Ethics training for life insurance agents

Definition of Ethics

The word ethics comes from Greek words meaning "moral character."  Scholars define ethics as a "branch of philosophy that deals with the values of human life in a coherent, systematic and scientific manner." In practice, ethics provides individuals with guidelines for living in harmony with other people. For example, people committed to ethical business practices feel an obligation to consider not only their own personal well-being but also that of others and of human society as a whole. The simplest definition of ethics is the Golden Rule: treat others as you would like to be treated yourself. We can sum things up by saying ethical behavior is doing the right thing the right way for the right reason.

Compliance

Compliance means conducting business in accordance with current rules and laws set by government regulatory agencies and the courts. It means following the rules and making sure life insurance producers and companies go by the book when conducting business. Laws and regulations set the minimum standard by which producers are expected to behave. Laws and regulations tell us what we must do.

Ethics

Ethics are standards of conduct and moral judgment. Ethics is the moral framework within which decisions are made. Ethics involves doing the right things the right way for the right reasons. Ethics are about what we should do. Codes of ethics identify and encourage desirable activities by formally establishing a high standard against which individuals may measure behavior. Characteristics of an ethical insurance producer are honesty, integrity, loyalty, fairness, compassion, respect for others, and personal responsibility and accountability.

Market Conduct

Market conduct is a combination of both ethics and compliance. Market conduct refers to how insurance companies and producers conduct themselves in accordance with ethical standards and in compliance with rules and laws governing insurance policy sales, marketing, and underwriting practices as well as policy issuance, service, complaints, and terminations. Market conduct is synonymous with professional behavior.
The ethical insurance producer knows and acts in accordance with ethical principles as well as in compliance with rules and laws governing the sale and servicing of insurance policies.
Click here for an activity on the differences between ethics, compliance, and market conduct.

Legal Definition of Ethics

Under the law, ethical conduct is normally defined as that conduct which is expected of a reasonable person under any and all circumstances. However, not all actions that are unethical (such as selling prospects more life insurance than they can afford) are illegal. A producer must pay attention to both the "have-to" legal requirements and the "choose-to" ethical standards of business.

Key Points

The following is the key point for this lesson:

• An insurance producer has ethical responsibilities to insurers, policyowners, the public, and the state.

Policyowners

Producers meet their major responsibilities to insured policyowners by filling their insurance needs and providing them with quality service. Service is a primary function of the insurance industry. The way that service is provided determines the future of agents, because satisfied clients are a good source for future sales and references. Producers also owe policyowners the same degree of loyalty they owe to insurers. Producers' ethical responsibilities to policyowners also include full disclosure, confidentiality, timely submission of all applications, and prompt policy delivery.

The Public

The insurance agent has more control over the public's attitude toward insurance than do sales representatives for most other consumer products. This is because the insurance agent initiates contact with a prospect, determines a prospect's need for insurance, recommends a certain product or solution, makes the sales presentation and, finally, develops a long-term relationship with after-sale service. In many cases, the prospect has little or no direct contact with the insurance company.

Because this special relationship involves a great deal of contact between the consumer and agent (and because the public generally understands very little about insurance), public perceptions of the industry itself are based on how well—or how poorly—an agent does the job. Thus, the professional insurance agent has two main ethical responsibilities to the general public.The first responsibility is to inform (and educate) the public about insurance with the highest level of professional integrity. A second responsibility is to display a high level of professionalism in all public contacts in order to convey a strong, positive image of the industry.

 

The State

Responsibility for regulating the insurance industry is shared between the federal and state governments. However, the states carry the more significant portion of the burden of regulating insurance affairs, including management of the ethical conduct of licensed insurance agents. In some states, the regulation of "ethical conduct" falls under the category of marketing practices, while other states refer to it in the context of unfair trade practices.

However classified, all states have established a code of ethical standards for insurance agents by defining what an agent can and cannot do through various laws and regulations. Though these laws may differ from one state to the next, there are basic similarities in these laws to enable discussion of them in general terms.

Let's take a closer look at the insurance producer's responsibilities to the insurer.

Agency

The relationship between an insurance agent and the insurance company is governed by the concept of agency. Agency is a legal term that describes the relationship between two parties. One of the parties, the principal, has authorized the other, the agent, to perform certain legally binding acts on the principal's behalf.

Principles of Agency Law

The key principles of agency law are:

1. The acts of the agent (within the scope of the agent's authority) are the acts of the principal.
2. A contract completed by an agent on behalf of the principal is a contract of the principal.
3. Payments made to an agent on behalf of the principal are payments to the principal.
4. Knowledge of the agent regarding business of the principal is presumed to be knowledge of the principal.

The essence of an agency relationship is power. In the case of an insurer and a producer, this power is granted through an agency contract, which is how an insurer appoints an individual to act on its behalf.
The agency contract gives the agent the power to act on behalf of the principal and, at the same time, describes the actions the agent is authorized to take. Practically and legally, however, an agent's authority can be quite broad.

Types of Producer Authority

There are three types of authority entrusted to insurance producers:

1. Express Authority
   Express Authority is the authority a principal intends to—and does, in fact—give to its agents, either orally or in writing.
   
    
2. Implied Authority 
   Implied Authority is authority that is not expressly granted, but which the agent is assumed to have in order to transact the business of the principal. It includes acts that are incidental to the accomplishment of the expressly authorized acts. If an agent has express authority to sell an insurance policy, for example, that agent has the implied authority to interpret and explain the policy to clients.
   
    
3. Apparent Authority 
   Apparent Authority is the appearance or assumption of authority based on the actions, words, or deeds of the principal or because of circumstances the principal created. If a third party in good faith relies upon the principal's intentional or negligent permissiveness in regard to the agent's acts, the principal will be bound by the acts of the producer because the producer possessed apparent authority. Apparent authority is the authority most often cited when problems arise. Although insurance companies are often held to promises made by agents, they can demand restitution from the agents to cover their losses.

The limits to an agent's authority are spelled out in the agency agreement, and an agent must act within those limits. The ethical significance of the agency contract is that producers must, first and foremost, serve the insurer, live up to the contract, and operate within the scope of their authority. However, an agent's duty to the insurer goes far beyond the wording of the contract. By entering into this contractual relationship, an agent also enters into a fiduciary relationship.

Click here for an activity on the differences between the various types of authority.

Types of Producer Authority

There are three types of authority entrusted to insurance producers:

1. Express Authority
   Express Authority is the authority a principal intends to—and does, in fact—give to its agents, either orally or in writing.
   
    
2. Implied Authority 
   Implied Authority is authority that is not expressly granted, but which the agent is assumed to have in order to transact the business of the principal. It includes acts that are incidental to the accomplishment of the expressly authorized acts. If an agent has express authority to sell an insurance policy, for example, that agent has the implied authority to interpret and explain the policy to clients.
   
    
3. Apparent Authority 
   Apparent Authority is the appearance or assumption of authority based on the actions, words, or deeds of the principal or because of circumstances the principal created. If a third party in good faith relies upon the principal's intentional or negligent permissiveness in regard to the agent's acts, the principal will be bound by the acts of the producer because the producer possessed apparent authority. Apparent authority is the authority most often cited when problems arise. Although insurance companies are often held to promises made by agents, they can demand restitution from the agents to cover their losses.

The limits to an agent's authority are spelled out in the agency agreement, and an agent must act within those limits. The ethical significance of the agency contract is that producers must, first and foremost, serve the insurer, live up to the contract, and operate within the scope of their authority. However, an agent's duty to the insurer goes far beyond the wording of the contract. By entering into this contractual relationship, an agent also enters into a fiduciary relationship.

Click here for an activity on the differences between the various types of authority.

The Producer as Fiduciary

A fiduciary is an individual whose position and responsibilities involve a high degree of trust and confidence. Trustees, guardians, and executors, by virtue of their responsibilities, are fiduciaries, as are insurance producers.

Through appointment, an insurance producer generally is given the power and express authority to act for the insurer by:

• soliciting applications for coverage
• describing coverage and policies to prospects and applicants and explaining how such policies can be purchased
• collecting premiums (or in some cases, only initial premiums)
• providing service to prospects and the insurer's policyholders

Serving this fiduciary role demands high ethical standards and performance.

The Producer as Fiduciary

Loyalty to the Insurer. The primary ethical responsibility that a producer owes to an insurer is loyalty—producers must act in the insurer's best interest in every matter involving the insurer's business. Producers are also charged with acting in accordance with the limits of their authority and performing within the guidelines of the agency contract.

Care and Skill. A producer has a duty to act with the utmost care and skill at all times. In some cases, this responsibility means that the producer must refer the business to others who might be more qualified.

Full Disclosure. A producer is obligated to fully disclose all information that may affect the insurer and its ability to conduct business with full knowledge. Practically speaking, full disclosure is most critical during the application and claims-handling processes. A producer must ensure that all application and claim forms are completed as accurately and as completely as possible. It is the producer's responsibility especially to see that the answers to questions on the application form are recorded fully and accurately.

The Producer as Fiduciary

Prompt Action and Follow-Up. A producer has the obligation to act promptly in all matters regarding the insurer's business. The producer's responsibility to transmit fully completed applications and notice of premium receipts as quickly as possible is most important. The insurer cannot begin the process of issuing insurance until it has received a completed application, and unless the applicant has been given a receipt, the applicant remains at risk until a policy is issued. If the applicant has been given a receipt at the time of application, the insurer is obligated to provide coverage at least until the applicant is formally rejected for coverage. In either event, a delay by the producer in turning over an application or notice of premium receipt to the insurer may place the applicant or the insurer in unexpected jeopardy regarding insurance coverage.

Handling Premiums. By law, payment of premiums to a producer is tantamount to payment directly to the insurer. The producer has a fiduciary duty to account for all funds he receives in connection with the insurer's business and to turn these funds over promptly. Even if there is no illegal intent, it is unethical for the producer to delay or withhold premium payments to the insurer. In many states, it is illegal to combine applicant premium monies with personal funds and rarely would it be ethical to do so in any event, whether or not such a specific law exists.

The Producer as Fiduciary

Avoiding Conflicts of Interest. Ethically, an insurance producer who has signed an exclusive contract with his insurer cannot serve two principals at the same time. As a "captive" producer, he owes a singular loyalty to that insurer. It would be unethical for that producer to represent two insurance companies selling the same policies. In addition, a producer has the ethical obligation to inform the company about any other related service he provides and receives payment for.

Independent producers also face this issue when they attempt to serve their clients while being contracted to an insurer. Conflicts can be avoided if the producer represents his client only during the process of helping the client select the insurance plan best suited to the clients' needs, and represents the insurer at all other times.

The Producer as Fiduciary

Careful Solicitation. A producer has the ethical duty to protect the insurer's interests by soliciting business that appears to be good and profitable for the insurer.

Competitive Integrity. As a duty to his insurer and the industry itself, a producer must resist the temptation to misrepresent or defame a competitive producer or insurer. Ethics requires that a producer acknowledge the worth of other producers and their policies and compete only on the basis of the value of the products and services that he can provide.

Duties of the Principal to the Producer

A rule of agency law is that the principal is responsible for all of a producer's acts when the producer is acting within the scope of his authority. This responsibility includes fraudulent acts, omissions, and misrepresentations.
The principal must select honest, loyal, and hard-working producers to protect itself from potential liability. In return, the principal gives the producer compensation for the business he brings in, and reimbursement for any damages or expenses incurred in defending against claims that the producer may be held liable for in the course of fulfilling agency obligations.

Duties of the Principal to the Producer

An insurance broker is a person who places business with more than one company and has no exclusive contract requiring that his or her business first be offered to a single company. Legally, a broker obtains insurance for anyone who requests him to do so and represents the customer.
The exception to this general rule occurs when an insurer gives a policy to a broker for delivery to an insured. During the delivery process, the broker becomes the agent of the insurer. Should collection of premiums become necessary, payment to the broker would be considered as payment to the insurance company.

