversight of the State Insurance Departments. The states, however, were left with the major burden of insurance regulation. This also included the regulation of matters relating to the ethical conduct of business by insurance professionals.
The code contains precise provisions, which spell out the manner in which mutual and stock carriers are to be taxed. The code also contains provisions, which affect the tax status of products sold by insurance companies. A good example would be the tax favors built up within the life insurance product, as well as the tax-free nature of death proceeds.
Insurance professionals should have a working knowledge of the code. Failure to provide clients with such valuable information would not only be a disservice, but could lead to a lawsuit.
In recent years, the federal government has shown much more interest in the regulation of the health insurance industry. The reason for this interest has been two fold:
1. The abuses that have occurred in the senior market as the federal program Medicare was being unethically utilized, and
2. The somewhat callus attitude that the companies have taken in protecting those with health problems.
Presently, the abuse of the Medicare supplement market has been lessened with the institution of the standardization of supplemental Medicare policies. It is our belief that once this program has been proven successful, the rest of the health insurance market will also see radical change as the federal government will extend such standardization to basic health care plans.
With the popular explosion of variable products in the marketplace, the Securities and Exchange Commission (SEC) has become much more active in overseeing this market.
The National Association of Securities Dealers (NASD) has also played a prominent rule in this area, as it has set specific procedures for licensing.
Many insurance companies have chosen pension marketing as their niche in the insurance industry. With the multitude of qualified retirement plans in the marketplace, both the Internal Revenue Service and Labor Department are playing major roles in this area. The Internal Revenue Service scrutinizes each plan to be sure it meets federal guidelines for
tax deferral. The Labor Department reviews plans to be sure that discrimination does not occur.
The landmark piece of legislation in the pension area was the Employee Retirement Income Security Act of 1974 (ERISA). ERISA's provisions apply to professionals who are involved in the areas of pension planning and administration. It is critically important for the insurance professional to be well versed in these laws, as running a foul of these rules will open the insurance professional to many problems and possible liability exposure.
In summary, the insurance professional who works in these technical markets should purchase Errors and Omission Insurance (E&O). Today, most agency managers and insurance companies will insist that insurance agents representing them, must have this protection.
Under this type of liability protection, the insurance professional is the insured and is covered for legal defense and settlement costs (up to a stipulated maximum) stemming from professional services he/she rendered or failed to render.
The professional services E&O insurance coverages include the sale of insurance and employee benefit plans, along with the advice, and administrative activities associated with or for the agent's or agency plans. Errors and omissions insurance is available on an individual or group basis. Whether or not this coverage is needed is an individual decision. However, for those professionals working in pension and the advanced markets, it should be mandatory.
The major burden of insurance regulation rests with the state governments. Regulation in the states is carried out by the state insurance departments as these departments oversee the operation of insurance companies, agent licensing and insurance marketing.
Throughout our history it seems that the federal government just could not decide who should have the immense responsibility of regulating the insurance industry.
As early as 1868, through the case of Paul vs. Virginia the United States Supreme Court ruled that "Issuing a policy of insurance is not a transaction of commerce" thus marketing the regulation of insurance under the domain of the states and not subject to federal regulation.
Then, in 1944, the Supreme Court reversed its position in Paul vs. Virginia when it ruled on United States vs. Southeaster Underwriters Association. In the case, the court ruled that insurance transactions across state lines were considered commerce and subject to antitrust laws, thus placing insurance regulations directly under the control of the federal government. The effect of this decision was quite extensive. The states became very concerned as the different State Insurance Departments controlled the insurance companies. By taxing the companies the states were able to generate badly needed revenue. This possible loss of revenue greatly concerned the states. The insurance companies were equally concerned as they believed that the sharing of data with other companies, for rating making purposes could be construed as the formation of a monopoly.
The final piece of the puzzle that gave the states the job of regulating and taxing companies was Public Law 15, better known as the McCarran-Ferguson Act of 1948.
Though state laws regarding sales and marketing practices by insurance agents vary, there is a great deal of uniformity in the principle and intent of these laws. All are designed to protect the interests of consumers by ensuring fair, reasoned and ethical conduct by the agent.
