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1.1 - What Is Ethics?

The insurance business is based on trust. The products the industry offers and the benefits these products provide are ultimately future promises. For insurance products to have any value, the public as a whole and insurance consumers individually must trust that those promises will be kept. To earn and keep such trust, insurance producers—as representatives of the industry, its products, and its promises—must embrace the principles of ethical marketing and ethical service standards.

In this chapter, we will define the concept of ethics and show how it shapes the conduct of the professional insurance producer. Upon conclusion, you should

  • know the distinction between ethics and compliance;
  • understand how and why compliance is simply a subset of ethics; and
  • be able to identify common situations that excuse the lack of ethical behavior.
1.2 - Ethics vs. Compliance

What is ethics? It’s a difficult question to answer, because it can and does embrace many different meanings, applications, and contexts. In the insurance arena, ethics refers to the moral and professional duties an agent or producer owes to his or her clients, to the company represented, to competitors, and to the public at large. In other words, ethics represents a consensus of the standards of professionalism expected of the agent in the conduct of his or her business.

Many of these standards have been codified into laws and regulations that are enforced by state and federal government agencies. Compliance with these rules and regulations is, of course, mandatory; there are penalties for failing to comply with them. But as sweeping as the written rules are, they are merely a subset of a larger body of ethical principles the producer should feel bound to live by.

Compliance is not the same as ethics. Being in compliance is not the same as being ethical. Think of ethics as a code of personal conduct; compliance is merely following a set of rules. In that respect, compliance is a subset of ethics. It is obedience to a set of ethical principles that has been reduced to writing and applied to specific situations. As such, compliance represents the minimum level of conduct that one must follow. However, these rules do not neatly apply to all situations. Compliance requirements cannot identify or define every issue, circumstance, or question that may arise. New and unanticipated personal and business transactions arise every day for which no written rules exist. It is here that the financial professional’s individual code of ethics comes into play.

Likewise, the nature of compliance is reactive. Compliance requirements are typically enacted in response to practices that tend to create negative outcomes or have the potential to harm. In contrast, ethics is proactive—it leads and guides one’s thoughts and actions, setting a larger framework for one’s activity and conduct.

Compliance depends on an individual’s desire to avoid punishment, whereas ethical conduct stems from an individual’s genuine desire to do the right thing. Anyone, no matter how unethical, will comply with the rules if the punishment is severe enough. Some people have no problem with doing something unethical as long as they can do so without breaking the rules. The ethical producer will not. Ethics, though grounded in the law, is associated with social responsibility and public welfare. An activity—or lack thereof—may be legal; it does not necessarily follow that it is also ethical. For example, consider the agent who learns that a client, who was recently issued a health insurance policy, has a health condition that was not disclosed on the application. Though the agent does not have a legal requirement to make this information known to the insurer, he or she has an ethical obligation to disclose this information. Again, whereas being ethical implies conforming to the law, being in compliance does not necessarily translate into being ethical. Compliance requirements are only an aspect of proper, appropriate conduct and practice. Where the requirements end, ethics continues.

The Concept of Liability

Before we move on, it’s important to understand one other concept as it relates to our discussion: liability. Liability is the state of being held responsible, chargeable, or accountable for doing wrong. While a particular action may not be illegal in the sense that it carries the threat of punishment in the form of loss of license, fines, and/or imprisonment, it can still expose the agent to civil suits for failing to meet the duties expected of someone in his or her position. Civil suits can arise alleging that the agent was negligent, misrepresented coverage, or simply failed to live up to the standard of care expected of someone in his or her position. Very often, it is within the broad landscape that lies between “legal” (that which is required) and “standard of care” (that which is rightfully expected and should be delivered) that problems arise.


1.3 - Rationalizing Unethical Behavior

Now that we have distinguished between what is ethical and what is merely legal, let’s look at some of the rationalizations that people use to justify unethical behavior.

“It’s common practice”

If “everybody is doing it,” how can it be wrong? Or, as others might think, “If I don’t do it, somebody else will.” The fact that “everyone” runs their home office with supplies lifted from the company supply room does not make the practice ethical or honest. This also applies to embellishing an application or exaggerating the merits of an insurance policy to make a sale. In both cases, one has betrayed a trust with his or her employer: by stealing outright in the first instance and by foisting risk onto the company that it might otherwise have rejected in the second instance. The fact that the company may have been betrayed by other agents does not excuse any individual representative’s conduct. By misrepresenting coverage, an agent also induces a client to enter into a contract that might fail to provide the protection the client is counting on. Defenses of “it is custom and practice in the industry” are often raised on behalf of agents— i.e., the agent acted as everyone else acts in the business of selling insurance. However, unless custom and practice conform to standards of prudence and competence, these defenses will probably fail.

“They had it coming”

This reasoning asserts that bad or unethical behavior by one party justifies unethical behavior by another. Consider, for example, Agent Ben. Ben thought he had won a sales award, only to find out that a delay in processing an application pushed that sale into the next sales period. As a result, he did not get the award, which went to Marie. Ben felt he had something coming, and if he couldn’t get the award he felt was rightfully his, he would get a “reward” in another way—by padding his expense account.

“There’s really no harm”

Unethical behavior is sometimes justified with the argument that the amount of harm is relatively trivial (stealing a box of pencils or adding a few thousand dollars to an applicant’s net worth). The argument is that if no tangible harm arises from a deception or other unethical act, it cannot be wrong. This is a way of turning things around and evaluating the expected consequences of an act first. The concept of “no harm” is easily equated to that of “little harm;” white lies are permissible because they are so small that they are really not ethical violations at all.

A variation of this theme is the reasoning that the act is not so bad when compared to something else. An individual who tells the boss that he is working on an important case when he is actually playing golf pales in comparison to someone who has embezzled money. However, that is not the point. There will always be someone less principled, but the less principled person should not be your gauge of ethical conduct.

“It’s okay because it’s George”

Sometimes unethical behavior is excused because it involves a person who is so important, or has done such worthwhile things, that we should look the other way just this once (or twice). A corollary of this is that it’s okay because it’s for a good cause. This is an extension of “There’s really no harm.” Maybe overlooking an obvious fire hazard is excused because the applicant is a pillar of the community and his business—which employs a lot of good people—cannot operate without the fire insurance. The producer should keep in mind that not only has he or she engaged in a falsehood, but by concealing information from his or her employer, the producer is transferring risk from one business to another without the other’s knowledge or consent.

“It’s not my fault”

The excuse here is that we need to confront only those problems we are personally responsible for. For instance, say an agent sells a large life insurance policy to an individual as part of an estate conservation program. The agent has some experience in the field and recognizes that the arrangement will not shield the applicant from estate taxes the way his lawyer suggests it will. Still, it is a large sale, and if it fails to accomplish the customer’s goals, it would be easy for the agent to say, “It’s not my fault; it’s the attorney’s.” This is not so. By purposefully participating in an insurance transaction that the agent knows will not achieve his customer’s goals and that is solely for the agent’s own enrichment, he has perpetrated a fraud. If the plan doesn’t work, it is as much his fault as the attorney’s.


1.4 - Trust and Promises—the Core of Insurance

The insurance business is, at its heart, about a customer’s financial security. It is about promises and trust—the promises an agent and his or her company make that they will be there when the policyholder needs them, and the trust the customer has that these promises will be kept. Underlying all of this is a faith in the agent’s and company’s honesty and a conviction that they will keep faith when it comes time to pay. Without that trust, the insurance business could not exist. And that is why ethical conduct is so fundamental to the interests and business of insurance professionals.



1.5 - Summary

In the insurance business, compliance and ethics, though related, are actually two different things—alternate sides of the same issue. Compliance sets minimum standards for conduct and practice; ethics guides one’s thoughts and actions beyond that which is required by law to a higher mark of service. There are a myriad of reasons and ways to excuse unethical behavior, but the core of the insurance business is based on trust and promises. Producers must live up to these trusts and promises in every way they can.