Duties of the Principal to the Producer

The insurance broker represents the buyer of insurance in most parts of the insurance transaction and, therefore, owes all of the duties of an agency relationship to the client. However, even though a broker technically represents the client, the ethical and fiduciary standards that apply to a producer also apply to a broker.
Perhaps the greatest source of ethical concern for many producers and brokers is the feeling that they are caught in the middle between two parties who have conflicting interests. On the one hand, a producer's primary responsibility is to serve the insurer. On the other hand is the consumer, to whom the producer also owes dedication, loyalty, and service.
How can a producer reconcile this conflict? Actually, it's quite simple. By acting in the best interests of the insurer, the producer best serves the consumer.

Needs-Based Selling

A producer must sell the kind of policies that best fit the prospect's needs and in amounts that the prospect can afford. Needs-based selling involves problem analysis, action planning, product recommendation, and plan implementation. This requires two important commitments on the producer's part:

1. a commitment to obtain and maintain the knowledge and skills necessary to carry out those tasks
2. a commitment to educate the prospect or client about the products and plans that may be implemented on the producer's recommendation

The policyowner must rely on the producer to provide informed options and must trust that the producer's recommendations for insurance are in his best interest. To ensure that this trust is justified, a producer has an ethical responsibility to obtain the knowledge and skills needed to evaluate and service the insurance needs of clients and to keep his base of knowledge and skills current by committing to a program of continuing education.

Client trust must be earned, nurtured, and constantly reinforced. The producer who remembers this basic rule is the producer who communicates to his or her client the reasons why a particular insurance policy or program is being recommended and how it will serve.
This communication and education continues long after the particular policy or program is sold and becomes part of the overall insurance program designed for that client. The professional producer will review each client's needs annually and meet with the client to explain and discuss the programs put in place to meet those needs.

Servicing the Sale

Service—during and after the sale—is just as important as selling to needs in meeting a producer's ethical responsibilities. One of the most important aspects of business ethics is that the characteristics one associates with an ethical person—fairness, honesty, and personal responsiveness—also affect the level of service that a company provides. For the purposes of this discussion, service is defined to mean:

• educating the client before, during, and after the sale, ensuring that he fully understands the application and underwriting processes, the policy purchased, and any attached rider;
• treating all information with confidentiality;
• disclosing all information so that the policyowner or applicant can make an informed decision;
• keeping the prospect or client informed of any rejection, exclusion, or cancellation of coverage; and
• showing loyalty to prospects and clients.

Service Begins with the Application

A producer's primary responsibility in the application process is to the insurer. However he also has an ethical duty to educate the prospective insured about the application process, including:

• why the information is required
• how it will be evaluated
• the need for accuracy and honesty in answering all questions
• the meaning of such terms as waiver of premium, automatic premium loan, non-forfeiture options, policy loans, and conditional receipt

Conditional Receipts

A conditional receipt normally is given when the applicant pays the initial premium at the time the application for a policy is signed. This means that the applicant and the company have formed what might be called a conditional contract—one contingent upon conditions that existed at the time of application or when a medical examination is completed. It provides that the applicant is covered immediately from the date of application as long as he passes the insurer's underwriting requirements. It is the producer's ethical responsibility to explain that the applicant is covered on the condition that he proves to be insurable and passes the medical exam, if required.

 

Explaining the Underwriting Process

Another ethical responsibility the producer owes the client is to briefly explain the underwriting process that the application will undergo. This explanation should include a description of the checks and balances that apply to underwriting a risk, such as the Medical Information Bureau, the inspection report, and the credit report.

• The Medical Information Bureau (MIB)
  
  The MIB serves as a clearinghouse of medical information concerning applicants and helps to disclose cases where an applicant conceals or submits misleading medical information. A life underwriter can check the MIB for information on an applicant's past medical history. This possibility should be explained to the applicant when you ask for a signature on the MIB authorization form.
  
  
  
• The Inspection Report
  
  An inspection report provides details on an applicant's lifestyle, finances, and exposure to abnormal hazards. An inspection report usually is ordered on applicants who apply for large amounts of insurance. It's conceivable that the prospect's friends and/or employer may be contacted for purposes of an inspection report. The purpose of this report is to provide a picture of an applicant's general character and mode of living.
  
  
  
• The Credit Report
  
  A credit report is ordered when there is reason to question the applicant's ability to pay the premiums and to determine whether he may be a poor credit risk. Applicants who have questionable credit ratings can cause an insurance company to lose money. Applicants with poor credit standings are likely to allow their policies to lapse within a short time, perhaps even before a second premium is paid. The purpose of this report should be explained when you ask the applicant to sign the authorization form.

Full Disclosure

Precision and accuracy in completing the application are in the best interest of both the insurer and the prospective insured. It is vital that a producer understands this and explains the need for full disclosure to an applicant.

Insurance producers are privy to a client's personal and financial information. Ethics require that the producer respect the sensitive nature of this information and keep it confidential. Personal information about a client should never be released without proper approval from the client.

In this context, full disclosure means informing the prospect or client of all facts involving a specific policy or plan so that an informed decision can be made.

Two forms that many producers use as educational tools and in sales presentations are: The NAIC Buyer's Guide and The Policy Summary

Full Disclosure

The buyer's guide and policy summary are especially helpful to producers who want to explain the features and benefits of the life insurance policy they are presenting. These forms also provide needed guidelines for the comparison of two or more policies.

Underwriting Process

The underwriting process for an insurance application can be time consuming. All information on an application has to be analyzed so that the applicant can be classified accurately and appropriate rates are charged for the risks involved. A producer's ethical responsibilities to the client during the underwriting process center on promptness and policy delivery. An insurance producer needs to ensure that there are no unnecessary delays in the underwriting process. This means making sure that all information on the application is complete, accurate, and clear before it is submitted. It also means submitting the application without delay. In addition, a producer who has reason to believe the underwriting process may take longer than anticipated should notify the applicant of the delay.

Policy Delivery

Most policies are issued as applied for. In such cases, the producer owes the new policyowner prompt delivery of the policy as well as a review of its features and benefits. Not only does this help solidify the sale, it represents a step toward making the policyowner a lasting client.
Unfortunately, some policies will be rated or rejected. When this happens, the producer has two responsibilities:

1. Personally review the rating or rejection. Was it medical? Was there an unfavorable medical report? Was something overlooked or not made known to the underwriter? Should additional information be submitted? Is the rating or rejection proper? Should the application be reconsidered? In any event, the producer should have as much information as possible and be able to explain the rating or rejection to the applicant.
2. Assuming the rating or rejection was valid, the producer has the responsibility to notify the applicant promptly. To withhold this information in an effort to prevent the applicant from seeking insurance elsewhere is a breach of ethics and could actually harm the applicant and family.

  

Special Situation: Estate or Business Planning Insurance

In most cases, an insurance producer needs only common sense to avoid an unethical situation with a policyowner. However, in some specialized areas, such as the sale of estate or business planning insurance, the ethical guidelines are clearly defined by professional organizations chartered to monitor the activities of their practitioners.
The insurance producer in the estate or business planning market works with other professionals, such as lawyers and accountants, and understands that meeting the client's objectives depends on the involvement of these other professionals and encourages their participation.

  
The American Bar Association (ABA) has issued opinions regarding the ethical conduct of insurance producers and their advertising and sales presentations to prospects and clients in these areas. The following is a summary of the American Bar Association's position regarding the relationship of the insurance producer and a member of the legal profession:

• Persons who are not lawyers can be active in the areas of analysis of facts—the orderly arrangement of assets to provide for a client's needs while living and for the economic needs of dependents after the client's death. Persons who are not lawyers also may provide general information as to the laws governing the disposition of these assets.
• Persons who are not lawyers but who do legal research, give specific legal advice, draft legal documents or apply legal principles to a client's specific situation are engaged in the unauthorized practice of law.
• A producer should never dissuade a client from seeking the advice of legal counsel. It is improper for a producer to attempt to divert legal business from one attorney to another.
• A producer must never share or participate in an attorney's fee; producers must not pay directly or indirectly any part of their commission to an attorney or any other person who is not a producer.

The professional insurance producer understands that each member of the estate or business planning team serves a specific function. The attorney drafts the documents necessary to accomplish the client's objectives and advises the client of any legal consequences, and the accountant determines the accounting and tax implications and procedures. The producer recommends specific insurance policies in appropriate amounts and ensures that ownership and beneficiary designations conform to the legal agreements prepared by the attorney.
   
Once the policy is issued and an applicant becomes a policyowner and client, service becomes more than the producer's ethical responsibility—service now forms the foundation on which the producer and the client form a lasting relationship. All policyowners should receive periodic reviews to ensure that their insurance programs are in step with their plans and objectives. Service after the sale is more than a responsibility; rather, it is a critical part of a life insurance industry tradition. Through the years, producers have helped build that tradition and their future success depends on continuing that tradition.

Role of Insurance in Society

Why is ethical behavior so important in the insurance business? It's because insurance is at the basis of a sound financial plan for families and, hence, society. Insurance plays a key role in our lives. We need life insurance to support our families in times of crises, to pay for our children's education, and to carry on our businesses. We need health insurance to gain access to health care services that are so expensive we couldn't pay for them otherwise. We need property coverage to protect our homes and other property, and we need casualty contracts like car insurance in case of accident or theft, and we need workers' compensation to cover losses from work-related injuries or diseases.
Insurance plays a major role in the lives of most people in the United States. Yet most people are woefully ignorant of how insurance plans work and how insurance can benefit them, a situation that offers opportunities for unethical producers. The ethical producer has a duty to provide the public with a fair and honest representation of the policies and services available.

Raising Ethical Standards: Advertising and Deceptive Sales Practices

Insurance professionals have been aware of ethical problems within the industry and have been reexamining and raising their ethical standards since the 1970s. As one step in this direction, the National Association of Insurance Commissioners (NAIC) began amending and expanding the model Unfair Trade Practices Act (created in the 1940s) to deal with the inappropriate use of advertising. Most states adopted all or portions of the model act. At the same time, a number of initiatives were undertaken to assure the proper use of policy illustrations.
In 1990, a survey of top insurance CEOs conducted by the Ethics Resource Center suggested that the two top ethics problems in the industry were deceptive use of advertising material and deceptive sales presentations. Another survey done by the Ethics Resource Center in 1994, this one of workers in eight different industries, indicated that either the ethics initiatives were working or the problems in the insurance industry may have been less widespread than feared. Among the eight groups, the workers in the finance and insurance industries had the highest confidence that their companies fulfilled their ethical obligations to both stockholders/owners and customers.

