Last week, “an unnamed SEC official has said that the agency will again delay proposing a universal fiduciary standard rule, resetting its timetable to 2012 due to demands of performing a cost-benefit analysis of its standard.” (AdvisorOne, October 8, 2011)
Currently brokers are held only to a rules-based suitability standard. The fiduciary standard of care is widely viewed as more stringent than the suitability standard. “The suitability standard focuses on sales conduct. It requires the representative to sell the most appropriate product for the client [from among those products that the representative is licensed to sell and without disclosing any sales limitations]. The fiduciary standard requires the representative to act solely in the interest of the client without regard to the financial or other interest of the broker, dealer, or advisor providing the advice.”i
So…why should you care?
Suppose a client visits an advisor with a need for $1 million in life insurance; an advisor gives the client a suitability questionnaire and determines that the client should purchase a variable universal life product. The advisor runs 5 different hypothetical illustrations and finds that 2 have identical low premiums. One gives the advisor a higher percentage of commissions and the other counts towards the “rewards trip” that the carrier offers. Both are lower premiums than the other three so either one would be considered a “suitable” recommendation under the standard definition so the advisor can make his decision if he wants higher commission or to go on a cool reward trip.
Under a fiduciary standard, the advisor would have to recommend the variable life insurance product that is best for the client, without regard for the incentives and would have to tell the client of any conflict of interest that arises. A true fiduciary would also know that pricing that appears competitive at the time of sale/purchase but which cannot be maintained can be worse than a less-competitive product with more stable pricing representations. While premiums are often considered the price/cost of a life insurance policy, the premium is not the price/cost of a life insurance policy (unless contractually guaranteed like in term life insurance or guaranteed universal life insurance) any more than the $2,000 contributed to an Individual Retirement Account (IRA) is the cost of the IRA. In both cases, the cost is the sum of what is deducted from the premium/contribution.
Premiums instead represent the funding plan necessary to cover expected cost of insurance charges (COIs), fixed administration expenses (FAEs), cash-value-based “wrap fees” (e.g., VUL M&Es) and premium loads over the expected duration of the policy contract. In other words, planned premium payments are always a function of the following formula: Premiums = COIs + E(expenses) – i%(interest). The suitability of a permanent life insurance product is also influenced by the degree of cash value liquidity throughout the life of the policy. All other factors being equal, the higher the liquid cash value after deduction of cost of insurance charges and policy expenses (including contingent surrender charges), the more suitable the policy. As such, measuring cash value liquidity for the life insurance products are based on the following formula: Premiums - COIs - E + i% = Cash Value.
The difference between a “suitable” low premium product and what is “best” for the client could be reflected in the cash values of the life product. With permanent life insurance, suitability depends on a number of factors, and the lowest premium may not always offer the best value. Research has shown, keeping costs low is the best predictor of investor success. The desirability of permanent life insurance products depends principally upon the following five (5) factors:
- Financial Strength and Claims-Paying Ability
- Cost Competitiveness
- Pricing Stability
- Cash Value Liquidity
- Historical Performance of invested assets underlying policy cash values
All 5 factors contribute to the appropriateness of permanent life insurance policies, and no single factor is sufficient to determine overall suitability. CPE research reports measure all 5 factors for any policy holding against benchmark averages for peer-group products and uncover the “real” costs of life insurance policies.
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i National Underwriter, “Are You a Fiduciary” Linda Koco. Oct. 5, 2009