2.1 - The Role of the Producer

For the insurance producer, ethics extends well beyond the imaginary lines set by the law or by compliance requirements. While ethics does embrace the law, it simultaneously defines the core of what the producer does and the service he or she provides. It offers a standard against which the producer measures the service and products he or she delivers and reflects the level of conduct, knowledge, and commitment that the producer continually aspires to offer to his or her prospects and clients.

In this chapter, we will look at the role of the producer and his or her relationship with the insurer and with clients. Upon conclusion of the chapter, you should be able to

  • define the distinctions between agent relationships, special relationships, and fiduciary relationships;
  • understand the duties and responsibilities producers owe to their insurers and to their clients; and
  • identify issues that may arise due to agent negligence or inattentiveness.
2.2 - Is the Agent an Agent?

The guiding principle of the ethical producer is to act always in the best interest of his or her customers. But how far does an agent have to go in determining what those interests are? Obviously it would be impractical for every agent to delve deeply into every customer’s personal and financial affairs to determine if that person has adequate coverage to meet all contingencies. There are circumstances, however, where that is exactly what the agent should do.

Much depends upon whether the producer is acting strictly as an agent or has taken on a more significant role as an advisor. Acting merely as an agent, a producer still has obligations to his or her customers and insurer, but the scope of these responsibilities is largely confined to his or her duties as a solicitor, a taker of applications, and a deliverer of policies. True, an agent still has to tell the truth, be responsible, and follow the rules set out by the regulatory authorities and his or her insurance company. However, an agent serving merely as an agent is generally not held to be personally—or morally—responsible if things do not work out exactly as the applicant hopes.

On the other hand, if the producer has a more significant role in shaping the customer’s financial security picture, he or she will be held to a higher standard. If he or she serves in the capacity as an advisor who renders advice and counsel, expectations are greater. And if expectations are greater, so too are the producer’s responsibilities.

Agent vs. Advisor vs. Fiduciary

Therefore, one question each agent should consider is whether the policyholder is essentially a customer or something more like a client. Does the producer have only basic agent responsibilities, or is the relationship something more—perhaps one where the producer is actually regarded as a fiduciary? (We will spend more time on the subject of fiduciaries and their duties to their clients later in this chapter.) Or is it something in between—a special relationship? Broadly speaking, a special relationship is “a non-fiduciary relationship having an element of trust, arising especially when one person trusts another to exercise a reasonable degree of care and the other knows or ought to know about the reliance.” (Black's Law Dictionary, 7th ed.) It refers to the extension of service beyond the basic duties that one owes and gives to clients.

The role that a producer serves and the responsibilities he or she has can be plotted along a continuum like the one shown here. The further along the continuum, the greater the attending legal, professional, and ethical duties.





More Than Just an Agent

An insured contacted his agent to renew his homeowner’s policy, asking for “proper and adequate coverage.” To determine this, the agent used a computerized program that calculated an estimate of the proper level of coverage, as was commonly her practice. After a fire destroyed the insured’s house, the insured discovered that he was underinsured and sued his agent for the amount of underinsurance.

The court ruled that “once the agent, in response to [the insured’s] request for ‘proper and adequate’ coverage, undertook to estimate the replacement value of the property to be insured, she owed [the insured] a duty to perform that estimation with a reasonable degree of care and accuracy.”


It is not unusual for an agent to offer to provide additional services to his or her customers as an integral part of making the sale. Agents should not obligate themselves, however, unless they are prepared to apply the same standards of care to those services as they do to the other aspects of their business.

Stephens v. Hickey-Finn & Co., Inc., 261 A D 2d300, N.Y.S. 2nd 411, 1999.


2.3 - A Range of Possible Roles

While the point at which one might fall on the agent/fiduciary continuum is not always clear, there are a number of indicators:

  • Are you a captive agent, an independent agent, or a broker? Independent agents and brokers are generally regarded as representatives of the insured and, as such, may have a higher duty to their clients.
  • Did the customer choose you because you held yourself out to be a specialist in the area, or did you advertise a special expertise as a result of training and/or experience? This would suggest that the customer is relying on your opinions to a greater degree than he or she would if you were only a salesperson.
  • Did you receive a fee for your professional services? Did you perform any special studies to determine the most appropriate coverage? This would make you more responsible for outcomes than simply accepting an application and a premium check.
  • Is there a history of your making insurance decisions for the policyholder in the past? Have you sold a significant number of similar policies to this policyholder and his or her relatives and business associates so that they have come to regard you as the go-to guy or gal who they rely on to handle insurance matters? Have you provided any assurances that the insured had nothing to worry about and that everything was covered?

So, are you an agent, are you a fiduciary, or do you have a special relationship with the client that falls somewhere in between? The next case study may prove enlightening.


Agent vs. Fiduciary

Sometimes the role of the agent is not clear and ends up being sorted out in court. In one case, an insured had been a client of a commercial insurance brokerage business for five years. A fire in the insured’s warehouse caused over $1.3 million in damages. However, because of a coinsurance provision in the fire insurance policy, the insurer paid only $750,000 against the claim. The client sued the broker for the difference, claiming all of the following:

  • The broker negligently failed to obtain an agreed value endorsement to cover the coinsurance provision.
  • The broker negligently failed to advise the client that an agreed value endorsement should have been obtained.
  • The broker failed to properly advise the client of the effect of the coinsurance provision without an agreed value endorsement.

The broker’s argument was that he did not advise commercial clients as to whether coverages were adequate for their businesses; it was his standard practice to advise clients as to what coverages were available and to let the client determine what amount and what coverage was desired. The insurance policy contained an explanation of the coinsurance provision, providing examples of how it would affect coverage; it also included a statement that an agreed value endorsement could be obtained if the insured completed a business income worksheet. The broker had sent the client a business income worksheet for the renewal coverage; it was never returned. Therefore, according to the broker, the fault was the client’s, not his.

The trial court sided with the broker, agreeing that the uninsured loss was a result of the client’s failure to read and understand the policy. However, the decision was reversed on appeal, in part because the broker was determined to have created a fiduciary relationship with the client. This was evidenced by the fact that while the principal broker testified that his policy was to simply advise clients as to what coverages were available, he also at one time convinced this particular client not to reduce what was then the client’s level of business income loss coverage. The court said, “[The broker] cannot . . . say that it was appropriate to encourage his client to increase coverage in one circumstance and then state he never became involved in a business decision.”


As this case study suggests, it is clear that the appellate court felt that the insured corporation was more than just a customer. It had become a client that relied on the broker to see that it had adequate coverage. As to the broker’s contention that all would have been clear had the insured simply read the policy, there was a summary page that said that the policy provided $1.9 million in coverage for the actual loss sustained, which would have been more than enough to cover the damage. Where the language was confusing and contradictory, and in this case led the insured to believe he was fully covered, the broker had an obligation to provide clarification.

Wanner Metal Worx, Inc. v. Hylant-Maclean, Inc., No. 02CAE10046, 2003.


2.4 - Fiduciary Duties

Now that we have introduced the subject of fiduciaries, let’s explore the concept a little further, beginning with a definition. A fiduciary is “a person who holds a position of trust with regard to the financial interests of another person. A fiduciary must exercise due care in safeguarding the other person’s property or other assets.”

Insurance producers have fiduciary responsibilities obligating them to act in the best interest of their customers and the insurance companies they represent.

A producer’s fiduciary responsibilities to his or her insurer include

  • gathering accurate information on which underwriting decisions can be based; and
  • complying with marketing rules on behalf of the company the agent represents.

Fiduciary duties to customers entail

  • acting only in the best interest of the customers;
  • making product recommendations that best serve the customers’ needs;
  • honestly and accurately representing the features and costs of these products; and
  • providing prompt and conscientious service.

Let’s be more specific.

Agent Responsibilities to the Insurer

Agents are generally the first point of contact between an insurer and a prospect. They are also frequently the main conduit of information between the applicant/insured and the insurance company and may have the responsibility for collecting the premium. Depending on the nature of the insurance product, agents may also have a role to play in resolving any issues regarding a claim.