We will focus on some of the more important of these laws.
By law, only insurers that are authorized or licensed by a state may issue policies in that state. It is the agents responsibility to be sure that the insurers he/she represents are licensed to do business in the state. Some states will hold the agent directly responsible for any insurance contract he/she places with an unauthorized insurer. Generally, a state's guaranty fund only covers the liability of authorized companies, so anyone purchasing policies from unauthorized or unlicensed companies would be at risk if those insurers failed to meet their claims.
As earlier noted, any written or oral statement that does not accurately describe a policy's features, benefits or coverage is considered a misrepresentation, and all states have enacted laws that penalize agents who engage in this practice.
Defamation is any false or malicious communication written or oral, that injuries another's reputation, fame or character. It is important to understand that both individuals and companies can be defamed. The spreading of rumors or falsehoods about the character of a competing agent or the financial condition of another insurance company is inherently unethical if such statements are made, the individual better be sure that such statements are correct.
As noted in an earlier chapter, both rebating and replacement have been widely abused in the marketplace. The states have enacted laws to discourage such practices as penalties, suspension and revocation of licenses could occur if these practices are continued and proved to be unethical in spirit.
Twisting is the unethical act of persuading a policy-owner to drop a policy solely for the purpose of selling another policy without regard to possible disadvantages to the policy-owner. Twisting involves some kind of misrepresentation by the agent to convince the policy-owner to switch insurance companies and/or policies. Virtually every state prohibits the act of twisting and will penalize the offender.
The law deals with unethical acts harshly. This is because what states consider unethical, they have made illegal. In most states, an agent's license can be suspended or terminated for the following fourteen reasons:
1. Giving any indication that future policy dividends are guaranteed;
2. Describing a premium as a "deposit" unless the payment establishes a debtor-creditor relationship and clearly shows when and how the deposit may be withdrawn;
3. Making a material untrue statement in the application for an agent's license;
4. Implying that a policy is being sold or issued by the investment department of a life insurance company;
5. Stating, or implying, that a policy is "self supporting" or that projected dividends under a participating policy will be sufficient to assure any benefits without any further payment of premium;
6. Conveying the idea that by purchasing a policy the applicant will become a member of a limited group of persons who will receive special advantages or favored treatment by the insurance company;
7. Stating that an insured will be guaranteed certain benefits should a policy lapse without giving an adequate explanation of non-feature benefits;
8. Using any method of policy cost comparison that does not take into account the time value of money;
9. Stating that a policy contains certain benefits not found in any other insurance contract;
10. Avoiding any clear and unequivocal statement that insurance is the subject of the solicitation.
11. Stating that a prospect must purchase a policy immediately or lose the opportunity to purchase it;
12. Disparaging a competitive agent or insurer, their policies, services or business methods;
13. Using such terms as "financial planner, "financial consultant, "investment counselor" or "financial counselor, implying that the agent is in an advisory business in which compensation is unrelated to sales, unless such is actually the case, and
14. Using amounts and numbers in such a way as to mislead the prospect with regard to the cost of the policy and any other significant aspect of the contract.
Knowledge and calculated awareness can help the honest and ethical agent avoid many of the traps just listed.
Financial planning as a specialty is a new field of expertise for the insurance agent. As noted earlier, financial planners are required to have additional education, training and experience. Financial planning involves a variety of services and the use of various financial products. An individual who sells only life insurance plans is not a full-fledged financial planner and should not represent himself/herself as such.
The most recognized ways to become a financial planner is to matriculate and pass the various courses requirements with either the College for Financial Planing (CFP) or the American College (CFFC). Both designations are widely respected in the industry.
There are three organizations that set the standards for ethical conduct in financial planning:
1. The Institute of Certified Financial Planners (ICFP).
2. The College for Financial Planning.
3. International Association of Financial Planners (IAFP).
Each of these organizations stresses the need for the insurance agent to consistently identify himself/herself as an insurance agent, to identify the company he/she represents and the nature of the sales call that the agent is making.