Raising Ethical Standards: Advertising The potential for deceptive advertising or promotion by insurance companies and producers alike is significant and the consequences to the consumer can be grave. Accordingly, all states have enacted laws regulating insurance advertising. The basis for many of these state statutes is the NAIC's model Unfair Trade Practices Act, which covers not only advertising but also such acts as coercion, unfair discrimination, rebating, and so forth. The NAIC has also created a model regulation specifically directed at advertising—the Rules Governing the Advertising of Life Insurance. This model regulation, adopted as approved by NAIC or through related regulation in 31 states, defines advertising and attempts to address the actions that have caused trouble in the industry. It also mandates the proper identification of insurance professionals and companies, a system of control over its advertisements, a description of the type of policy advertised, and the disclosure of graded or modified benefits over time. In practice, most of the advertising and sales literature a producer uses is prepared by the insurer under the careful eye of its legal staff. For a producer, then, the ethical issue isn't necessarily the material itself, but how the material is used—and the deceptive sales presentation that may result. Raising Ethical Standards: Deceptive Sales Practices Deceptive sales presentations have probably generated more complaints of unethical behavior than any other activity. A deceptive sale is any presentation that gives the prospect or client the wrong impression about any aspect of an insurance policy or plan, one that does not provide complete disclosure, or that includes any misleading or inconclusive product comparisons. Deceptive sales presentations can be blatant, but even subtle misrepresentations are unethical. And, even if the deception is unintentional, the producer has done the client a great disservice. Raising Ethical Standards: Policy Illustrations Of all the complaints surrounding the marketing and sale of life insurance, none resonate so loudly as those over the use—and misuse—of policy illustrations. A policy illustration is a document that lists both guaranteed and nonguaranteed benefits and values in a series of columns. Policy illustrations originally were designed to help clients understand how a given policy is expected to perform under the circumstances the insurer foresees. Unfortunately, many clients look primarily at the nonguaranteed projections rather than paying attention both to certain guaranteed and nonguaranteed values. More disturbingly, some unethical agents have treated the nonguaranteed elements as if they were guaranteed and, moreover, have sold a policy mainly on the strength of the numbers in the illustration rather than on its broader merits. As the types of insurance policies rapidly evolved and multiplied in the last quarter of the twentieth century, many new issues arose, including the rate of return and growth potential of cash values—the 'unbundling' of a policy's accumulation and protection elements and the flexibility of premium payments. Some of these concepts are complex and even confusing, and insurers and agents discovered that one of the best ways to demonstrate the intricate mechanics of a policy was through the use of the computerized policy illustration. Policy illustrations are based on certain expectations of what will or might happen. When premiums, rates of returns, and death benefits are fixed and guaranteed as in whole life, such expectations are not a large problem. When these things become variable and contingent, however, the projected numbers are nonguaranteed. In the past, agents sometimes used illustrations to predict a policy's potential and its future performance based on assumptions that may or may not have been realized, leading to the much-publicized problems with so-called vanishing premiums. What did not originally accompany these illustrations was a consumer understanding that the values they were being shown would materialize only if the underlying assumptions came true. Along with the changing dimensions and features of today's life insurance products came a shift in risk from the insurer to the buyer. The more flexible the policy and the more aggressive the assumptions, the more sensitive the product is to changes in mortality, expense, and interest rates. However, this fact was buried, ignored, or glossed over—intentionally and/or unintentionally—in too many sales presentations. Agents occasionally spotlighted current and illustrative values while downplaying guaranteed values. In many sales situations, the policy illustration became the focus of the presentation—in other words, the illustration became the product. The consequences of illustration-based selling became quite apparent in the early 1990s. Individuals who purchased life insurance policies in the mid-1980s (when interest rates were high) with the expectation that they would pay premiums for only seven or eight years found out that their policies' accumulated values were insufficient to continue the plans in force; consumers didn't understand that their premiums don't really "vanish" but are charged against the policy's accumulated values. Likewise, others who bought plans with the understanding that premiums of a few hundred dollars a year would produce values of a million dollars by the time they were ready to retire discovered otherwise. Such experiences gave momentum to the charge that the misuse of policy illustrations had created a crisis in the insurance industry. Consumer groups, politicians, and journalists charged that life insurance buyers were being misled by many in the insurance industry who abused the use of policy illustrations and didn't distinguish between values and benefits that were guaranteed and those that were not. For some agents and companies, the allegations led to lawsuits, and, given the long-term nature of insurance, these lawsuits continue to be filed even when alleged abuses occurred years in the past. The problems associated with policy illustrations compelled the industry to respond in an appropriate manner. Insurance companies redesigned their disclosures to promote better consumer understanding of policy pricing, company and product performance, and illustration assumptions. Agents were instructed to show illustrations based on a variety of assumptions, not only those in which current assumptions prevail against the guaranteed projections. Probably the most significant initiatives, given their combined impact and reach, came from the National Association of Insurance Commissioners (NAIC) and the Society of Financial Service Professionals (SFSP). The NAIC drafted model legislation on policy illustrations, while the SFSP developed illustration questionnaires to help agents understand the assumptions that are used to design and create sales illustrations. Because of the problems associated with policy illustrations, the NAIC adopted the Life Insurance Policy Illustration Model Regulation in December 1995. Overall, the purpose of this regulation is to provide rules for life insurance policy illustrations that will "protect consumers and foster consumer education." Specifically, the goals are to ensure that illustrations do not mislead life insurance purchasers. Over two-thirds of the states have adopted the NAIC's model regulation, and other states have passed legislation similar to or based on the model. In so doing, states have forced changes to life insurance product design and assumptions, illustration systems designed for field use, illustration systems designed for product testing, and standards that attest to the "supportability" or "reasonability" of a policy illustration. Furthermore, actuaries have had to certify that their companies' illustrations conform to and meet the requirements of this legislation. The model legislation requires insurers to identify policies that are to be marketed with an illustration. Policies that are not so identified may not be marketed or sold with an illustration. In addition, under the model regulation, the following apply: Illustrations must clearly be labeled "life insurance illustration" and contain basic information such as the name of the insurer, name and address of the producer, identification of the proposed insured, and so forth. Producers may not represent the policy as anything other than life insurance, use an incomplete or noncompliant illustration, or mislead the prospect about the contents of the illustration. The illustration must conform to a certain basic format that accentuates clear, accurate labeling of information, especially nonguaranteed elements. The illustration must include both a narrative summary, explaining how the policy works, and a numeric summary, which details the death benefits, death values, and premium amounts. The illustration must be signed and dated by the applicant or policyowner, certifying that the agent has not guaranteed the nonguaranteed elements of the policy. Policy illustrations include a table that indicates the scheduled premium, corresponding guaranteed death benefit, and corresponding guaranteed surrender value for each of the first 10 years and for at least every fifth year up to age 100.    This model regulation is based on the concept that life insurance buyers whose policies perform to their understanding will be better served and far more satisfied than buyers whose policies do not live up to illustrative projections. Although the NAIC model regulation may not be a panacea for all policy illustration misuse and abuse, it certainly helps deter problems by requiring reasonable assumptions and fostering better consumer understanding of how a life insurance policy functions. The fact that prospects have to sign and date such illustrations proves especially important not only because it prompts the prospect to carefully consider a document that can be problematic but also because it creates a paper trail. This paper trail can prove quite helpful in solving disputes with policyowners when a product falls short of expectations; it also can protect agents who make mistakes accidentally. Since their introduction, policy illustrations have been the source of controversy, ethical problems, and misunderstandings. They are complicated documents, and the assumptions on which they are based are even more complex. Indeed, many agents found them confusing when they first appeared, and many still do not fully understand them today. Most problems with policy illustrations seem to occur because of a lack of understanding. So that ethical agents can better inform themselves of the ways in which insurance companies create their illustrations, the SFSP has developed two tools: the Life Insurance Illustration Questionnaire (IQ) and the Variable Life Insurance Illustration Questionnaire (VIQ). The IQ, first introduced in 1993, is an educational tool designed to help agents understand products and illustrations, specifically the nonguaranteed performance assumptions that insurers use to design policy illustrations for participating and nonparticipating general account products. The VIQ, which first appeared in 1996, is similar to the original IQ but deals specifically with variable life insurance products. Illustrations are very useful in demonstrating combinations of a policy's features and characteristics. With relative clarity, they outline which guarantees a policy contains. They also must, by their nature, attempt to demonstrate how a specific policy is expected to perform, above and beyond guarantees, under a certain set of predicted circumstances. But no illustration—or human being, for that matter—can predict the future with complete accuracy. Thus, the outcome a given illustration describes almost certainly will not happen. The consumer must know that the policyowner bears certain risks above and beyond contractual guarantees. The purpose of the IQ and VIQ, according to the SFSP, is to enable agents to learn more about the internal assumptions of future events which ultimately determine policy performance. They are designed to serve as a means of communication between agents and insurance companies. Each questionnaire contains questions about insurance company policies, illustrations, and the assumptions that go into them. The questions are divided into five categories: general information, mortality, interest or crediting rates (investment performance in the VIQ), expenses, and persistency. Taken together, the questionnaire answers uncover how a company evaluates and assesses the nonguaranteed, fluctuating elements of insurance policies. An agent who has studied a completed IQ or VIQ will be more competent and skilled in using an illustration as a sales tool. Such an agent will be less likely to feel it necessary to hide behind the numbers that an illustration contains.           IMSA The capstone of the renewed commitment to ethical sales and marketing practices in the insurance industry was the formation of the Insurance Marketplace Standards Association (IMSA) in 1996. The emergence of IMSA was a high point in the ethics movement of the last quarter of the twentieth century. IMSA is a self-imposed watchdog group in which member companies agree to adhere to and enforce ethical principles. The purpose of IMSA is to promote high ethical standards in the sale of individual life insurance, annuity products, and long-term care insurance by its member companies. With more than 200 voluntary member insurance companies, IMSA demonstrates the firm commitment to ethical market conduct that a large portion of the insurance industry has made. IMSA delineates its standards of ethical market conduct through six principles, each of which is supported by several codes. To join, an insurance company must go through two assessments (one internal and one third-party) to demonstrate that it upholds these codes, a process that must be repeated every three years. The principles and codes demand that each member company promote ethical standards to its producers. Following are the six Principles and the Code of Ethical Market Conduct with brief commentary on each point. To conduct business according to high standards of honesty and fairness and to render that service to its customers which, in the same circumstances, it would apply to or demand for itself. As noted in IMSA's own commentary on its website (www.imsaethics.org), the very first principle is a restatement of the golden rule. This principle eliminates double standards and encourages the two most essential standards of ethical sales: honesty and fairness.   To provide competent and customer-focused sales and service. The codes supporting this principle emphasize proper licensing, training, and continuing education. Knowledge of products, including their intended uses, receives special emphasis.   