So, the agent is an insurance company’s critical link to a customer, and much of the success of the insurer’s relationship with the customer depends on how well the agent represents it. As such, he or she owes a number of duties to the insurer.

Professional Representation

Producers owe their companies the duty of professional representation. This goes well beyond simply following the requirements and rules that govern a producer’s activities and market conduct. It means fully knowing the insurer’s products and services and applying them to best suit clients’ needs. Producers must follow their company rules for field underwriting and policy delivery. They must not accept or bind the insurer to any risk or obligation that runs counter to the company’s interest or intent. Agents owe their companies the duty of loyalty and must perform in a manner consistent with the insurer’s goals and objectives.

Due Care and Diligence

Agents must exercise skill and diligence to avoid any negligent act that could expose the insurer to liability. For example, incorrect policy dates, limits of liability, or omissions of endorsements could potentially lead to problems for both insurer and agent. Agents are responsible for tending to the interests of the insurer in a way that a prudent person would tend to his or her own interests and affairs.

Proper Use of Premium Funds

The agent is a fiduciary for all the money received on behalf of his or her customers and his or her insurer in the form of claims payments or premiums and must remit these monies to the persons to whom they are owed in a timely manner. Agents are not permitted to appropriate premiums for their own use (also known as embezzlement), even temporarily, and must remit them to the insurer as soon as possible. Premiums must be kept separate and not commingled with the agent’s personal funds. When an agent collects funds on behalf of insurers with whom he or she does not have appointments, the agent must maintain separate accounts for each of these insurers. When the agent receives premium payments for remittance to the insurer, he or she must use reasonable accounting methods to record funds received in his or her fiduciary capacity, including the receipt and distribution of all premiums due each of his or her insurers.

Complete Disclosure

Insurers rely on their agents to collect and record the information that is used to assess and underwrite policies. If the information provided to the insurer is incorrect or incomplete and it is material in the issue of a policy, the insurer will be liable for covering a risk it might otherwise have rejected. In these situations, the insurer may have cause to sue its agent for negligence. (See “The Agency Relationship” case study coming up.)

Timely and Proper Notification

Normally, agents do not have an obligation or the authority to cancel an insured’s coverage. However, they may occasionally be in a position of having to provide notice to policyowners regarding a change or cancelation of coverage. And in the event that they have accepted some aspect of this responsibility, they may be liable. For example, in one case, the insurer instructed an agent to obtain a flood and landslide endorsement from an insured. If the insured refused to accept the endorsement, the agent was to notify the company, which would then cancel the policy. The agent did neither. He was held liable to the insurer for the insured’s flood damage (Mitton v. Granite State Fire Insurance Co., 196 F.2d 988, 10 Cir. 1952).

Appropriate and Fair Business Conduct

Agents owe their insurers the duty to follow appropriate and fair business practices as set forth by the laws of their states. Virtually every state has adopted some version of the NAIC’s Unfair Trade Practices Act, which specifies prohibited market and business activities such as misrepresentation, false advertising, and other unfair or dishonest marketing practices. We will discuss these in more detail later in this course.

Violations of these duties tend to have severe implications for both insurer and agent. The insurer may be held liable for a risk it did not anticipate as well as for consequential damages ensuing from the malfeasance of its agent. First, the agent can lose his or her contract with the insurer. He or she may also be exposed to license suspension or revocation, fines, and even imprisonment. Finally, the agent may be served with a judgment in a civil suit.


The Agency Relationship

The following case points out that the ability of an agent to bind a principal does not necessarily release the agent from any liability the principal may incur.

An applicant for insurance owned two corporations that operated at the same location. One was a metal and machine part fabricating business (Company A); the other was a semiconductor company (Company B). An agent issued a fire insurance policy to Company A without mentioning Company B in any of the documentation. Company B suffered a fire in its warehouse and filed a claim.

The insurer denied the claim because Company B was not a named insured on the policy. The insured went to court, which held the insurer liable for $385,000. The insurer then sued the agent to recover the money, arguing that the agent had failed to promptly inform the insurer either of the existence of Company B as a corporate entity or of the exact nature of its business. The insurer claimed that, had it known that Company B was engaged in the business of distributing electronic components, it would have declined to issue coverage. Thus, the insurer’s position was that the agent was obligated to indemnify the company because he breached his duties as its agent.

Although the court found both sides to be negligent, it awarded the insurer $52,000. “It reasonably could be concluded that as an experienced insurance agent, [the agent defendant] . . . should have known that for purposes of business interruption coverage, a distributorship of electronic components may be a materially different risk than a manufacturer of metal machine parts and that he should have communicated such facts promptly to [the insurer].”


An agent does not abandon legal responsibility—or liability—when an insurer accepts a case. The agent is required to exercise due care and provide complete disclosure when writing business. Negligence in this area could leave all parties—insured, insurer, and agent—vulnerable to harm.

New Hampshire Insurance Co. v. Sauer, 83 CA3d 454 (1978).

Agent Responsibilities to Clients

In the insurance industry, the area that gives rise to many ethical issues involves the relationship between the producer and his or her clients. Producers, after all, are those who deal directly with clients and prospects. Producers represent the face of the company and the industry in which clients have invested both money and trust. If a client has a problem, issue, or concern, it’s likely that he or she will first contact—or, in some cases, blame—the producer. Though every producer-client relationship is different, certain standards exist that any consumer should be able to expect a producer to render.

The Duty of Service

An agent’s customers have the right to expect professional and competent service. After all, one of the purposes of insurance is to provide customers with relief from worrying about the consequences of an unfortunate event. To one degree or another, the insured transfers this worry to the insurer through its agent. The policyholder needs to know that the agent is up to the task and that he or she regards his or her responsibilities toward servicing customers as an important professional duty. Some of those responsibilities include

  • obtaining the specific coverage the client desires and notifying the client promptly if the agent is unable to do so;
  • informing the client of any specific risk the policy does not cover if the client specifically had mentioned the risk;
  • advising the client with regard to recommended coverage as well as investigating and ascertaining the financial condition of prospective insurance companies;
  • notifying the client of any premature termination or cancelation of the policy;
  • notifying the client of possible financial problems with the insurer that issued the policy;
  • informing the client of possible conditions of an insured’s property that could void the client’s coverage under the policy;
  • keeping the client informed of changes in available insurance coverage; and
  • maintaining a relationship with the client to ensure that, should circumstances or needs change, the appropriate coverage is in place or recommended.
Professional Competence

State insurance laws set education standards for insurance producers. Insurance companies have their own training standards concerning product knowledge. These are minimums, however, and success in the marketplace often requires going further.

To his or her clients, an insurance producer typically occupies the position of expert in a field about which clients know very little. This status undeniably gives the producer credibility and what has been termed justified believability among clients and potential clients. Producers have an ethical obligation to live up to these standards and expectations by maintaining an appropriate level of knowledge regarding the products they are selling and the needs these products address. Depending on the level of product sophistication and the degree of expertise advertised to the public, this may require going beyond the required continuing education courses (compliance) and attaining a higher professional level, such as through CLU, ChFC, or CPCU studies.

As the level of professionalism increases, so does the level of expected service; as the expected level of service increases, so does the required standard of practice and responsibility. It’s in this area that providing the appropriate level of service to a client could pose problems for agents or brokers if they don’t live up to the expectations that they have set. The public expects more from a financial planner, for example, than from a newly licensed life agent. Greater expertise on the agent’s part may lead to a greater passiveness on the client’s part, thus pressing the producer to assume a more active role in the relationship. And, once again, the more active the producer’s role, the greater is his or her responsibility and ethical duty to ensure that the client’s needs and expectations are met.

Standard of Care

Earlier we used the term due care in defining a fiduciary. It is one of the standards to which fiduciaries are held. Like so many aspects of ethics, due care or standard of care cannot be absolutely defined, but they are undoubtedly responsibilities that producers have. When acting as a professional—a standard that clients expect—a producer is required to apply the level of care and service that is obtained through specialized knowledge, training, skills, and experience. A client has a right to depend on an insurance producer to apply that knowledge and skill to the very best of his or her ability and to assume that the producer is acting in the client’s best interest.

