Life Insurance: Fiduciary Duties Vs. Suitability Standards

Life Insurance: Fiduciary Duties Vs. Suitability Standards

Much has been written about the fiduciary versus suitability argument. It is a debate that has caused quite a bit of tension amongst planners vying for client attention and trust.

Fiduciaries frequently promote the standard by which they operate by suggesting that those that operate under a suitability standard are simply out for their own interests, not their clients’.

Operating under a fiduciary standard provides that the advisor must at all times operate in the best interests of the client and always put their client needs above their own.

A suitability standard provides that the advisor must reasonably believe that a recommendation is appropriate and suitable given the client’s circumstances, which can leave room for bad actors to make suitable recommendations that are in the best interest of themselves or their firm.

Some boil it down to a simple distinction between advisors versus brokers. Most poignantly, it is fee-only planners versus those that earn commissions through the sale of products.

where life insurance fits

How does life insurance fit in the picture? After all, with only few, rare exceptions, life insurance products pay commissions, which can create conflicts of interest.

As we have written in previous posts, we believe that life insurance fits squarely in the discussion for all planners offering planning advice and guidance to clients of all ages, incomes and net worth. This belief is based on the asset class’ tax-deferred growth, tax-free death benefits, unique risk profile, lack of correlation to markets and its flexibility to suit a myriad of needs.

Certainly, commissions can, in the hands of bad actors, drive bad behavior. But I don’t think that either a suitability or fiduciary standard eliminates bad actions by bad actors.

As an example, Bernie Madoff was forced to register as an investment advisor in 2006, making him a fiduciary. That certainly didn’t change the outcome for all of the people that he left penniless.

In reality, the broad brush used to paint suitability-based planners can also be turned on fee-only fiduciaries. Many fee-only planner shun commission-based products as bad simply because they pay commissions.

As a result, they often ignore these products or spend a limited amount of time investigating them because they pay commissions.

Further, if the fee-only planner advises on life insurance, it may be only limited to the few no-load life insurance products available. But what if a commissions-paying product was more efficient and better matched the client’s objectives?

Check out our Guide to Choosing the Right Life Insurance Professional to ensure that you’re properly showcasing the strengths of your practice – fiduciary or not – to your clients.

re-thinking commission-based products

Disregarding commissions-based products is about how the advisor gets paid (fee-only).  It is not about the clients’ best interests. Certainly, if a no-load product outperforms, it should be the winner.

However, when the no-load product is outperformed by a commissions-paying product, shouldn’t the client see that and be provided the opportunity to make a choice?

Most clients will want a product that is the most efficient and effective in achieving their objectives regardless of the compensation structure.

I would argue that ignoring commissions-based products does not yield a comprehensive analysis for a client and is a clear violation of the requirement to put clients’ interests first at all times.

analyzing the numbers

Many financial planners overlook insurance as a poor allocation of funds. But the numbers beg to differ.

According to DALBAR, Inc.’s 2011 Quantitative Analysis of Investor Behavior, the average equity investor, for a 20-year period ending December 31, 2010, realized a nominal return of 3.83%. The same average fixed-income investor experienced a nominal return of 1.01% for the same period. The asset allocation model achieved a paltry 2.56%.

These returns are, of course, pre-tax and not adjusted for inflation, which averaged 2.57% over the same period.

Whole life is perceived by many as an expensive product. So it is the perfect product to compare to the returns above.

Let’s look at a whole life policy issued December 31, 1990 by one of the largest writers of whole life in the United States, on a 45-year-old male, preferred non-smoker with a face amount of $250,000.

The actual internal rate of return on cash value (with paid-up additions) for the 20-year period ending December 31, 2010 was 5.11%, with an IRR on death benefit of 11.18%, according to The Full Disclosure Report.

Now, bear in mind that while the inflation rate for the period of 2.57% erodes the returns of all investments, life insurance cash values can be accessed through tax-free withdrawals and loans if the policy is well-managed.

In light of the erosion of investment gains in many asset classes to taxes, inflation and investment expenses, insurance is not such a bad allocation.

In fact, I argue that every portfolio should have an allocation to the type of insurance that best fits the client’s objectives at the time. That may be term, whole, variable or indexed universal life insurance.  The allocation can be multifunctional in providing an attractive return, non-correlation and risk reduction, as well as replenishment in the form of death benefits.

life insurance’s role with financial advisors

While a large number of advisors do not offer insurance, many clients would prefer to get insurance advice from their advisor. Of the 29 million households that LIMRA reported in 2006 that needed more life insurance, 29% indicated that they had not acquired it because they had not been approached by anyone about it.

Clients can get frustrated having to go to multiple places to access different financial products. Providing insurance only helps a client’s satisfaction level. The advent of no-exam insurance up to $1 million of death benefit under age 60 is surely to help.

Insurance has a place with financial advisors of all types, whether operating under a suitability or fiduciary standard. Partnering with a back office that can support either type of advisor is critical for the completion of comprehensive insurance analysis.

For suitability-standard planners, shaping your practice in a way that expresses your principles-based approach to client advice is key to compete against the fiduciary-standard advisors that tout theirs as a higher standard.

A critical piece of this is working with a capable, reputable brokerage general agency that will assist you in developing a documented statement of principles and providing a comprehensive analysis for your clients.

Fiduciaries have the opportunity to partner with a brokerage general agency that can assist them in meeting their fiduciary obligation by evaluating all products, regardless of commissions, in order to provide appropriate and complete advice to clients. Fiduciaries are uniquely positioned to engage clients in a discussion about insurance, as it fits squarely in portfolio allocation and risk discussions with clients.

We can help you navigate the complex world of insurance and make it simple, yet comprehensive for you and your clients.

Life insurance can greatly enhance and protect client portfolios while also bolstering client relationships and retention. It is an oversight and disservice to clients to not incorporate full-breadth insurance evaluation into any financial practice.

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