To engage in active and fair competition. This principle seeks to limit inappropriate replacement and defamation, unethical methods that some producers employ to generate business. Although these techniques might result in short-term monetary gain, they are likely to hurt the producer's business in the long run and certainly hurt the insurance industry as a whole. For the most part, this principle reinforces rules, regulations, and laws that already exist. Under this principle come actions such as passing out a buyer's guide, showing an illustration that meets NAIC model regulations, and using only approved advertising and marketing material. To provide for fair and expeditious handling of customer complaints and disputes. This principle encourages member companies to avoid extreme alternatives: ignoring complaints or forcing civil litigation. In particular, IMSA encourages alternative dispute resolution, a formal, nonlitigious way to settle such matters. To maintain a system of supervision and review that is reasonably designed to achieve compliance with these Principles of Ethical Market Conduct. IMSA recognizes that management support is critical to achieving the preceding five principles. Although IMSA takes a top-down approach by having member companies rather than producer members, it fully recognizes that unless producers abide by its principles, the member companies will not live up to IMSA's standards. And for individual producers to comply, managers must encourage and fully support them. IMSA has poised itself for success with one further step. Instead of making only companies and producers aware of its existence and efforts, it reaches out to consumers. IMSA has created a special logo that will cue consumers to recognize that a company is a member of IMSA. Although they carefully note that companies supporting ethical market conduct may choose not to join IMSA, it is clear that IMSA members uphold ethical standards. Companies may use this logo on their products. IMSA also has advertised in a number of national, consumer-oriented, financial publications to raise awareness of its existence. As consumers start to view the IMSA logo as a sort of "seal of approval", the advantages of IMSA membership are likely to begin to have positive effects on companies' and producers' bottom lines. Raising Ethical Standards  Without a doubt, insurance company CEOs feel strongly about ethical issues. But what about the views of insurance producers engaged in field sales and marketing? In 1995, the Society of Financial Service Professionals surveyed life insurance professionals on ethical issues. This was a follow-up to a similar study conducted in 1991. The purpose of these surveys was to gather information regarding the key ethical concerns and challenges facing the industry today. Both the 1991 and 1995 surveys presented more than 30 ethical situations and issues and asked the participants to evaluate each as to whether or not it is a problem in the life insurance industry. Despite the four years that separated the surveys, the results remained essentially the same for both. According to the surveys' results, the top ethical concerns producers have can be broadly categorized into three areas: skill and competence issues obligations associated with a commitment to—or lack of—professionalism moral issues stemming from individual behavior Let's consider each. Skill and Competence Issues Many ethical problems that producers often face can be traced to a simple lack of skill and competence. For example, according to the 1995 survey, producers feel that failure to identify prospects' needs and recommend appropriate products is a problem; producers who misrepresent their abilities to provide competent service are a problem as well. Yet it is obvious that these problems would not exist if producers were knowledgeable and competent. A knowledgeable, competent producer would not fail to identify a prospect's needs nor would he have to misrepresent his capabilities. Skill and competence are prerequisites to selling insurance. These qualities are the means by which an insurance producer provides informed options and recommendations that are in the client's best interest. Thus, a producer has the ethical responsibility to: Develop and maintain a high level of knowledge and skill through concentrated study and dedicated work. Skill can be mastered and knowledge can be acquired, but only through dedication and a willingness to work. All producers should be committed to a program of continuing education and participate in industry organizations, such as the National Association of Insurance and Financial Advisors (NAIFA). Acknowledge those cases or situations that are beyond one's skill level to deal with alone. No one can be an expert at everything. When a case is clearly beyond a producer's expertise, the producer should seek help from a more experienced and capable colleague or other professional. Professional Obligations  A number of ethical issues can develop when a producer lacks a commitment to professionalism. For example, disparaging the competition, not being objective with others in business dealings, failing to provide prompt and honest answers to clients' questions, and failing to provide products and services of the highest quality in the eyes of the customers were all listed in the 1995 survey as problems the industry faces. However, producers who make a true commitment to professionalism will not be hampered by these conflicts. Professionalism requires a producer to: Place the client's interest beyond one's self-interest. Professionals are loyal to their clients and are dedicated to protecting client welfare. This means professionals remain independent and objective in their judgment and evaluations and recommend plans or policies that most benefit the client. When a policyowner asks for help or advice, the producer is quick to follow up, embracing client service as an important responsibility. Be dedicated to industry and supportive of all its member companies and representatives. A true professional aligns himself with colleagues and competitors alike, knowing that all represent the same products and services and that all should share a commitment to the purpose and goals of these products and services. Offer quality plans and represent quality companies. A professional producer represents only those companies with solid financial standings and accurately informs prospects and clients of an insurer's financial position as part of the sales process. The lure of additional commission incentives a company might offer should be ignored if the company can't deliver quality products backed by a sound financial base. Moral Issues Finally, producers responding to both the 1991 and 1995 surveys identified two problems associated with what is best described as moral issues. These problems are (1) false or misleading representations of products or services (which producers ranked in both the 1991 and 1995 surveys as the number one ethical problem the industry faces) and (2) the temptation that exists between opportunities for financial gain (or other personal benefit) and the proper performance of their responsibilities. While many questionable practices can be condemned outright as being immoral or unethical, perhaps the root of the problem is a lack of knowledge or understanding on the producer's part. The producer who misrepresents a policy may not realize that what he or she is doing is unethical. After all, if a prospect needs insurance, does it matter how it is sold? If a client needs a specific type of plan but is willing to purchase a higher-priced alternative, should the producer redirect the focus to the policy that's more appropriate? The answers, of course, are "yes." If a sale can't be made with honesty, fairness, and objectivity, it must not be made at all.  If there is an opportunity for personal gain, but it comes at the expense of another person or company, it must be ignored. Thus, the ethical producer behaves in the following manner: Learns very early the difference between right and wrong in business and sales practices and acts accordingly. He develops high ethical standards through training with experienced professionals and association with industry groups. Consistently adheres to his values and maintains this integrity throughout a sales career. The ethical producer resists conflicts of interest—real or perceived—in all business dealings. Ethics means emphasizing the interests of clients and company over one's self. Willingly assumes the obligation to perform duties in a way that reflects the highest degree of dignity on the industry and best serves the interests of the client or prospect. Occasionally, this means that the producer must put service above sales The Public's Perceptions of the Insurance Industry An insurance producer represents his insurance company to the general public and prospective insureds. A producer's actions help shape the public's perceptions of the insurance industry. A producer's primary ethical duty to the public and to each prospective insured is to provide accurate information regarding insurance policies and benefits in a fair and unbiased manner. That information should be complete in every way, providing the prospect with the details of any deductibles, waiting periods, benefit limitations, exclusions, or qualification requirements for the policy. A producer's ethical duties to the public and prospects are quite demanding. In addition to the responsibilities the surveys indicated—skill, competence, professionalism, and moral integrity—there are other ways in which producers can help (or hinder) the public's perception of insurance and the insurance industry. A prospect's inadequate understanding of which benefits an insurance policy will or will not provide is usually the result of poor communication between the prospect and producer. Sometimes the source of this problem is that a producer is attempting to sell a new product without fully understanding the policy's features and/or benefits. Attempting to sell a new type policy or any other more familiar policy without adequate knowledge and training is unethical because it is a producer's responsibility to determine whether a policy will be appropriate for the prospect's needs. An understanding of how policies work will help the producer determine the suitability of the fit and how the policies compare with those of the competition. It is a producer's duty to present each policy with complete honesty and objectivity. This means pointing out any limitations or drawbacks the product may have, along with its features and benefits. The discussion on the deceptive uses of a policy illustration demonstrated how the buyer could suffer from a deception. When a buyer suffers, the industry suffers. The best solution is to know all the assumptions the insurer is using for expenses, mortality, interest, and lapse rates in its calculations of cash value projections and then inform the prospect of these assumptions. In all cases, a simple, straightforward explanation of the policy and how it will help fill the prospect's needs is always the proper ethical course. A prime violation of a producer's ethical duty to a prospect is deliberately selling to fit the needs of the producer rather than the needs of the prospect. The typical result is a prospect being sold insurance with the highest premium (and the greatest commission) instead of the proper coverage. The answer to this problem can be found in the CLU pledge: In all my professional relationships, I pledge myself to the following rule of ethical conduct: I shall, in light of all conditions surrounding those I serve, which I shall make every conscientious effort to ascertain and understand, render that service which, in the same circumstances, I would apply to myself. Insurance producers have faced numerous complex ethical issues over the past several years, which have ranged from misleading advertising and policy illustrations to a lack of knowledge necessary to perform in a professional manner. These issues are not likely to go away. As competition increases, insurance producers may find themselves faced with even more ethical challenges. However, by committing themselves to professionalism and the needs of the client, insurance producers can act both responsibly and ethically. Now, we will turn our study to the insurance producer's responsibilities to the state. State Insurance Statutes Two of the most important ethical questions that all insurance producers should ask themselves are: "How does an insurance professional come to know what is right and wrong in carrying out the business of insurance?" and "How can I do what is right once I understand what is right?" In other words, once an insurance producer understands and embraces a personal and professional code of ethics, he must also find ways to avoid the temptation to use illegal, unethical, or questionable practices that could provide short-term profit at the expense of compromising integrity. Those who wish to have a producer's code of ethical conduct precisely defined often find some pleasure in state insurance statutes that define both acceptable and unacceptable ethical conduct. The purpose of this chapter is to review and discuss the ethical standards mandated by most states. We also will cover the ethical standards of financial planning and the federal regulation applicable to many producers—the Investment Advisers Act. The responsibility to regulate the insurance industry is shared jointly by the federal government and the various state governments. States carry the major burden of regulating insurance affairs, including the ethical conduct of agents licensed to conduct business within their borders. This regulation of ethical conduct in some states is called marketing ethics. An important characteristic of the insurance industry in the United States is that it is regulated primarily by the states rather than the federal government. This has been true throughout the history of insurance in the United States. The U.S. Supreme Court, in the case of Paul v. Virginia (1868), seemed to settle the question of state-versus-federal regulation when it decided that the insurance industry should remain regulated by each state. The rights to regulate insurance remained relatively unchallenged until the U.S. Supreme Court case of United States v. Southeastern Underwriters Association (1944). In that case, the court reversed its earlier decision and ruled that insurance should indeed be regulated at the federal level, as are almost all other interstate trades. The Southeastern Underwriters case threatened to throw the insurance industry into turmoil. In response, the U.S. Congress enacted Public Law 15, better known as the McCarran-Ferguson Act. This law, passed in 1945, reserves for the federal government the authority to regulate insurance in areas such as fair labor standards and antitrust matters. All other insurance regulation is reserved for the states. As a result, the states carry the burden of regulating insurance affairs, including the ethical conduct of producers licensed to conduct business within their borders. Regulation of an insurance agent's ethical behavior is usually conducted through an insurance commissioner's or director's powers to oversee the marketing practices of both producers and insurance companies in that state. Many of the regulations governing ethical conduct are derived from model legislation developed by the NAIC. The Role of the NAIC  All state insurance commissioners, by whatever title they hold in their respective states, are members of the NAIC. The organization has standing committees and has worked regularly to examine various aspects of the insurance business and recommend appropriate state insurance laws and regulations. Its recommendations and model laws are studied by its committees and discussed at semiannual meetings in an attempt to attain some uniformity of insurance regulation and practice among the various states. The NAIC has four broad objectives: to encourage uniformity in state insurance laws and regulations to assist officials in administering these laws and regulations to help protect the interests of policyowners 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 laws for that state. The NAIC has worked diligently to create model legislation that promotes fair and ethical sales and marketing practices by producers and insurers alike. Its model Unfair Trade Practices Act, which has been adopted by virtually every state, seeks to regulate insurance practices by defining and prohibiting unfair trade and business practices. Prohibited practices include defamation, unfair discrimination, and unfair claims settlements. The NAIC's Life Insurance Illustrations Model Regulation prohibits false advertising and the use of deception in policy illustrations. The Unfair Trade Practices Act also gives a state's insurance commissioner the power to investigate insurers and producers when any violation is suspected. Punishment for violations includes not only a fine, but possibly suspension or revocation of an insurance license as well. In addition, the NAIC created the Life Insurance Solicitation Regulation and Life Insurance Replacement Regulation, which set forth marketing and disclosure standards for producers who solicit life insurance sales. Though not all states have adopted these models, many have used them as the basis for their own laws. Unauthorized Insurers Although the various states' laws regarding sales and marketing practices by insurance producers do vary in specific detail, 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 a producer. Let's take a look at some of the most significant of these laws. Unauthorized Insurers By law, only insurers that have been authorized or licensed by a state may issue policies in that state. Consequently, a producer must make sure that the insurers he represents are licensed to do business where solicitation is made. Generally, a state's guaranty fund only covers the liabilities of authorized insurers, so anyone purchasing policies from unauthorized or unlicensed companies would be at risk if those insurers could not meet their claims. Some states will hold the producer personally liable on any insurance contract he places for an unauthorized insurer. Misrepresentation and Defamation Misrepresentation Any written or oral statement that does not accurately describe a policy's features, benefits, or coverage is considered a misrepresentation, and the states have enacted laws that penalize producers who engage in this practice. Keep in mind that it is unlawful for producers to make any misleading representations or comparisons of companies or policies to insured persons with the intent to induce them to forfeit, change, or surrender that insurance. Producers have an ethical duty to present their policies in a truthful and open