Due care is often defined by the so-called prudent man (or prudent person) rule: “the care, skill, and diligence that would be exercised under similar circumstances by a reasonably prudent person who is familiar with such matters.” As an insurance agent, you are presumed to be familiar with such matters. When working with an insurance consumer, ask yourself if you would follow the same course if you were in his or her situation.


Standard of Care

The devastation wrought by Hurricane Katrina left many gulf coast residents homeless and seemingly without recourse. Insurers argued that much of the damage was flood-related and was therefore not covered by homeowners’ policies (an issue that is still being argued in the courts). Many homeowners did not carry flood insurance that would have covered such damage. While there is no doubt that many of these cases involved bad judgment on the part of the homeowners, in some instances, the finger of blame pointed elsewhere.

In one case, it was charged that an agent specifically told policyholders not to buy flood insurance, and as a result, they suffered losses from the hurricane. The agent’s rationale was that unless flood insurance was required as a condition for obtaining a mortgage, there was no need to buy it. That the agent made these recommendations was not disputed.

Most of the court’s scrutiny centered on the wind versus water issue. The agent’s role in the affair was dispensed with a finding that

“There is no evidence in the record to establish the standard of care applicable to an insurance agent who is asked about the advisability of purchasing flood insurance.”

The court agreed that the agent had given an advisory opinion and that the insured would have relied on that opinion, but the court still found no evidence that the opinion was given negligently or that it was a misrepresentation.

The court went on to say:

“There was no testimony that established the standard of care for insurance agents in connection with the sale of flood insurance policies, and there was no testimony that established the standard of care for the training of insurance agents who are authorized to sell and interpret flood insurance policies.”


After reading the facts of this case, it is unlikely that plaintiffs’ lawyers in future claims disputes will neglect to introduce evidence about the agent’s standard of care regarding recommendations on the adequacy of coverage. Had the plaintiff’s lawyers in this case done so, the findings might have been different. Compare the holding in this case to that of the case mentioned earlier in this course, where the insurance agent underestimated the value of a house and was held liable for the amount of underinsurance.

Leonard v. Nationwide Mutual Insurance Company, United States District Court of Mississippi Southern Division, CIVIL ACTION NO.1:05CV475 LTS-RHW, August 15, 2006


2.5 - The Issue of Negligence

While failures in living up to the duty of care can be willful, more often they are the result of simple negligence. Many of the issues stemming from negligence are not those associated with malicious or gross intent, but rather with neglect or carelessness, leading ultimately to underperformance. One legal definition of negligence focuses precisely on this. It defines negligence as “the failure to exercise the degree of care considered reasonable under the circumstances, resulting in an unintended injury to another party.”

The opportunities for negligence can be traced along the full length of the insurance transaction, beginning with the application:

  • The agent fails to communicate with the client regarding necessary information or timetables for securing coverage.
  • Through ignorance or inattentiveness, the agent leads the insured to believe that adequate coverage is in place when in fact it is not—it is either inadequate or not in place at all.
  • Through a lack of attentiveness or care, the agent fails to advise the client that additional coverage is necessary or available—in other words, he or she fails to keep the coverage up to date.
  • The agent fails to advise a client of the need to renew, or of a policy’s imminent cancelation and the need to acquire alternative coverage.
  • Through ignorance or inattentiveness, the agent improperly counsels the client on the information necessary for the insurer’s evaluation of the risk.

Consider, for example, the following two scenarios:

  • An agent writes a $300,000 life insurance policy and gives the applicant/insured a binding receipt. The agent explains that the receipt provides coverage from the point of application through the underwriting period, but neglects to mention that it limits the insurer’s liability during this period to $100,000. Before the insurer is able to determine the insured’s eligibility for coverage, the insured is killed in a car accident. The insurance company pays the policy’s beneficiary $100,000. The insured’s beneficiary sues the agent for the full $300,000.
  • An agent writes a workers’ compensation policy on a house painter who owns and operates a small painting company. After having insured the business for some time, the insurance company decides not to renew the coverage. The notice of nonrenewal is sent to the agent for delivery to the client. The agent sets it aside, and it soon becomes buried and forgotten. Three weeks after the policy expires, an employee of the painter falls from a ladder and is seriously injured.

In both of these examples, the wrong done to the client was not intentional; it was simply the result of carelessness or neglect—a breach of the duty of care.


Breach of Due Care

A husband and wife had health insurance through the husband’s employer. When the husband’s employment was terminated, the couple contacted an agent to determine whether they should purchase new health coverage or extend their previous employer-provided coverage through COBRA. They met the agent in person. He recommended that the couple purchase a new policy and provided them with an application form.

The application included detailed questions about medical history. The husband noted on his application that he had undergone heart surgery three years earlier. The wife indicated that she had merely undergone routine exams. In discussing the effect that the husband’s heart surgery would have on the application, the wife informed the agent that she had been told by physicians for many years that she had a functional murmur. She asked the agent whether she should include that fact on her application. The agent inquired whether she had ever been treated or prescribed medication for this condition. Based on the wife’s response that she had not, the agent instructed the wife that it was not necessary to note the functional murmur on the application form.

Following submission of the application, the insurance company declined coverage to the husband due to his heart condition but issued a policy to the wife. With this coverage, the wife terminated her existing health coverage provided by her husband’s former employer. Six months later, the wife underwent heart valve replacement surgery. The $40,000 in medical expenses was submitted to the insurer. The insurer denied the claim and provided notice that it was rescinding the policy, retroactive to the issue date, on the grounds that the wife’s adverse health condition had not been disclosed on the application. The insurer stated that, had it known of this condition, it would have only issued the policy had the wife agreed to an exclusion rider for all heart conditions.

The wife filed suit against the insurer, alleging wrongful rescission, breach of contract, and fraud. The trial court ruled in favor of the insurer, citing the following:

  • There was a material misrepresentation or omission of fact in the insurance application (well-established grounds for rescinding a policy).
  • The wife’s signature on the application renders the agent’s advice—and the wife’s reliance on that advice—irrelevant.
  • The applicant is responsible for any material misrepresentation or omission, regardless of the agent’s capacity or role as an agent.
  • False representations that mislead concerning a material fact will void an insurance contract, regardless of whether the misrepresentation was made innocently or with fraudulent intent.

In this case, though the trial court found in favor of the insurer, there is little doubt that the problem and conflict stemmed from the advice the agent gave to the applicant. In all probability, the advice was rendered in good faith—it is likely that the agent truly believed that disclosing the condition of the functional murmur on the insurance application was not necessary. Unfortunately for the client, the advice turned out to be disastrous. The agent should have rendered a higher degree of due care and verified with the insurer whether this condition should have been disclosed on the application. Had the agent done so, and had the agent ultimately informed the applicant that her condition would not be insurable, she may have determined to continue her coverage through COBRA. It’s not difficult to imagine the impression that this couple has of the insurance business and insurance agents.

Ila R. Jesse v. American Community Mutual Insurance Company, on appeal from the Allen Superior Court, Cause No. 02D01-9801-CT-35, 2000


2.6 - Chapter Summary

Agents must be aware of the kind of relationship they have or create with their clients. The higher the level of service rendered, promised, or implied, the higher a client’s expectations will be and the greater the service mark the agent must meet. The range of an agent’s role in a client relationship can extend from that of agent to special relationship to fiduciary. Fiduciaries hold a position of trust with regard to the financial interests of another and must exercise due care in safeguarding those interests. While failures in living up to the duty of due care can be willful, more often they are the result of simple negligence. Many of the issues associated with negligence are the result of simple carelessness or inattentiveness, leading ultimately to underperformance.


