Journal of Financial Planning: December 2019
David Buckwald, CFP®, CLU®, ChFC®, CLTC®, NSSA®, is the CEO of OneTeam Financial LLC, a holistic financial planning firm serving the greater New York area. He is a representative of M Holdings Securities.
Steven Zeiger, CEBS, TEP, is a managing director at KB Financial, an integrated family office platform. He is a representative of M Holdings Securities. He and David Buckwald advise high-net-worth and ultra-high net worth families and their businesses.
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When the state of New York amended Insurance Regulation 187 this year, it broadened the regulation’s scope significantly. Originally, this “best interest” rule applied only to annuities. Now life insurance transactions also will be covered, with major consequences for advisers such as RIAs, attorneys, and CPAs who help clients address their life insurance needs. The amended regulation is scheduled to go into effect for life insurance transactions February 1, 2020.
An initial reaction might be to downplay this regulation because it’s a state, rather than a federal rule. However, the amended Regulation 187’s footprint can extend beyond the state’s borders. The official language says the rule applies to life insurance policies delivered or issued for delivery in the state. Thus, this best interest standard could be imposed on a transaction with almost any connection to New York state, including current residents of New York who spend considerable time in another state and have advisory relationships in another state; former residents of New York with a life insurance trust created in New York or with a trustee domiciled in New York; or consumers with a financial adviser in New York.
From a broader perspective, New York has long been a bellwether state for financial regulation, so other states may follow its lead. Indeed, many other states have already passed similar rules or are contemplating them. Any adviser who makes life insurance recommendations or consults in the process should be prepared for this type of oversight, probably sooner rather than later.
What’s In?
Under the amended Regulation 187, advisers involved in life insurance sales will have to act solely in the “best interest” of individual clients, considering their personal circumstances and objectives.1 Significant fact-finding must be done in order to arrive at recommendations that serve the clients’ interests foremost, and documentation must show those efforts. What’s more, these rules apply not only to new policy sales, but also to modifications of in-force policies.
According to the Regulation, advisers should be careful about how they communicate with clients or prospects. The regulation states that someone “shall not state or imply to the consumer that a recommendation to enter into a sales transaction is comprehensive financial planning, comprehensive financial advice, investment management, or related services unless the producer has a specific certification or professional designation in that area.”2
What’s Out?
A major takeaway from the amended regulation is the change in due diligence that it will require. For years, advisers evaluating life insurance policies (especially permanent life policies) relied on comparing policy illustrations. They might request illustrations from two or more insurers and see which one had the lowest premiums or the highest projected cash value, etc. The “winner” would typically be recommended to clients.
The amended regulation effectively prohibits such use of side-by-side policy illustration comparisons as proof of due diligence. Questionable methods of crediting—projecting increases in cash value—may lead to misleading conclusions.
To cite one real-life example (not found in the amended Regulation 187, and originally shared by Barry Flagg3), a financial planner determined that a 45-year-old client who was in excellent health would be well-served by $1 million of permanent life insurance, with significant cash value. The planner called a trusted life insurance professional to request premium quotes payable for 20 years, calculated using a 5 percent interest rate. The planner’s objective was to get quotes that could be compared “apples-to-apples” to decide which product would be best for this client.
Of the two illustrations that were submitted, one was based on annual premiums of almost $8,500, while the other stated that premiums would be nearly $13,000 a year. Thus, the former illustration appeared to represent the better choice.
However, a closer look showed that the lower-premium policy was illustrating a crediting rate of approximately 14 percent one year, and the higher-premium policy was using an interest rate of approximately 8 percent that year. Neither was close to the 5 percent rate that had been requested, so a comparison of policy illustrations was not a valid test. Such inflated policy crediting is often found in life insurance policy illustrations. Yet guidance from the new regulation and a prudent process would “catch” the inflated returns and risks associated with those high returns.