manner. Defamation Defamation is any false, maliciously critical, or derogatory communication—written or oral—that injures another's reputation, fame, or character. Individuals and companies both can be defamed. Unethical producers practice defamation by spreading rumors or falsehoods about the character of a competing producers or the financial condition of another insurance company. Both of these actions would be considered illegal in most states. Rebating  Rebating occurs if the buyer of an insurance policy receives any part of the producer's commission or anything else of significant value as an inducement to purchase a policy. State regulations are very strict in this respect and are designed to prohibit discrimination in favor of, or against, policyowners. In most states, the practice of rebating is illegal and the following are defined as illegal inducements to buy: offering, paying, or allowing any rebate or other inducement not specified in the policy, or any special favor or advantage concerning the dividends or other benefits that will accrue, in order to place, negotiate or renew the policy. offering, selling, or purchasing anything of value not specified in the policy. offering, paying, or allowing any rebate of any premium on any insurance policy or annuity contract. A few states, such as Florida, will allow rebating to take place. In Florida, rebating is allowed if the agent adheres to the following rules: The rebate has to be available to all insureds in the same actuarial class. The rebate must be in accordance with a rebating schedule (filed by the agent with the insurer issuing the policy) to which the rebate applies. The rebating schedule must be uniformly applied so that all insureds who purchase the same policy through that producer for the same amount of insurance receive the same rebate percentage. A rebate should not be given to an insured who purchases a policy from an insurer that prohibits its producers from rebating commissions. The rebate schedule must be prominently displayed in public view at the producer's place of business and a free copy made available to insureds on request. The age, sex, place of residence, race, nationality, ethnic origin, marital status, occupation, or location of the risk cannot be used in determining the percentage of the rebate or whether a rebate will be available. Twisting and Churning Twisting is the unethical act of persuading a policyowner to drop a policy solely for the purpose of selling another policy without regard to possible disadvantages to the policyowner. By definition, twisting involves some kind of misrepresentation by the producer to convince the policyowner to switch insurance companies and/or policies. In some states, persuading a policyowner to surrender a whole life policy and use the cash value to make other investments falls under the category of twisting. Directly related to twisting is churning—a practice in which the policy values in an insurance policy are used to purchase another policy with the same insurer for the sole purpose of earning additional premiums or commissions. In cases involving churning, there is no demonstrable benefit to the insured with the new policy. Replacement Replacement of one policy with another involves convincing a policyholder to lapse or terminate an existing policy and purchase another. Although policy replacement is generally not in the insured's best interest, there are times when a replacement may give a real advantage to the policyowner. State laws recognize that policy replacement is sometimes in the policyowner's best interest. State laws do not prevent a producer from replacing one life insurance policy with another. For example, suppose an insured has a $10,000 whole life policy that was established 15 years ago by his parents when he was a child. Now this insured has a family and quite likely may want to consider replacing the whole life policy with a $250,000 or greater term policy. While replacement is not necessarily illegal, it may not always be in the best interests of the policyowner. To interrupt one cash value insurance plan to begin another could cause serious financial problems for the policyowner. Where allowed, the practice of replacement is strictly regulated and the following two steps must be taken: The producer must make a full and fair disclosure of all facts regarding both the new coverage and the existing insurance. Policyowners who consider replacing policies should be fully aware of how cash values, incontestability provisions, and other features of their existing policies will be affected by changing policies. The appropriate replacement forms must be properly completed by the producer and signed by the insured, acknowledging understanding of which benefits are being given up and which benefits are being accepted by purchasing the new coverage. Replacement Questionnaire The ethical misconduct and abuses associated with replacement have been well documented. Unfortunately, the negative publicity surrounding replacement has given consumers the impression that replacement is always harmful. In fact, in some instances, replacement may serve the client well. But how does a producer know when a replacement is appropriate? In 1995, the Society of Financial Service Professionals developed a Replacement Questionnaire (RQ) to help producers recognize circumstances in which replacement is in the client's best interest. The RQ addresses all of the factors necessary when replacement of one policy with another is being considered. The intention of the RQ is not to automatically allow the producer to establish a basis for the replacement of one policy with another; rather, it is to be used strictly for evaluation purposes. Realizing that replacement is rarely in a client's best interest, the producer should use the RQ as an impartial guide to determine the suitability of a possible replacement. The RQ identifies critical issues pertaining to a policy replacement, such as cash surrender values, tax issues, financial ratings, and death benefits. The RQ, which does not satisfy or fulfill any state requirements regarding replacement, provides agents with a thorough process and educational tool for evaluating the regulatory and tax issues associated with replacement. The four-page RQ form is divided into 13 sections that permits the agent to take a step-by-step process through a replacement evaluation. Replacement Questionnaire Questions asked in the RQ include the following: Is there a potential taxable gain if the current policy is replaced? What are the differences in the plans of insurance? What riders do the current and proposed policies include? How long is the initial death benefit guaranteed to be in force at the illustrated premium for both the current and proposed policies? What premium is necessary to guarantee coverage at initial/current levels for life in both the current and proposed policies? What are the financial strength ratings of both the current and proposed insurers? If the proposed policy is a variable life policy, what gross yield rate is being assumed? Although replacement usually is not in the client's best interest, the Society of Financial Service Professionals' Replacement Questionnaire (RQ) gives agents an extra tool to determine whether a given replacement is appropriate and ethical. Solicitation and Disclosure Approximately two-thirds of the states require that agents provide certain disclosure documents when they solicit any insurance sale. These documents usually take the form of a buyer's guide, with simple explanations of various types of policies and cost comparisons. These documents are intended to help the consumer make an informed decision about what plan of insurance is the best buy. Some states also require a policy summary to be given to buyers, which discloses financial information pertinent to a specific policy. The NAIC has encouraged the use of buyer's guides and policy summaries to improve the consumer's understanding of insurance. Though not all states require that the NAIC's model disclosure documents be used, they are excellent tools that can help make the case for an insurance sale. License Suspension/Termination  When it comes to the law, an unethical act can have severe repercussions. This is because what states consider unethical, they have usually made illegal. In most states, a producer's license can be suspended or terminated for any of the following unethical actions: making a materially untrue statement in the application for a producer's license 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 premiums implying that a policy is being sold or issued by the investment department of a life insurance company 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 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 giving any indication that future policy dividends are guaranteed stating that an insured will be guaranteed certain benefits should a policy lapse without giving an adequate explanation of nonforfeiture benefits stating that a policy contains certain benefits not found in any other insurance contract stating that a prospect must purchase a policy immediately or lose the opportunity to purchase it avoiding any clear and unequivocal statement that insurance is the subject of the solicitation using such terms as financial planner, financial consultant, investment counselor or financial counselor, implying that the producer is in an advisory business in which compensation is unrelated to sales, unless such is actually the case using amounts and numbers in such a way as to mislead the prospect with regard to the cost of the policy or any other significant aspect of the contract disparaging a competitive producer or insurer or their policies, services, or business methods using any method of policy cost comparison that does not take into account the time value of money State Regulation of Unethical Conduct by Insurance Producers This overview of state regulation of unethical conduct by insurance producers is but a sampling of the unfair practices defined by state insurance laws and the NAIC. Fortunately, unethical and dishonest producers are few and far between. But even honest producers must be careful not to succumb to the temptation of manipulating the truth to land a big sale. Wrong decisions and inappropriate actions made under the pressure of the sales process can give rise to personal dissatisfaction and loss of integrity. Knowledge and calculated awareness can help the honest and ethical producer avoid many of the traps just outlined. State Regulation Financial planning is another area of producer activity that is regulated by both state and federal authorities. Common sense dictates that the same levels of ethical conduct appropriate for insurance sales and service carry over to activities in financial planning. Unfortunately, there are those who call themselves financial planner even though they do not have the experience, education, or training to justify the title. This creates problems for those who have a legitimate claim to financial planning and undermines the public's confidence in the financial services industry. Financial planning involves a variety of services and the application of a number of financial products. An individual who only sells and services life insurance plans is not a true financial planner and, consequently, must not represent himself as such. Let's examine some of the important ethical issues facing the financial planner. Credibility through Education A successful financial planner must have the confidence of the public using his services. The best way to earn that confidence and establish credibility is through education. The most recognized avenues of structured financial planning education are those leading to the Certified Financial Planner (CFP) designation and the Chartered Financial Consultant (ChFC) designation. There are two organizations that set the standards for education and ethical conduct in financial planning: the Financial Planning Association (FPA), which is composed entirely of CFPs; and the College for Financial Planning. Insurance producers who wish to enter the financial planning field should contact one or more of these organizations to learn about educational and licensing requirements. Additionally, each of these organizations stresses the ethical need for the insurance producer to consistently identify himself as an insurance producer, to identify the company that the producer represents, and to identify the nature of the sales call that the producer is making. Conflicts of Interest As insurance producers move from life underwriting to financial planning, they must accept a broader scope of ethical responsibility. For example, if a producer has the qualifications to give advice or sell securities and tax-sheltered investments as well as life insurance, the ethical standards of investment advising must be observed in addition to the ethical standards of insurance selling. A producer subject to the Investment Advisers 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 insurance producer is required to disclose to the client all material information that pertains to the services rendered. This could conflict with the producer's status as a fiduciary of the insurer. On the one hand, the producer 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 are charged. The Investment Advisers Act of 1940  Financial planners who engage in rendering investment advice as part of their services likely fall under the jurisdiction of the Securities and Exchange Commission (SEC) and its Investment Advisers Act of 1940. Among the many important aspects of this federal act are the requirements that those who are in the business of giving investment advice and who receive compensation for doing so must: register as an investment adviser with the SEC conform to certain standards of ethical conduct as defined by the act The best explanation as to how and why the Investment Advisers Act applies to financial planners is based on an opinion statement by the SEC: "Financial planning typically involves the provision of a variety of services, principally advisory in nature, to individuals and families with respect to management of financial resources based upon an analysis of client needs. Generally, financial planning services involve the preparation of a financial program based on information furnished by the client. Such information normally covers present and anticipated assets and liabilities, including insurance, savings, investments and anticipated retirement and other benefits.” "The program developed for the client typically includes recommendations for specific actions to be taken by the client. The client is assisted in implementing the recommended program by the financial planner selling to the client insurance, securities or other investments. A financial planner may also review the client's program periodically and recommend revisions.” "A determination as to whether a person providing financial planning services is an investment advisor will depend upon whether such person: 1. provides advice regarding securities 2. is in the business of providing such services 3. provides such services for compensation” The Investment Advisers Act of 1940 The SEC's position as applied to a financial planner or insurance producer means that if the professional's services involve rendering advice or analysis concerning securities, he is then considered an investment adviser. As such, the individual is subject to the act's registration and standards of conduct provisions. Because of the nature of their business and the trust a client places in an advisory relationship, the standards of ethics to which investment advisers are expected to conform are quite high. Among these standards are prohibitions against: using any fraudulent, deceptive, or manipulative scheme or device in dealing with prospects or clients; and engaging in any transaction, practice, or course of business that is intended to deceive a prospect or client. Actually, these provisions of the Investment Advisers Act apply not only to registered investment advisers, but to anyone who fits the definition of an investment adviser, whether or not that person is registered with the SEC. Insurance Producer's Ethical Responsibilities to the State An insurance producer's ethical responsibilities to the state in which he is licensed are set forth in statutes and regulations. In a way, each state creates a code of ethics by defining and codifying what is not legal and, by extension, not ethical. However, it is wise not to confuse laws with ethics. While laws set the minimum standard by which producers are expected to behave, a person's personal values or ethics provide a guidance system to help choose the right answer or alternative to ethical dilemmas when several choices are available. In other words, laws tell us what we must