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3.1 - Ethics in Practice

We have looked at ethics and compliance in fairly general terms. In the balance of this course, we will get more specific. The following pages deal with many of the areas of compliance that an insurance professional would encounter in marketing insurance and financial products and services. We then move beyond the written rules to a more general application of ethical principles. The insurance producer has ethical obligations to all parties in an insurance transaction: the policyholder, the insureds, the beneficiaries, and the insurer.

Upon conclusion of this chapter, you should

  • be familiar with the body of activity broadly defined as “unfair marketing practices”; and
  • understand the importance of integrating ethical standards and benchmarks into your day-to-day business practices.
3.2 - Unfair Marketing Practices

A substantial body of state insurance law focuses on unfair insurance trade practices. Every state has enacted regulations that define certain activities as unfair in the business of insurance and that prohibit their practice. These regulations, which apply to both producers and insurers, are intended to protect the public from unfair methods of competition and unfair and deceptive acts or practices in the marketing of insurance.

The following is a partial list of unfair marketing practices. Later we will discuss other unfair marketing practices that warrant further elaboration. Unfair marketing practices include

  • passing off services as those of another;
  • causing a confusion or misunderstanding concerning the source, sponsorship, approval, or certification of services offered;
  • causing a confusion or misunderstanding with respect to the affiliation, connection, or association with another;
  • using deceptive representations or deceptively misrepresenting the state in which one is selling services;
  • representing that services have sponsorship, approval, characteristics, or benefits when, in fact, they do not;
  • making false or misleading representation regarding the services or the business of another;
  • advertising services with the intent of not selling them as advertised;
  • advertising services with the intent of not supplying a reasonable and expectable public demand unless the advertisement discloses a limitation on quantity;
  • representing that an agreement confers or involves rights, remedies, or obligations that it does not have or that are prohibited by law;
  • misrepresenting the authority of a salesperson or an agent to negotiate the final terms or the execution of a transaction;
  • inducing a consumer into a transaction by failing to disclose information, when the consumer would not have otherwise entered the transaction had the information been disclosed;
  • advertising under the cloak of obtaining sales personnel when, in fact, the purpose is to first sell a service to the applicant;
  • making false or misleading statements concerning the price or the rate of services;
  • employing bait-and-switch advertising in an effort to sell services other than those advertised. Bait-and-switch is a deceptive trade practice in which a person advertises or offers one product as a lure to sell something less desirable. For example, an insurance company could advertise attractive rates that are not really available. Then, when consumers inquire about these rates, they are told that they do not qualify for the best rates. The agent then attempts to sell them a more expensive service.
  • requiring tie-in sales or other undisclosed conditions that must be met before selling the advertised services. Tie-in means that to purchase something a consumer wants, he or she is required to buy something else as well. An offer must stand on its own and must not be conditional on something else.
  • refusing to take orders for advertised services within a reasonable time;
  • advertising services that are guaranteed (“you can’t be turned down”) without clearly disclosing the nature and the limits of the guarantee; and
  • placing an inferior or unnecessary product that does not meet the client’s needs solely for the purpose of meeting a sales quota or increasing commissions.
FINRA: Fair Dealing with Customers

In addition to the rules on unfair marketing practices promulgated by the states, sales of variable insurance products are also governed by federal securities laws and FINRA (Financial Industry Regulatory Authority) rules on fair dealing with customers. Dealing fairly with the public means engaging in sales efforts that conform to high ethical standards. Fair dealing can also reasonably be said to mean treating customers fairly. While many of the specific FINRA rules apply more directly to the sales of stocks and bonds than to insurance contracts, fraudulent activity can occur in any of these areas. Fraudulent activities include

  • establishing fictitious accounts;
  • executing transactions that are unauthorized by customers;
  • sending confirmations to cause customers to accept transactions not actually agreed upon; and
  • using or borrowing customers’ funds or securities without their authorization.

Other fraudulent acts include forgery, nondisclosure or misstatement of material facts, manipulations, and various deceptions.

3.3 - Ethics in Practice

Adhering to a professional code of ethics requires a producer to incorporate high standards of practice into his or her daily business activities. Ethics in theory becomes ethics in practice. At every phase of the sales cycle—from prospecting to policy delivery to follow-up service—the producer must define and abide by the principles and practices that

  • bring the producer in contact with those who have a true need for the products and services the producer represents;
  • guide the selection, presentation, and recommendation of appropriate, suitable products that meet the need and benefit the consumer; and
  • support and sustain ongoing relations and service opportunities.

The remainder of our discussion focuses on activities that must be avoided and the standards of market practice that must be integrated into the principal aspects of the selling process. To this end, we will examine the ethics attending to

  • soliciting customers;
  • selecting and recommending products; and
  • servicing the client.
Soliciting Customers

In the course of soliciting customers, an agent owes honest representation to prospects concerning

  • who he or she is;
  • the company he or she represents; and
  • the types of products and services he or she provides.

Consumers must know that they are dealing with an insurance company and are being solicited or contacted to buy insurance products. Company representatives must clearly indicate to prospective insureds that they are acting as insurance agents or producers with regard to insurance products and identified insurers.

False Advertising

The first point of contact with a prospect may well be a promotion or advertisement in any of the following ways:

  • in a newspaper, magazine, or other publication;
  • in a notice, circular, pamphlet, letter, or poster;
  • over a radio or television station;
  • over the Internet;
  • through a cold call; or
  • through a referral.

While most insurance companies exercise strict controls over the advertising of their appointed agents, noncaptive producers have more latitude and may be tempted to take liberties. There are strict prohibitions, however, against distributing an advertisement or announcement containing an untrue, deceptive, or misleading statement regarding the producer, insurer, or insurance product.

More specifically, this means that ads may not

  • conceal the true identity of the insurer;
  • mislead the public as to the true role of the agent;
  • misrepresent the product as something other than insurance; or
  • provide incorrect information regarding the product’s features or benefits.

For example, Harlan was pleased with a flier he created for a product he named the Triple Protection Plan. He touted it as an investment program that would provide benefits at retirement as well as benefits if the investor should die or become disabled before retirement age.

What Harlan was actually selling was a cash value insurance policy that

  • was paid up at 65;
  • provided a death benefit; and
  • included a waiver of premium that would waive premium payments if the policyholder became disabled.

At no point did he mention any of this information or the subject of insurance in his flier, nor did he identify himself as an insurance agent. Instead, he called himself a “retirement consultant.”

Ethics demands that producers openly and honestly identify themselves and the product or products they represent. The following describe other types of false or prohibited advertising.

Deceptive Name or Symbol

In most states, insurance ads are prohibited from using, displaying, publishing, circulating, or distributing any name, symbol, slogan, or device that is the same as or similar to a name adopted and already in use.

Defamation and Disparagement

Defamation involves making false statements, written or oral, that are derogatory and are intended to injure an insurer or person engaged in the insurance business. An agent or insurer might defame another agent or insurer by spreading false information regarding the integrity or financial condition of a competitor. Ads cannot contain statements that are untrue in fact or misleading by implication with regard to another insurer’s assets, corporate structure, financial standing, age, or relative position in the insurance business. In addition, an advertisement cannot unfairly disparage competitors or their policies, services, or business methods, nor minimize competing methods of marketing insurance (such as agent versus direct response).

Unfair Comparisons

An advertisement cannot make an unfair or incomplete comparison of policies, benefits, dividends, or rates, or compare noncomparable policies (such as term to whole life). Any ad that compares policies of different insurers should indicate the source of the information and whether it did not come from the competitor.

Unlawful Inducement

An advertisement cannot imply that a policy comes with a valuable guarantee or contractual right that is not expressly contained in the terms of the contract offered in the advertisement. In addition, an ad cannot convey the idea that an organization such as a charity will benefit from the purchase of a contract by implying that any part of the premium will be applied as a contribution to that organization.