When an insurance agent moves from life underwriting to financial planning, the scope of ethical responsibility widens. If an agent has the qualifications to render advice or sell securities, the ethical standards of investment advising must be observed in addition to the ethical standards of insurance selling. For example, an agent subject to the Investment Advisors Act of 1940 who charges a fee for services, rather than a commission, is deemed to be a fiduciary of the client. As such, the agent is required to disclose to the client all material information that pertains to the services rendered. This could conflict with the agent's status as fiduciary of the insurer. On the one hand, the agent would have the duty of loyalty and care to the client, and on the other hand the same duties are owed to the insurer. The problem of conflict of interest intensifies if both a fee for service and a commission on the sale is charged.
Financial planners who engage in rendering investment advice as part of their services will fall under the jurisdiction of the Securities and Exchange Commission (SEC) and its Investment Advisors Act of 1940. There are many important statutes in this law but for the financial planners, two stand out:
1. If the financial planner is in the business of giving investment advice, and receives compensation for doing so they must register as an investment advisor with the SEC; and
2. Must conform to certain standards of ethical conduct as defined by the act. The SEC believes that financial planning involves a variety of services, principally advisory in nature. Since financial planning services involve the preparation of a financial program based on information furnished by the client, the discussion of insurance, savings, investments and other benefits will occur upon which, a program developed for the client will include recommendations for specific actions by the client.
The SEC determines if a person is providing financial planning services and is acting as an investment advisor, by asking three questions:
1. Does the person provide advice regarding securities?
2. Is the person in the business of providing such services?
3. Does the person provide such services for compensation?
The SEC's position as applied to a financial planner means that his/her services involve rendering advice or analysis concerning securities, he/she is an investment advisor. If so, the individual falls under the jurisdiction of the Act. Because of the nature of their business and the trust a client places in an advisory relationship, the standards of ethics to which investment advisors are expected to conform, are naturally quite high.
All State insurance commissioners are members of the National Association of Insurance Commissioners. This organizations purpose is to examine various aspects of the insurance business and recommends appropriate state insurance laws and regulations.
The NAIC has four broad objectives:
1. To encourage uniformity in state insurance laws and regulations.
2. To assist officials in administering these laws and regulations.
3. To help protect the interests of policy-owner and
4. To preserve state regulation of the insurance business.
To promote uniformity among the various states in insurance regulation, the NAIC formulates and drafts what is called "model legislation. This term includes representative bills or statutes presented to the individual state legislatures for consideration and passage, creating insurance law for that state.
The NAIC created the "Unfair Trade Practices Act, which has been adopted by virtually every state. This Act seeks to regulate insurance practices by defining and prohibiting unfair trade and business practices. The Act also gives the state's insurance commissioner the power to investigate insurers and agents when any violation is suspected.
An insurance agent's ethical responsibilities to the state in which he/she is licensed are the most strident, because they are set forth in statutes and regulations. These statutes call upon the insurance agents to use common sense and practice the GOLDEN RULE. These attributes, plus knowledge and awareness can help the ethical agent steer clear of many problem areas.
CHAPTER 5 - PRACTICE QUESTIONS
1. The Constitution gives the _____________________ government the power to regulate insurance:
A. Federal
B. State
C. Local
D. None of the above.
2. One way the Internal Revenue Service regulates insurance would be:
A. Instituting higher tax rates
B. Lower allowable deductions
C. Tax the status of different products
D. Increase withholding tax
3. The federal government organization that sets procedures for proper licensing of security sales people would be:
A. National Association of Independent Agent
B. National Association of Security Dealers
C. Securities and Exchange Commission
D. National Association of Insurance Commissions
4. State insurance commissioners oversee:
A. Agent licensing
B. Insurance marketing
C. Insurer activity
D. All of the above.
5. Although the various states have their own laws regulating the insurance industry the main cause of concern is to:
A. Protect the agent
B. Protect the companies
C. Protect small business
D. Protect the consumer
Unit 5 – Answers
1. A
2. C
3. B
4. D
5. D