do; personal values and ethics, as defined by what we actually do, tell others what we believe in and who we are. Laws and law enforcement develop from those values and principles that a society has internalized. Compliance with society's values was originally assured through peer pressure and the moral persuasion of the group as a whole, or by the strength of its leaders. Creation of written laws and formal punishment for violating those laws came much later. However, given the sometimes limited economic resources that a society can allocate to enforcement of every law, it is clear that any society must look to its members to formulate some sort of self-regulation in the form of codes of conduct or ethics. Historically, certain codes of ethics developed as a covenant among peers; however, modern codes of ethics have also been based on essential considerations of the public interest—especially with regard to trade and commercial relationships. Codes of ethics identify and encourage desirable activities by formally establishing a high standard against which each individual may measure performance. Most professions have written codes of ethics that pledge the members of the profession to certain standards of conduct. For example, in addition to having a broad understanding of accounting and tax laws, Certified Public Accountants (CPAs) must pass a series of rigorous examinations and are expected to adhere to a code of ethics. Many other professional codes of conduct, such as the American College of CLU & ChFC, National Association of Insurance and Financial Advisors, National Association of Fraternal Insurance Counselor Certified Financial Planner Board of Standards, Inc., address the issue of ethics by establishing strict codes of ethics. These professional ethics are designed to guide, advise, and regulate behavior on the job. Uncovering Needs/Solving Problems There are two principles that form the foundation for an ethical sales presentation. An ethical sales presentation's purpose is to uncover the needs of the prospect and eventually show how life insurance may satisfy those needs. Everything a producer does and says during the presentation is part of the strategy to influence the prospect to make a decision that the prospect had no thought of making prior to the presentation. The second principle is that the function of the life insurance producer is to help people solve financial problems. It's likely that many people a producer talks to will not recognize these problems, or, if they do, they will be inclined to ignore them. People are engrossed in the task of taking care of today's needs; if they think of the future at all, they are inclined to put it in second place because today's pressures consume their attention. A producer's role is to isolate these problems and present them to prospects in such a way that they will want to do something about them. A life insurance producer does not create problems, but helps people solve problems. A producer does not approach people to interfere with their plans but to help them organize their plans. These two principles—to uncover needs and to solve problems—are at the heart of all ethical sales presentations. Keep them in mind as we turn our attention to the sales presentation itself. Steps in the Sales Process The steps in the sales process are not theoretical concepts, but proven, time-tested methods. In many cases, the entire sales process can be accomplished in a single interview or meeting. Other times, it will require two meetings because the producer will need to spend some time assessing the information received in the initial meeting before he recommends an appropriate life insurance solution. The sales process proceeds according to the following six steps. The approach Establishing the general problem Establishing the specific problem Assessing the need Presenting the life insurance solution The close The Life Insurance Solution This unit focuses on presenting the life insurance solution to the client. This step is the most enjoyable part of the sales process for many producers because it involves Selling, spelled with a capital "S". However, during this step, serious problems of misrepresentation can occur, as producers warm to the task of talking about products they believe will meet their clients' needs. Therefore, producers must use special care to provide full and accurate disclosure when presenting products to clients and motivating them to buy those products. This unit looks at the importance of full disclosure when presenting recommendations and examines how to make sure that requirement is met. It also looks at specific ways to avoid making misrepresentations when presenting, including what constitutes a misrepresentation. Some specific problem areas that traditionally have caused misunderstandings are also addressed. This includes a review of the correct use of policy illustrations and a thorough discussion of the subject of policy replacement—when it is appropriate, when it is not appropriate, and how to carry out a by-the-book replacement when necessary. Click here for a listing of the key ethical issues of the 1990s Informed Decisions Once pertinent facts have been gathered and analyzed and suitable products have been identified that will help a client achieve his objective(s), the next step in the selling process is the sales presentation. In days gone by, at this step in the sales process, the prospect was convinced, fairly or unfairly—using virtually any means available—to buy the recommended product and pay the first premium amount. Sometimes this sales presentation was accomplished using a scare tactic in which the client was asked to visualize the backing up of a hearse to his back door. The client was reminded, often with the help of fictitious motivational stories, that death was inevitable, even perhaps imminent. Furthermore, the producer used the tactic that if the client cared about his or her spouse, children, and other loved ones, it would be criminal not to buy the policy under consideration. Life insurance was always presented as the solution, and the time to buy was now, rather than later. If clients raised objections, producers were trained to overcome or ignore them. The client's real needs and wishes were secondary to the producer's need to sell the product. Informed Decisions Today, such hard-sell tactics are not acceptable. The only proper approach is needs-based, with the focus on the client. Needs-based selling means selling products that meet identified needs of clients. The objective is to educate clients so they can make informed decisions about what's best for them, not to sell them or convince them that the producer's recommendations are best. It is the producer's role to provide clients with complete and accurate information under the ethical and legal requirements of full disclosure. When a client asks questions or expresses concerns, the producer must treat the client with respect and address these issues directly and honestly. Questions should not be treated as objections to be overcome. Rather, producers should consider client questions as concerns to be addressed, signs of interest, and opportunities to further explain a certain feature or benefit of the policy. The needs-based approach to selling involves a partnership between producer and client that enables the client to make informed decisions based on facts. It also is recognized, in this day of diverse product options, that a producer may offer more than one way to help a client meet objectives. This is one reason many producers present several alternatives, all of which may be suitable. The idea is to provide clients with choices that allow them to make their own decisions about what's best for them. Ethical producers see this method of doing business as liberating. Not only does it take the sales pressure off clients, it also removes it from producers. If they have taken the time to establish relationships, conduct quality fact-finding interviews, and select products that reflect genuine needs, this next step, the product presentation, is simply the logical progression in the client's decision-making process. It involves discussion and disclosure, not pressure and manipulative selling tactics. If the client disagrees with the recommendations, the producer may suggest alternatives. It is also possible that no sale will result; the client simply may not be ready to act. Ideally, however, the door will remain open for future contacts. With this approach, producers may meet and work with a smaller number of prospects and clients. The emphasis is not on quantity, but quality. This low-pressure approach to selling also may yield fewer initial sales than a high-pressure, take-the-money-and-run sales method. Still, the business that comes in will be more likely to remain. Relationship-based selling tends to reduce lapses and generate more repeat business in the future. Overview of the Presentation The product presentation may take just a few minutes, or it may require an hour, depending on the complexity of the product or products under discussion. Regardless, the presentation will flow through the following four steps: First, the producer reviews and reestablishes the relationship with the client. A week or longer may have elapsed between the fact-finding interview and this next meeting. The producer also should take a few minutes to review qualifications to offer financial advice to the client. As with the initial meeting, it is important to make sure that all information is accurate. The producer then reviews the client's needs and priorities. Clients are busy. Odds are that the details of a conversation that took place several days ago will be vague at best. It is in everyone's best interests to review the priorities discussed and any decisions made at that first meeting. This step helps ensure that you and the client agree about the facts and that all relevant information has been disclosed. Next, the producer introduces one or more specific product solutions and provides an overview of how the policies work. This usually involves a description of policy features and benefits. (Note: There will be occasions when no product should be recommended. At these times, the producer should schedule an appointment, nonetheless, to confirm this with the client. This not only ensures that the client understands and agrees with the decision, it also leaves the door open for future business.) Finally, if the producer uses a product illustration, he should review and explain the illustration in detail as part of the product presentation process. Within this framework, the producer is responsible for meeting all disclosure rules, being careful to avoid even the impression of misrepresentation. Now, let's look at the presentation process, identify areas where possible problems may occur, and discuss how to deal with them. Full Disclosure Full and accurate disclosure is the cornerstone of the product presentation. This means more than just serving up the facts about a particular policy. The producer also must explain these facts so the client understands the ramifications of a given decision in relation to his particular situation and objectives. The producer is responsible for communicating relevant information in an understandable manner. Remember, the goal is to explain and educate, not to sell. The producer must be careful not to go from an accurate presentation of factual information to an overenthusiastic and inaccurate song of praise for a particular policy. It is easy for a producer who believes in a company's products to be so positive and motivated that he crosses the line to misrepresentation. At the same time, the producer should not be afraid to motivate; however, the producer never should forget that his role is to motivate by educating and informing. The client makes the decision to buy or not to buy. In this respect, the producer is a teacher and facilitator. The producer presents the facts; the client makes the decision. Nonetheless, the more conscientiously the producer has built a relationship, listened carefully to the client, analyzed needs accurately with the client's best interests always in mind, and conscientiously sought to make only appropriate product recommendations, the greater the likelihood that the client's decision will be to buy. Educational presentation means full disclosure. When presenting recommendations, many producers prefer to start with a general overview of how a particular product meets identified needs, followed by a detailed explanation of specific features and benefits. This presentation may include the use of policy illustrations, company-approved product brochures, and other support materials. (The use of preprinted materials is recommended because they generally have been reviewed for compliance so they meet requirements of full disclosure and market conduct.) Full disclosure also means discussing a policy's limitations openly. In our sophisticated society, most people know that drawbacks and limitations accompany most purchases. They often have no problem with the limitations; most complaints arise only when such limitations have been concealed from them. Most consumers welcome being given the complete picture as candidly as possible. A simple way to help explain today's more complex products is to take a "features/benefits" approach. Identify the feature clearly and then explain it in terms of its benefits. Also be sure to indicate possible limitations of a particular feature. Click here for an example of possible features of a variable universal life policy, along with a summary of the product's benefits and limitations. With certain policies, it may take some time to provide full and accurate disclosure. Even though the client may not be all that interested, it is still important to provide a brief overview of the policy's major features. Here is one way to position the policy with the client: Henry, based on everything we discussed last week, it is my recommendation that one of my company's variable universal life policies has the potential to meet your needs. This type of policy, called VUL for short, has some unique features that I want to go over with you. This policy offers life insurance protection, tax-favored accumulation, competitive returns on account values, allocation control of cash value accounts, death benefit flexibility, premium flexibility, access to cash values and more. At this point, the producer should go through each key feature and its benefits, being sure to explain the potential drawbacks as well. The key is to be accurate and balanced in the presentations. For example: The cash value in this policy increases or decreases depending on the actual returns of the individual funds. Now, you can adjust the level of risk to reflect your own objectives and risk tolerance. The policy also offers a fixed account, which pays a guaranteed rate of return. Therefore, you can diversify your account value to meet your individual needs and situation. This policy provides an opportunity for competitive growth. Still, keep in mind that the cash value is not guaranteed. Also, remember that the account values that accrue in your policy enjoy four very attractive income tax advantages, including tax-deferred accumulation of cash values, tax-deferred borrowing, tax-free payment of proceeds to beneficiaries and tax-free transfers between the variable accounts. It is important that producers respond in an honest and straightforward manner to questions and concerns. They should not view questions as objections to be overcome. Instead, questions should be treated as signs of interest, as requests for information. They present producers with the opportunity to further explain a particular feature or benefit to the client. The most important point a producer should remember when discussing a product with a client is that while its features and benefits are familiar to the producer, those features and benefits may confuse the client. A producer should take care to be sure to explain the policy clearly and completely to the client. Misrepresentation  Perhaps the biggest market conduct danger producers face during the presentation is that of misrepresentation. Sometimes, it is the result of over-enthusiasm, of selling the benefits of a policy too strongly. Or it may be the result of a willingness to stress the upside benefits of a particular product and ignore or sidestep any drawbacks. Providing vague or elusive responses is just as serious a form of misrepresentation as is deliberately lying about a policy's features or expected performance. Wrong Way Client: Are the cash values on this VUL policy guaranteed? Producer: Well, not exactly, but if you look at the stock market over the last 60 years, it's a pretty safe bet that your policy's values will grow handsomely Right Way Client: Are these policy values guaranteed? Producer: No, they are not. They may rise or fall depending on market fluctuations. There is also a risk of loss of principal. As the policyowner, you bear all market risk. You also benefit fully from market gains. Misrepresentation Producers must be sure to avoid creating a false impression about themselves, their companies, their products, or their services. They must say or do nothing that could give a client the wrong impression. A misrepresentation can be a verbal statement, a brochure or policy illustration that has been altered, or some other written communication with a prospect or client. Some of the most common examples of misrepresentation follow: Misrepresenting a policy's provisions or benefits or how the policy can be expected to perform over time. This includes referring to a policy as anything other than insurance—for example, a wealth-building plan or an insured investment. Or it may consist of making inaccurate statements or providing inadequate disclosure. For example, some clients do not understand the tax and other consequences of decisions regarding insurance policies. It is the producer's job to explain these things to them. This is why it is important today to be particularly familiar with the withdrawal penalties and tax consequences of all decisions and recommendations. Most of all, a producer must make sure that clients understand them. Overstating promises and guarantees. Sometimes just a few words make the difference between a projection and a guarantee. When explaining dividends to clients, for example, producers should be very clear that they are discussing projections, not guaranteeing the figures. There is a big difference between stating that "earnings are guaranteed" and "earnings are possible." A producer must ensure that clients clearly understand that difference.   