Selling Insurance to Soldiers

Characterizing life insurance premiums as “savings” or “an investment” was fairly common many years ago. Over time, the practice fell out of favor given the implications it posed for consumers. Today, such characterization is generally prohibited, but the practice continues to surface. In 2004, it was reported that some financial companies had used misleading or improper sales tactics to sell insurance to military personnel, many of whom were about to be deployed to Afghanistan and Iraq, or that they had promoted products like high-cost life insurance and contractual plans, which were ill-suited to these consumers’ financial needs. (Under contractual plans, mutual fund shares are purchased in monthly installments over 15 or 20 years. Sales charges are so steep—up to 50 percent of the first-year contributions—that they have almost disappeared from the civilian market.)

The sales were orchestrated through meetings—sometimes compulsory—where soldiers were encouraged to purchase high-cost products from salespeople under the guise of financial planners working on the soldiers’ behalf. The agents were sometimes introduced as the “unit insurance counselors” or “veterans’ benefits counselors” and would then give a presentation on a savings plan that would be deducted from the soldiers’ pay. The implication was that the plan was endorsed by the military and that the insurance agent held an official position. The soldiers were often left with the impression that they were entering into a savings program, that the interest stated in the policy was applied to gross insurance premiums, and that there was no cost for the death benefit. Rarely was the term “life insurance” mentioned.

As a result of these and other abuses, Congress enacted the Military Personnel Financial Services Protection Act in 2006, which bans the sale of contractual mutual funds on military bases and grants state insurance commissioners explicit authority to regulate insurance sales to military personnel on bases in the United States and abroad. State insurance commissioners quickly implemented new laws that make it an unfair marketing practice to do any of the following:

  • imply endorsement by the federal government or the Department of Defense;
  • sell a policy to a serviceperson that excludes coverage as a result of war; and
  • engage in other practices that have resulted in the sale of unsuitable contracts to military personnel.

This example points to several ethical issues. First is the issue of ethics versus compliance. Although some of the sales tactics (such as soliciting soldiers in their barracks) violated Department of Defense regulations and, in some cases, the insurance companies’ own procedures, there was ultimately nothing illegal about what the salespeople were doing. However, the practice was deemed to be harmful, hence, the need for legislation. At the time, state laws on unfair marketing practices did not apply to federal facilities. Therefore, the agents were technically in compliance. However, ethically speaking, what they were doing was highly questionable.

In addition, the agents violated a basic ethical principle by not being honest about who they were and what they were offering. They did not identify themselves as insurance agents and often made no reference to life insurance as the product they were selling.

Finally, the products the agents were selling were unsuitable for their customers. They not only cost far more than similar products available to buyers in the civilian market but also offered little in near-term benefits to young persons with limited funds who were engaged in highly dangerous, life-threatening work.

Recommending Products and Services

The second category of unfair practices involves those that occur during the actual sales process. These generally involve practices that induce a person to purchase a policy that he or she would not have bought if there had been an honest presentation and he or she had known all the facts.

Proper Identification

In the course of soliciting or placing individual life insurance policies, producers are required to provide their clients with certain specific information. The client must be informed that the producer is acting as an agent, and the producer must provide the full name of the insurer he or she represents. The producer may not describe him- or herself as a financial planner, investment advisor, financial consultant, or financial counselor when he or she is in fact acting in the capacity of a salesperson.

Prohibited Compensation

An insurance producer cannot receive compensation for the sale, solicitation, negotiation, or renewal of any insurance policy for which the producer, for a fee, acts as an insurance consultant unless he or she provides a written agreement to the client that discloses that the insurer will pay a commission to the consultant on any insurance placed. Even then, the practice of accepting consulting fees and commissions from the same client is subject to special scrutiny. The potential for a conflict of interest is obvious here: being paid for a professional recommendation and being paid again when that recommendation is “buy from me.” The following case study illustrates this point.


Employee Benefit Plans

Earlier we provided some general rules regarding how a person moves from being simply an agent to the higher level of fiduciary. In some areas, however, the law is very explicit as to what makes an agent a fiduciary. One such area is employee benefit plans.

ERISA is a federal law that governs employee benefit plans (like pensions and welfare plans) and explicitly supersedes state laws pertaining to—among other things—insurance agents and their relations to these plans. ERISA provides three alternative definitions for a fiduciary. The term “fiduciary” includes

  • those with discretionary authority or control over the management of the qualified plan or the disposition of its assets;
  • those who render investment advice for a fee or other compensation; and
  • those who have discretionary authority or responsibility in the administration of the plan.

Classification as a fiduciary is not limited to individuals. It can also apply to plan administration companies, consulting firms, and insurance companies. The law specifies certain prohibited transactions between “parties in interest” (such as a fiduciary) and the plan, which includes the sale of property to the plan. In old-fashioned terminology, the idea is to prevent conflicts of interest for persons who play more than one role with respect to the plan.

This could cause complications for insurance companies and their agents, who are often involved in the design, implementation, and administration of employee benefit plans (which generally involve fees), as well as selling commissioned products to the plan. There is a special exemption, however, for the sale of insurance products in the normal course of business, provided the fees and commissions are reasonable. If these conditions do not apply, the agent may be deemed to be a fiduciary and held liable for any losses to the plan.

So, that gets us back to our basic question for an insurance company and its agents: “When does the agent cross the line from being merely a seller of insurance to becoming a fiduciary?”

In one case, an insurance agent owned two companies, one of which provided consulting to a union health and welfare fund plan; the other sold insurance to the plan. During the two and a half years after the agent became the fund’s consultant, the fund spent nearly $1 million in premiums on the purchase of life insurance. The agent and his companies received over $550,000 in commissions. The Department of Labor sued the agent on behalf of the fund and its members, alleging fiduciary breach and other violations of ERISA. The court held that the agent was a fiduciary because he exercised discretionary authority and control over assets in the fund.


Even though the agent did not have actual authority or control, his dual role as consultant and insurance agent and the low level of sophistication on the part of the fund’s trustees made his recommendations the same as fund policy—in essence, de facto control. Accordingly, that level of indirect control made him a fiduciary. As such, the agent violated his duty to the plan participants in not putting their interests first. He did so by

  • recommending an unsuitable investment (whole life insurance) solely for the purpose of producing the maximum in commissions;
  • receiving unreasonable compensation himself (collecting sums in excess of the premiums and paying it to himself); and
  • failing to disclose fees or commissions as well as the basis for his recommendations.

Even though this case was brought under the specific provisions of ERISA, it could just as easily have been argued under other legal auspices. Either way, it is clear that the relationship violated the client’s misplaced trust in the agent to do the right thing.

Reich v. Lancaster, 55 F.3d 1034 (5th Cir. 1995)


Misrepresentation occurs when an insurer or its agent provides a customer with information that is untrue, deceptive, or misleading. This may take the form of an advertisement, sales literature, illustrations, or oral statements. A violation occurs when any method of marketing fails to disclose in a conspicuous manner that its purpose is the solicitation of insurance. Knowing or purposeful misrepresentation can result in loss of an agent’s license or an insurer’s certificate of authority.

Among other things, misrepresentation can mean making false or misleading statements regarding

  • the terms, benefits, advantages, or conditions of an insurance policy;
  • the dividends to be received or that were previously paid on an insurance policy;
  • the true nature of an insurance policy or class of insurance policies, e.g., by using a misleading name or title of the policy or class of policies. In the case of life and annuity products, the agent cannot make any representations that characterize the product as something other than insurance, such as “investment plan,” “expansion plan,” “profit-sharing,” “charter plan,” “founders’ plan,” or “surplus-sharing,” nor can it be implied that the customer is purchasing shares of stock instead of insurance.
  • the suggestion to a customer that his or her purchase makes him or her part of a limited group that will enjoy special benefits not available to other customers.
Insurance Fraud

Insurance fraud involves submitting false information or concealing material information with the attempt to mislead in the process of applying for insurance coverage or filing a claim for benefits under an insurance contract. It also refers to taking assets or records from an insurer or diverting funds from an insurer.


Replacement of one insurance policy with another is a matter of particular regulatory and ethical concern, notably with life insurance policies and annuities. Replacement may be permissible if done properly; if done improperly, however, the replacement could very well be illegal. Because of this, the practice is worth examining more closely.