Regulation 187 amended, requires product recommendations to be based on a “careful, skilled, prudent, and diligent evaluation of costs, performance, and risks relative to benefits.” Side-by-side policy illustration comparisons were omitted from the regulation, so advisers can’t rely upon their use for approved due diligence. Other financial, insurance, and banking industry regulators such as FINRA, the Treasury Department’s Office of the Comptroller of the Currency, and the Society of Actuaries warn that illustration comparisons can be misleading, fundamentally inappropriate, and unreliable.
The bottom line: after the amendment of Regulation 187, life insurance illustration comparisons may obfuscate costs, performance, and risk. If so, they’ll provide consumers with unreliable product information that may not be in their clients’ best interests. Accordingly, advisers who seek out life insurance professionals who have evolved beyond illustration comparisons may enjoy the protection provided by well-established practices for serving clients’ best interests.
What to Do
To decide whether a particular policy is suitable for a particular client, it is necessary to learn about individual clients and why they want life insurance. The relevant information to be discovered includes the person’s age, income, existing assets, financial experience, liquidity needs, financial time horizon, risk tolerance, and tax status. Advisers also should determine the intended use of the policy, including any riders. It’s vital to retain all decision support materials—those documents that help to record evidence of an adviser’s efforts to act in a client’s best interest.
Once a client’s personal and financial information have been obtained, advisers can search for life insurance policies that will be in the individual’s best interest. The amended Regulation 187 requires proceeding with the “care, skill, prudence, and diligence” that an astute person would employ, and making an appropriate recommendation. Besides describing the advantages of a particular policy, advisers should prominently disclose in writing any significant limits that can be found in the recommended contract.
How to Do It
How can advisers exercise the requisite care, skill, and prudence in selecting suitable life insurance policies if illustration comparisons don’t pass muster for acceptable due diligence? The regulation lists product costs, reasonably expected returns, and relevant risks as factors to consider. Of those factors, costs may be the one most readily discovered.
Therefore, one plan for acceptable due diligence is to focus on the costs embedded in the policies under consideration. Assuming that the insurance companies issuing the policies have sufficient financial strength, the lower-cost contracts are more likely to offer lower premiums, higher cash values, or greater death benefits to policyholders.
When it comes to comparing life insurance costs, benchmarking is a practice that is well-established among investments. A mutual fund’s performance might be compared with the performance of a relevant benchmark such as the S&P 500 for large-cap funds, or the Russell 2000 for small-cap funds.
Similarly, costs of insurance (COIs) and other expenses for a given life insurance product can be compared with benchmark data from the Society of Actuaries (SOA). The significant SOA tables include its 75–80 Basic Select and Ultimate Gender Distinct Mortality Tables and, for aggregate expense ratios, its Generally Recognized Expense Table (GRET).4The practice of comparing costs to benchmarks is consistent with prevailing practices in other segments of the financial services business, complies with FINRA rules, and addresses the requirements of Regulation 187, as amended. Veralytic, a life insurance research company, has developed techniques for comparing data between industry benchmarks and individual policies.
Consequently, due diligence for life insurance selections can and should compare expected cost of insurance charges with mortality experience, expected policy expenses with operating experience, and expected cash value returns with historical performance of specific asset class benchmarks. Advisers can exercise due diligence by looking into such data, recording the results of their research, and reporting their conclusions to consumers.
Endnotes
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Read the full text of the regulation at dfs.ny.gov/docs/insurance/r_finala2018/rf187a1txt.pdf.
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Editor’s note: In a comment letter dated June 18, 2019, the Financial Planning Coalition—of which FPA is a part—urged the New York State Department of Financial Services to further clarify section 224.4 of the regulation by specifying “accredited credentialing organizations.” That comment letter is available at FinancialPlanningCoalition.com.
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See Barry Flagg’s March 2019 article, “New York Best Interest Rule for Life Insurance: New Requirements for Life Insurance Producers and Ethical Considerations for Other Estate Planners,” from Leimberg Information Services Inc. Available at leimbergservices.com/all/LISIFlaggPDF3_26_2019.pdf.
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Access mortality tables at mort.soa.org. See the 2019 GRET recommendation at soa.org/resources/research-reports/2018/2019-gret-recommendation.