Giving the impression that policy dividends or cash value projections (other than those that are, in fact, guaranteed, as stated in the policy) are guaranteed. Producers should take the time to distinguish between projections and guarantees, and make sure that clients understand the distinction.   Using inaccurate or misleading information or numbers that misrepresent the financial condition of an insurance company, a broker/dealer, or another producer. When producers venture into discussions about a company's financial stability, they must be sure to adhere strictly to the facts. The fact that a company is in receivership is public information; however, producers should use caution in explaining the ramifications of a company's financial condition. It is equally important not to spread rumors about another producer, agency, or broker/dealer. Making any statements or giving reassurances of any kind about coverage, the policy, or premiums that are not true or that cannot be supported clearly by the policy. One of the most serious examples of this practice would be to tell an applicant that he is insured when this is not the case or coverage is only conditional.   Engaging in the most serious type of misrepresentation—intentional fraud. This criminal act can lead to a fine and loss of license, possibly even criminal proceedings. The agency, manager, broker-dealer, and home office may be held liable as well. This is why it is important for producers to make sure their comments and actions remain within the legal limits of their state laws, as well as their companies' ethical guidelines. Misrepresentation accounts for the majority of complaints insurers and regulatory agencies receive. In most cases, misrepresentation is not intentional. For example, a client might not completely understand a producer's explanation because the producer could not define certain industry terms. Most misrepresentations result from inexperience, lack of knowledge, or just plain carelessness, all of which can harm clients and damage the credibility of the producer, the company, and the industry. These are the reasons why it is so important for producers to know their products and sales materials and be able to present and explain them clearly. This is also why it is so critical for producers to be able to determine whether their clients completely understand what they have been told and that they are making informed decisions in purchasing products. Knowledge is the key to avoiding misrepresentation. Intentional misrepresentation aside, knowledge of a company's products can help producers avoid many problems involving misrepresentation. But the producer's understanding is only the first step. Producers also must be willing and able to communicate this information clearly to clients. The following two steps can help producers use their knowledge to benefit clients and themselves: Learn the products and the industry. Producers should read their policies to make sure they understand them. If they have questions about provisions or clauses, the producers should contact their home offices and ask for clarification. This is because a producer's knowledge and ability to explain all policy provisions clearly can help protect clients from costly mistakes in making a policy decision. Plus, knowledge truly is power in that it increases the producer's confidence, which in turn enhances selling effectiveness and overall productivity. Plan sales presentations carefully. Producers must be sure to make complete and accurate sales presentations, disclosing fully all relevant information about their products to clients. The best guideline is to make sure that clients understand all information from the outset so that no surprises or misunderstandings occur later. Common Danger Areas of Misrepresentation Some specific topics consistently cause the most problems when it comes to misrepresentation. These areas, which often are fairly complex in nature and difficult to explain, include the following: Vanishing Premiums. This term, which has fallen into disfavor because of past abuses, should no longer be used. During the early days of interest-sensitive and variable products, when interest rates generated double-digit returns, companies began to realize that under ideal conditions, some policies could become self-paying. This possibility went from "could happen" to "will happen" in the collective mind of the entire industry. It wasn't long before the "vanishing premium" was touted as a major feature of policies, complete with specific (if only implied) vanishing premium dates. The fact that these vanish points were not guaranteed or that they depended on unrealistic rates of return was often ignored. When projected or promised vanish dates came and went and policyowners continued to pay premiums, lawsuits and complaints multiplied. In today's more sober environment, producers recognize that the best course of action is to steer clear of the words vanishing premiums with clients. While it is possible for premiums in some policies to vanish under certain conditions, producers should make no guarantees for this possible event. The vanishing premium concept allows a policyowner to make cash payments on a policy to a point where future dividends and the increase in other cash values may be sufficient to pay all future premiums. However, the vanishing premium feature is not a contractual provision or part of the policy, and it is not guaranteed. While policy value growth often can be fairly accurately projected, it cannot be guaranteed. This is an important distinction producers must emphasize with clients. Under no condition should a producer state or imply that premiums will vanish (even though they may) or that premiums may end on a specific date. One way of presenting the concept is as follows: Under one policy option, it is possible, after the policy has been in force for a number of years, to allow your dividends and cash value accumulations to pay your premiums, possibly for good but not necessarily. Whether the premium ends depends entirely on several factors, including policy dividends the company declares. Flexible Premiums. In many of today's policies, once the initial premium has been paid, the amount of additional premiums in the future is flexible or even optional to some degree for the policyowner. Generally, a recommended or guideline premium exists; however, the policyowner has the option to pay more premiums, less premium, or even skip premiums completely. While this is a valuable option for policyowners, it never should be implied (as it sometimes was in the past) that after the initial premium has been paid a policy generally would fund itself. Instead, this feature should be presented as a tool to help clients achieve financial objectives, such as the option to suspend premiums temporarily during times of financial stress or high expenses, perhaps when children are in college. Most of all, clients must be informed of the potential consequences of skipping premiums and how this course of action may affect policy values. Insurance Presented as a Savings or Retirement Plan. In the past, it was not uncommon for companies to promote cash value or whole life insurance as an asset accumulation vehicle with a death benefit. Great emphasis was made on the policy's ability to build up tax-advantaged savings in cash value. In some instances, life insurance was not even mentioned during the explanation of the policy. The "retirement income element" contained in the policy was actually nothing more than (and a misrepresentation of the benefits of) the policyowner's ability to access policy cash values via policy loans. While cash value life insurance does have an accumulation element, producers should not give the impression that life insurance is anything other than life insurance, even when it has cash value features. In fact, producers must make sure that the cash value is identified and described as just that, cash value. "Guaranteed" versus "Potential" Cash Value Accumulations. When the cash value growth is guaranteed by the insurance company, as it is in fixed-return policies, it can be stated as such. In all other cash value policies, however, including universal life (which has a declared rate of return) and variable universal life (which features competitive returns based on market performance), clients should be made aware how cash values are credited. Insurance Described as Investments. If the product is life insurance (even if the cash value depends on securities), producers must not imply that the product is an investment or describe it as such. Nor should they mention investment returns. The emphasis should be on life insurance as a protection tool, with accumulation features that receive favorable tax treatment. Additionally, producers should not describe cash values as investments, investment returns, or equity, savings, or emergency accounts. These amounts are simply projected. Dividend Misrepresentation. When dividends are possible in participating policies, it is common for clients to believe that the dividends are earnings similar to those associated with stocks. Producers must explain that dividends are a return of premium, which is why they are not taxed. Most of all, producers must make sure they never give clients the impression that dividends are guaranteed or in any way promised. Producers should make this especially clear when giving cash value projections. Also, a company's past dividend performance must be presented as just that—a history of past performance, which in no way can be interpreted as a projection of future dividends. Premiums Referred to as Other Than Premiums. Producers always should refer to premiums as just that—premiums. They should not be described as payments, contributions, or some other similar term. Failure to Distinguish between Tax-Free and Tax-Deferred Accumulations. While it is recommended that producers tell clients that the cash value increases in their policies are tax-deferred, producers should be sure not to imply or state that cash value growth is tax-free because this is not always the case. It is acceptable to remind clients, however, that beneficiaries receive proceeds tax-free in most situations. Failure to Divulge Risks. In addition to its positive aspects, producers have an obligation to divulge the risks associated with insurance policies, especially when discussing variable-rate products. Clients must understand that they—not the insurance companies—bear the full risk of loss with the cash values in variable products. Failure to Explain Product Differences. Producers should help clients understand the key differences between the various policies under consideration. For instance, it would be grossly unfair to compare premiums and cash values between a traditional whole life policy and a variable universal life policy without also pointing out the other differences. Policy Illustrations One of the best ways to explain policies clearly and completely is to use policy illustrations. Traditional fixed-value policies could be explained with one or two pages showing guaranteed values. A policyowner knew with certainty that, at specific ages, he would have "X" dollars of cash value, barring loans, available within the policy. With the development of interest-sensitive and variable policies, however, that was no longer possible. As a result, computer-generated life insurance policy illustrations, illustrating policy performance under a handful of what-if scenarios, were developed to explain potential policy performance. Many producers began to build all their policy presentations around these illustrations. Early Problems with Illustrations. Policy illustrations as educational sales tools were developed to help clients better understand guaranteed and projected policy values. Unfortunately, of all the complaints surrounding the marketing and sale of life insurance, none resonated so loudly as complaints about the use—and misuse—of policy illustrations. Problems arose for three reasons: Because they were actuarially designed and demonstrated little awareness of the needs of the individuals who would have to interpret and work with them, early illustrations were extremely confusing; producers and the public alike struggled to make sense of them. These early illustrations were honest attempts to clear up any confusion and help producers explain policies. However, because they were far from user friendly, they actually caused more confusion. Like early handbooks on computers, they often caused more problems than they solved. In attempts to interpret the information, many producers oversimplified these documents and, often inadvertently, delivered completely erroneous information to their clients. Fortunately, due to model regulations and design evolution, illustrations today are much more readable.   Overenthusiastic producers (again, often unintentionally) misinterpreted the information. Trained to present products in their best possible light, these producers naturally emphasized the most attractive what-if scenario and often overlooked the less favorable but more realistic possibilities. They sometimes blurred the distinctions between guaranteed values and projected values, implying that all were guaranteed. Producers often explained that premiums would (not could) vanish after a certain period of time, or suggested that the illustration's highest possible assumed rate of return was as good as guaranteed.   Applicants often were unwilling to look at anything but blue-sky projections—a result of human nature. When a man is told that his home is valued at between $150,000 and $200,000, he tends to remember only the higher number. When it sells for $175,000, he might feel that he has not received a fair value for it. So it can be with clients. Even when told that a 6% projection is realistic and reasonable based on today's rates, many people are tempted to focus more on an illustration's 10% or 12% column.   As a result of these problems, illustration reform and presentation regulations became a centerpiece of ethical market conduct.   