Sometimes it is in the customer’s best interest to replace one or more existing policies with another policy. The reason may be

  • to increase the amount of coverage without adding on another small policy;
  • to reduce the customer’s premium by changing to a lower-cost policy;
  • to obtain contract features or provisions not available in the existing contract; or
  • to take advantage of other consumer benefits that are unavailable with existing coverage.

In some cases, however, agents have orchestrated changes that were not in their clients’ best interests simply to generate sales commissions. The practice of providing misleading information to induce a client to replace one policy with another—or to deplete an existing policy of its cash value and apply it to another—to increase commissions is prohibited by law in all jurisdictions. Depending on the situation, this practice is known as either twisting or churning:

  • Twisting is when one insurer’s policy is replaced by one from another insurer.
  • Churning is when the existing and replacement policy are both issued by the same insurer.

Either way, the improper replacement of insurance policies is strictly prohibited. One way to protect the public from these practices is to require that all parties to the transaction—including the applicant, the replacing insurer, and the existing insurer—are informed that a policy is being replaced.

Failure to Disclose

Allegations of failure to disclose are the source of many legal actions against insurance companies and their agents. In one respect, agents and brokers are taught to promote the virtues of their products and not to point out the disadvantages. However, most insurance agents are not eager to explain the intricacies of policy exclusions. Any allegation of failure to disclose requires the consumer/plaintiff to prove that the undisclosed information was important and would have influenced his or her decision to purchase. The consumer must also show that the insurer-defendant intended to induce him or her into a transaction that he or she would not have otherwise entered. Knowledge and intent are the necessary elements of the failure to disclose.

Negative Options/Roll-Ons/Sliding

Most insurance contracts come with offers of additional coverage, generally in the form of optional riders that the insured may choose for an additional premium. A negative option or roll-on may provide additional or changed coverage as well. The insurance becomes effective and the additional premium is charged unless the insured actively rejects the coverage.

The use of a negative option or roll-on where not specifically prohibited by statute generally constitutes an unfair method of competition or an unfair or deceptive act or practice in the business of insurance.

Sliding occurs when an agent sells an applicant a coverage or product without the applicant’s knowledge or informed consent. This can take the form of

  • persuading an applicant that an additional product or policy feature is required by law when it is not;
  • telling the applicant that an additional product or policy feature is included at no additional cost when there is an additional charge; or
  • adding a product or policy provision and charging the policyholder without obtaining his or her consent.

The issue of suitability is of particular importance in the sale of financial products. Referring to the relationship between a customer’s needs and capabilities and a producer’s product recommendation and placement, suitability is the foundation of market conduct practices. It requires that all product recommendations and sales are suitable for the customer based on his or her needs, circumstances, and abilities (financial and otherwise). Accordingly, the producer must strive to answer all of the following questions:

  • What are the client’s needs?
  • What product or products best address those needs?
  • Does the client completely understand the product and its provisions?
  • Does the client understand and accept the product’s limitations?
  • Is the product in the client’s best interest?

The issue of suitability has significant application in the life and health insurance arena. For these products particularly, regulatory authorities have implemented strict suitability requirements. For example, when recommending the purchase, sale, or exchange of any variable life insurance or variable annuity contract, both state insurance law and FINRA suitability rules apply. Generally speaking, these laws and rules require that there be reasonable grounds for believing that the recommendation is suitable for the customer. That recommendation should be based on facts that the customer discloses regarding his or her other security holdings, financial situation, and needs. To establish those grounds, before the sale, the representative must make reasonable efforts to obtain the customer’s:

  • financial status
  • tax status
  • investment objectives
  • other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer

Generally, gathering this information involves a detailed questionnaire that establishes the customer’s:

  • tolerance for risk
  • need for income
  • other sources of income and emergency funds
  • other factors that could influence the investment or insurance recommendation

Failing to obtain this information or failing to make a recommendation that is suitable and appropriate based upon such information can lead to the reversal of the transaction and penalties for the seller.

Another FINRA rule regarding suitability is “Recommending Purchases Beyond Customer Capability.” This rule applies when the seller continues to recommend the purchase of securities in amounts that are inconsistent with the reasonable expectation that the customer has the financial ability to meet such a commitment. This scenario is closely related to the suitability requirement.

Finally, some states have rules affording additional protection for senior citizens with regard to the sale of life insurance and annuities. There are also special notification rules that apply to applicants for Medicare supplement insurance and long-term care insurance.

Boycott, Coercion, and Intimidation

It is unlawful in most states to enter into any agreement to commit an act of boycott, coercion, or intimidation that results in a monopoly or in the unreasonable restraint of the insurance business.

Unfair Discrimination

Unfair discrimination can occur if insureds of the same class and risk are charged different premiums or other rates or receive differing dividends or other policy benefits. It can also occur if the insurer refuses to insure, refuses to continue to insure, or limits the amount of coverage available to an individual or risk because of any of the following:

  • race, color, creed, marital status, sex, or national origin;
  • the residence, age, disability, or lawful occupation of the individual or the location of the risk, unless there is a reasonable relationship to the risk (though insurers may specialize in or limit transactions of insurance to certain occupational groups); and
  • previous denial of insurance coverage by an insurer.

While the decision on whether to accept a risk is generally up to the insurance company’s underwriting department, the agent should always be aware of the possibility or occurrence of unfair discrimination. Within the past few years, several major insurers have been sued for charging race-based premiums for burial policies in the South, in some cases charging applicants of color 40 percent more than comparable protection would have cost other applicants. Similar complaints have been lodged against homeowners’ insurance carriers for redlining—either charging more for coverage in certain areas or refusing coverage altogether. In some of these cases, agents had been trained to help implement these policies and were knowing participants in the violations. Like an insurer, an agent has the duty to avoid unfair discrimination. Paying more attention to ethics would probably have helped some agents avoid these violations.


We have equated ethical conduct with trust. One of the things an agent is entrusted with is personal confidential information about his or her clients. This information is used in the underwriting process to help the insurer decide if it will assume a risk and how much to charge for it.

The concern with privacy in general has encouraged various legislatures to enact privacy laws, among them:

  • the NAIC Model Privacy Acts, adopted by most states;
  • the Health Insurance Portability and Accountability Act; and
  • the Gramm-Leach-Bliley Financial Services Modernization Act.

Generally, these acts have the effect of protecting personal, financial, and health information by

  • restricting the dissemination of this information to those parties who have a need to know it;
  • requiring disclosure to applicants about the reason the information is being gathered and the persons who will have access to it;
  • affording a means for customers to correct misinformation; and
  • providing customers with the right to place additional limits on distribution of this information to third parties.

The agent is the conduit through which much of this information is transmitted. Because revealing certain types of customers’ personal information can be detrimental, maintaining confidentiality is one of the agent’s more important ethical responsibilities.


The Vanishing Premium

Sometimes unfair marketing practices become widespread, forcing the authorities to adopt new regulations to put an end to them. One such practice involved the marketing of individual life insurance policies—generally universal life policies—using “vanishing premium” sales illustrations. The key selling point was that the interest earned on the policies’ cash values would accumulate to the point where the policies would be paid up after a relatively short period of years, and no further premium payments would be required.

This sales approach was popular in the 1980s, following dramatic events in the money markets. In 1979, to get inflation under control, the Federal Reserve instituted new monetary policies that resulted in a sharp rise in interest rates. The prime rate nearly doubled from 10 percent in 1978 to almost 20 percent in 1980. Seizing on these higher numbers, many agents incorporated them into their sales illustrations, showing clients how the rapid accumulation of interest or dividend earnings could lead to a policy that would pay for itself in perhaps less than ten years.

The illustrated policy interest rates were atypical and completely out of line with historical trends. By 1985, the prime rate had dropped to pre-1979 levels and continued to fall for the next decade. While the policyholders continued their scheduled premiums for the number of years illustrated by the agent, the insurance companies were quietly reducing their interest rates or dividends to lower but more realistic levels—in some cases to less than 5 percent. About the time the policyholder was expecting to stop making premium payments and let the policy pay for itself as represented, he or she would be informed that things hadn’t turned out as predicted. These policyowners were told that they must either continue making premium payments for many more years or risk having the insurance policy lapse for nonpayment. As one would expect, most of these policies lapsed.


Not all universal life sales turned out this way, of course. Some agents took the longer and more ethical view, basing their illustrations on the average rate levels before 1979. In doing so, they spared their clients unpleasant surprises, retained their reputations, and probably avoided nasty lawsuits as well. (Note that vanishing premium policies are no longer marketed, and states now impose limits on the maximum rate of return that may be used in a policy illustration.)

Servicing the Client

Much of the foregoing discussion has focused on ethical conduct in approaching the client and in making the sale. However, ethical obligations do not stop once the prospect becomes a policyholder. The ethical producer recognizes that the client relationship does not end with the sale. He or she strives to preserve and foster the relationship with continued follow-up and service. The client should be able to expect that the producer is willing to answer any questions or address any concerns or complaints with regard to the coverage that he or she purchased.

Periodic Reviews

An important part of an agent’s duty to his or her clients is to provide ongoing reviews of the coverage that was placed. Certainly, the agent who has assured his or her client that coverage is adequate has a duty to periodically review that coverage in light of the client’s changing situation and to suggest additional coverage if necessary. He or she is also obliged to communicate information concerning an anticipated cancelation.

With regard to changing or upgrading coverage, life producers in particular must be wary of unnecessary or questionable contract replacements or exchanges. Though the many new features and provisions now available with life and annuity products might encourage replacements, the producer is bound to ensure that such transactions will provide additional benefits to the client. The producer must be certain that any advantages a new policy or contract might provide outweigh the costs of giving up an existing plan. In addition, the prohibitions on selling unnecessary or unsuitable products solely to generate commissions remain in effect.


Dividend Accumulations

As is usual with compliance measures, the rules and regulations tend to be quite specific, leaving room for the clever and unscrupulous to circumvent them. One such situation involved an unethical marketing practice and existing life insurance clients.

One of the options available to participating cash value policyholders is to apply their policy dividends to the purchase of paid-up additions to increase coverage. An alternative is to let dividends remain with the insurer to accumulate at interest, an option known as dividend accumulations. At one time, agents for some insurers would comb the records of existing policyholders, looking for those who had significant sums of dividend accumulations. They would then approach these clients about applying their accumulations to the purchase of new, commissioned policies—a loophole in the replacement rules. In some cases, the full amount of client accumulations was applied to first-year premiums on new policies. This afforded the agent a hefty first-year commission but left the insured with the prospect of a lapse when the second year’s premium came due, and there was no money to pay for it.


Insurance regulators eventually caught up with this practice, but many insureds saw their dividend accumulations disappear into agent commissions before the curtain was lowered on this practice. By ignoring perhaps the most important ethical principle—that clients’ interests always take priority over those of the agent—these unprincipled agents violated their clients’ trust. They not only ignored their clients’ financial needs and left them the poorer for it, but also failed to point out an option within the existing contract for acquiring additional insurance if the customer needed it.

Claims Duties

Perhaps the most important area of dealing with existing customers concerns the processing of claims. After all, when a claim is presented, the policyowner is asking the insurer to fulfill the promise the policy represents. While claims are generally administered through a claims department of the home office, policyholders frequently look for assistance from the agent who sold them the policy. Indeed, some insurance companies promote the involvement of their agents at claims time in their advertisements.

With that in mind, agents should be familiar with their companies’ rules on handling claims as well as state laws on unfair claims practices. While the list is lengthy, the unfair claims practices can be grouped into the following major categories:

  • failing to respond to a claim promptly or failing to respond at all;
  • misrepresenting the terms of the policy so as to deny liability when in fact the policy calls for payment of the claim; and
  • stalling or unreasonably denying claims so regularly that the insurer is a frequent subject of complaints or lawsuits.

As with other relationships with customers, the processing of claims imposes duties on the insurer and its representatives. By now it should be clear that the same kinds of ethical standards apply in all stages of the insurance process from beginning to end—from the point of application to the time the claim is paid.

The duties owed to insureds, beneficiaries, and third-party claimants when a claim is filed are summarized in the following sections.

Duty of Care

As was explained earlier, the duty of care is associated with a standard of that care. To paraphrase the “prudent man” rule, an insurer’s standard of care is measured by whether another insurer, under the same or similar circumstances, would have acted in the same way in delaying or denying a claimant’s benefits. The measure of the duty of care is the degree of care and diligence that a person of ordinary care and prudence would exercise in the management of his or her own business.

With the payment of claims, the duty of care requires the insurer to perform its obligations with care, skill, reasonable expedience, and good faith. However, the duty of care does have limits. For instance, the courts have held that the insurer is not financially obligated to a third-party claimant (a claimant who files claims against the insurer’s policyholder). This rule applies even if the claimant is one of its own insureds who presents a claim against another of its insureds. Within the context of such a situation, the third-party claimant is a third party first and an insured second.

Duty of Good Faith and Fair Dealing

All insurers have the duty of good faith and fair dealing. The courts have upheld this duty many times, because the insurer has the advantage in the claims-handling process. This advantage creates a special and unequal relationship. In some states, a liability insurer can be liable to an insured for damages exceeding a judgment if the company does not exercise good faith in dealing with a third-party claim.

Implicit in the duty of good faith and fair dealing is the obligation to avoid bad faith. Unfortunately, bad faith is a part of almost all insurance disputes today. The most common assertions of bad faith are when the insurer denies a legitimate claim or delays paying a claim. Urging a claimant not to retain legal counsel is also considered to be in bad faith.

To determine bad faith, a two-part analysis is used:

  1. First, the insured must prove that the insurer’s conduct was unreasonable.
  2. Second, the insured must prove that the insurer intentionally denied a claim or intentionally delayed paying a claim while knowing it to be valid.

Bad faith cannot exist as long as the insurer has a reasonable basis for denying or delaying a claim.

In addition to the duties we’ve examined so far, there are several more that apply to insurers specifically at the time a claim is filed. Producers should be aware of these duties so that they can advise and counsel their clients appropriately.

Duty to Defend

The duty to defend arises from the liability insurance policy contract. An insurer has the duty to defend any suit against one of its insureds that seeks damages resulting from bodily injury or from damage to property. This duty to defend stands even if the allegations of the suit are considered to be groundless, false, or fraudulent.

Duty to Indemnify

Insurers have the duty to indemnify, which means that the insurer must compensate or otherwise pay for any incurred harm, injury, loss, or damage for which the policyholder was insured.

Duty to Settle

The insurance company has the duty to settle all valid claims within a reasonable period. Within policy limits, every reasonable settlement demand should be accepted. The insurer can also be liable to an insured for failing to settle a third-party claim against the insured. A significant factor in how an insurer settles a claim is how much consideration the insurer must give to the insured’s interests relative to its own interests. The insurer does not have to put the interests of the insured ahead of its own. However, the prevailing view among the courts is that an insurer must equally consider the insured’s interests when making decisions concerning settlement or litigation of a claim.

Client Service Is Good Business

Service after the sale and ongoing contact with one’s clients is simply good business. Not only can it expose and provide an opportunity to address any issues before they become problems, but it can also lead to enhanced relationships, increased persistency, and the opportunity for additional sales. Continued client service and continued client contact enable the professional producer to understand and evaluate how his or her products and services are perceived and valued through the eyes of the client. From that perspective, the producer is able to map the role he or she should serve and the actions he or she should take to better meet and serve the client’s needs.

3.4 - Chapter Summary

The application of ethics and ethical business standards extends throughout the entire insurance transaction: from soliciting business to service after the sale, including claims. In each phase of the sales process, certain minimum or required standards of conduct apply. However, the agent should use the opportunity he or she has through direct client contact to elevate the level of service and therefore enhance the relationship.

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