The American Society of Financial Services Professionals began by providing an explanation of just what illustrations are supposed to accomplish:  An illustration is merely an insurance company's estimate of how an insurance policy might perform over time if a given set of assumptions, including interest rates earned [on premiums], mortality experience, and expense costs was to occur exactly as projected. Today, as a result of the NAIC's Model Regulation on Illustrations and efforts by individual companies, illustrations have become somewhat standardized. Most important for insurance producers, the rules and requirements for presenting and explaining policy illustrations have also become standardized. The NAIC's Model Regulation sets the following guidelines: Each policy illustration must be accompanied by a written explanation or policy summary. Each policy illustration must show that cash values and coverage will vary, depending on changes in an insurer's costs and dividends. Each policy illustration must be labeled life insurance illustration and contain such basic information as the names and addresses of both the insurer and the producer, as well as other relevant identifying information regarding the source of the illustration. Each policy illustration must describe nonguaranteed elements in a straightforward manner and must not give the impression that they are in any way guaranteed. Each policy illustration must be complete. No pages should be removed; nor should the illustration be altered or marked up in any way to highlight any particular area. No policy illustration can represent or imply that premium payments are not required, unless that is the case. No policy illustration can contain the word vanish or vanishing premium or similar wording that could mislead the applicant into believing the policy will become paid up based on the use of nonguaranteed or projected elements. No policy illustration can represent that the policy is anything other than life insurance. No policy illustration can show projections of elements (such as reduced expenses or mortality gains) that have not yet taken place. Each policy illustration must follow a specific basic illustration format. Finally, when using an illustration, producers must obtain a signed and dated statement from the applicant with wording similar to the following: I have received a copy of this illustration and understand that any nonguaranteed elements illustrated are subject to change and could be either higher or lower. The producer has told me that they are not guaranteed. When using illustrations as part of the presentation, producers should take a proactive approach. Illustrations cannot stand by themselves; they make little sense (or, worse, are open to gross misinterpretation) unless accompanied by explanations. For this reason, it is not recommended that producers give illustrations to clients without explanation and discussion. To best use illustrations to help clients make informed buying decisions, producers should take the following nine steps: Become knowledgeable. Producers should complete the Society of Financial Service Professionals' Illustration Questionnaire to acquire a better understanding about how illustrations are developed, how they work, and how they should be presented. It is imperative that producers understand completely the assumptions underlying illustrations and how those assumptions affect a policy's future performance. Completing the Illustration Questionnaire goes a long way in providing that knowledge and avoiding errors in communicating illustration information to clients. Make only credible and realistic assumptions when requesting illustrations from insurers or developing your own from compliance-approved software. For example, introducing 20% projected rates of return in a 5% current environment simply is not ethical. Take time to make sure applicants understand clearly that illustrations are not predictions but simply what-if scenarios that indicate what could take place based on the assumptions used. Make clear distinctions between guaranteed and nonguaranteed cash values. Policy guaranteed cash values are just that: the policy's guaranteed cash values. Assuming that the applicant pays all premiums on time and takes no policy loans, these amounts represent the amount of cash value in the policy each year—guaranteed. These amounts are often referred to as the policy's minimum cash value. Other values, including dividends and account value increases, are merely projected, based on present assumptions, and can change over time based on performance.   Encourage applicants to ask questions about illustrations; then answer those questions candidly.   Review the entire illustration with the applicant, starting with the proposal cover page. This page identifies the type of policy, face amount, premiums, and other relevant information. Then, the producer should note that the rest of the illustration consists of columns that show the projected changing values of the policy, year by year. Point out that the total cash value includes nonguaranteed values. This number is a projection of how policy values could look over time. The figure is based on the company's current dividend scale continued into the future. It should not be presented as or implied to be a guarantee or prediction of future performance. Be aware of the assumptions used in illustrations—that no policy loans may be taken against cash value and that dividends are used to purchase paid-up additions, for example. All these have an impact on future values. Ask questions. An illustration can be fairly complicated, so remind applicants that the only dumb question is the one they do not ask. Policy Replacement Perhaps one of the biggest challenges an ethical producer faces is deciding when it is appropriate to replace an existing policy with another. On one hand, due to the rapid evolution of new (and, in many cases, improved) products in recent years, a replacement may be in the client's best interests. On the other hand, a replacement often exposes the client to undue financial loss and risk. Generally, replacement results from one of two possible motives. First, the producer genuinely may believe cancelling one policy (or reducing its values) for the purpose of replacing it with another benefits the client. This can occur when an existing policy appears to be completely inappropriate or no longer meets client needs, such as in a divorce or the death of beneficiaries. The second motive—the one that has resulted in investigations into abuse—is the result of a producer's desire to generate new first-year commissions without regard to the client's needs. Producers are paid high first-year commissions, followed by lower subsequent renewal commissions. A producer can receive up to 80% of the first-year premiums as commission on life insurance policies. The legal definition of replacement varies from state to state, so it is important that each producer knows the law of the state(s) in which he does business. Producers should be aware that replacement, by its broadest definition under the American Society of Financial Services Professionals, may involve: an action which eliminates the original policy or diminishes its benefits or values. Examples of such actions are policy loans, taking reduced paid-up insurance or withdrawing dividends. Therefore, the producer who recommends that a client borrow cash value from an existing policy to pay premiums on a new policy may be engaging in replacement just as much as the producer who encourages a client to drop one policy and replace it with another. Traditionally, replacement is divided into two categories: twisting and churning: Twisting also is referred to as external replacement. It involves a producer illegally inducing a person to drop existing insurance to purchase similar coverage with that producer or company. This often is associated with making false statements about another insurer or producer, an illegal act that also runs contrary to ethical market conduct. Churning also is known as internal replacement. It involves replacing policies within the same company, often by the same producer who sold the original policies. Policy replacement is serious business. It never should be undertaken routinely but recommended only after careful deliberation. As a rule, producers should avoid replacement unless it is obviously so appropriate that they cannot in good conscience think it best to leave an existing policy in force. Most of all, they should not look for opportunities to replace existing coverage. And, of course, they never should initiate replacement to generate commissions for themselves. At times, it is advisable to replace a client's policy with another. However, the litmus test must be how well the action serves the best interests of the client, not the producer. All too often, replacement—especially when cash value policies are involved—is not clearly in the client's favor. Before executing a policy replacement, producers should make sure it is appropriate. Also, they should not assume that it is automatically acceptable to replace a policy with another one from the same company. The National Association of Life Underwriters, in its consumer publication, Points to Ponder If You're Considering Replacing Your Life Insurance, reports that in most situations "the life insurance you already own is your best buy." This statement is generally true for the following reasons: Changes in health and age. The risk always exists that the client has become uninsurable or insurable only at a higher rate. Even if the client's health is still sound in later years, a whole life policy purchased at age 20 almost always carries a lower premium than one purchased at age 48.   New contestable period. A company's right to challenge a death claim or other information, usually within two years from the date of policy issue, may expose the client to the risk of dying without coverage or may subject beneficiaries to legal conflicts.   New policy fees and expenses. The new policy often comes with new sales loads, policy fees, and other expenses that could take years to amortize before the client is able to break even in terms of total policy values.   Possible loss of policy upgrades or automatic improvements that may meet the policyowner's objectives. Many companies are introducing unilateral policy improvements to existing policies. These also should be considered before a replacement is initiated.   Loss of grandfathered rights. For example, if the original policy was purchased when tax laws were more favorable, replacement may entail the loss of grandfathered income tax benefits. When replacement may be appropriate. Producers should not be under the impression that replacement is never in order. At times, recommending that one policy be cancelled and replaced by another is best for the client. Here are some examples of situations when replacement may be appropriate: The client's health has improved for one reason or another. For instance, a man diagnosed with childhood leukemia at an early age survived; however, because traces of the disease were evident for the next 30 years, the insurance he was able to obtain was steeply rated. Finally, at age 45, he was declared completely free of the disease. In this case, a policy he could obtain at age 30 may no longer be appropriate for his needs, especially if he can obtain new coverage at a rate half that for the existing policy. Of course, it might be possible to convince the existing carrier to reconsider the rating and reduce the premium.   A female client originally was underwritten with unisex rates in compliance with the laws of her state. When she moves to another state, one that allows sex-based rates, it may be possible that a new policy will reduce her coverage cost.   A policy that was issued at a young age and features a small death benefit for an inappropriately large premium (de minimus coverage) no longer meets the client's needs.   The purpose of the replacement is to undo a bad replacement. For example, this may occur when a middle-aged client who had whole life insurance was induced to replace this policy with term insurance. The recommendation to replace the temporary coverage with a permanent policy may indeed be appropriate. The above examples are not automatically reasons to replace coverage. It is crucial to replace policies conscientiously! Replacement is a serious action. Before recommending replacement, even if it appears to be ethical at first glance, producers should make sure it is in their clients' best interests to do so. Click here to find out what you should do when you discover that a client is considering a policy replacement. When it appears that replacement may be in a client's best interests, a producer should conduct a rigorous series of tests. If even just one of these is not carried out or fails to conclude that replacement is ethically and legally appropriate, the producer should not recommend replacement. Following are some of the steps involved: Make sure the replacement is legal according to state regulations. If the replacement fails to meet state law, discontinue all replacement activities. Note that even when the replacement is not illegal, this does not necessarily mean that it is appropriate. Conduct a self-check to ensure that the replacement is ethical. One of the best tools, developed by the American Society of Financial Services Professionals, is the Replacement Questionnaire (RQ). The form is not designed for direct use with clients but should be completed by a producer considering replacement. (If the form will be shown to the client, it should be approved by the home office and, if variable products are involved, by the producer's broker/dealer.) Copies of the Replacement Questionnaire may be obtained from the American Society of Financial Services Professionals in Bryn Mawr, Pennsylvania. Give the client a form called a Notice Regarding Replacement, which provides up-to-date information about the client's existing coverage so he can compare it with the new, proposed policy.   Provide the client with a completed and signed comparison statement that fairly and accurately allows the client to compare the two policies.   Notify the existing carrier of the proposed replacement. Where external replacement is involved, this enables the policyowner an opportunity to meet with the original selling producer. Where internal replacement is involved, this also enables the company to ensure that all internal replacement rules are being met.   Make full and fair disclosure of all facts regarding both the new coverage and the existing insurance. Policyowners who consider replacement should be fully aware of how cash values, incontestability provisions, and other features of their existing policies will be affected by changing coverage.   Provide a follow-up letter to the client that summarizes the meeting with the producer, including what they talked about regarding replacement, what the producer recommended, and what the client decided.   Complete all other appropriate forms properly. By signing these forms, the insured acknowledges that he is fully aware of which benefits are being given up and which benefits are being accepted when he purchases the new coverage. The regulations on replacement demand an appropriate amount of due diligence on the part of the producer because they are designed to reduce the number of inappropriate replacements. In this respect, they work to the benefit of ethical producers by reducing the incidence of inappropriate replacements of their policies. Just as producers have a responsibility not to replace a policy without carrying out due diligence, they have the opportunity to stop inappropriate replacement of their own coverage by other producers. When it appears that another producer is attempting to replace a client's policy unethically, it makes sound business sense to make sure that the other producer is going by the book, as well. A producer should use any and all resources available to resolve client complaints, including those that might involve policy replacement. Settlement of a client complaint short of litigation is generally always in the best interest of both the producer and the policyowner. The term "alternative dispute resolution" (ADR) refers to any means of settling disputes outside of the courtroom. ADR generally includes various processes, including early neutral evaluation, negotiation, conciliation, mediation, and arbitration. In the wake of burgeoning court queues, rising costs of litigation, and time delays in most decisions, more states have begun using ADR programs. Some of these programs are voluntary, while others are indeed mandatory. To avoid inappropriate replacement, producers should meet the following service guidelines: Maintain close contact with clients. At the minimum, conduct an annual review. Client contact is crucial if you intend to be responsive to clients' changing needs and concerns. Do not give clients a reason to discuss their insurance needs with any insurance professional but yourself. Educate your clients about how the policies they purchase from you suit their needs. Periodically remind your clients why they purchased coverage and how it benefits them and their families. Ask clients to contact you if they're ever asked to consider replacing their policies. Explain that part of your service is to review other plans and help them make informed decisions. Question 2 of 35      In what phase of the selling process are serious problems of misrepresentation likely to occur? A) Policy delivery and ongoing service B) Fact finding and needs analysis C) Approach D) Presentation of recommendations Question 3 of 35 Which of the following phrases should agents no longer use? A) Flexible premium B) Cash value C) Vanishing premium D) Death benefit