Suitability White Paper

The first breach of fiduciary duty lawsuit related to the suitability of a TOLI policy set a precedent for the industry's evolving legal landscape. Over the past two years, cases involving the breach of fiduciary duty due to unsuitable recommendations have doubled, leading to heightened scrutiny of agents' and brokers' actions.

Several regulatory changes are driving this increased focus on suitability. For example, New York's Producer Disclosure Regulations have introduced a higher standard of care for agents and brokers. Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act empowers the SEC to enforce fiduciary standards for advisors, which could raise the bar for suitability in the years to come.

These regulatory developments highlight the critical importance of ensuring that life insurance products align with clients' specific needs, financial situations, and objectives.

Determining the suitability of a life insurance product requires a thorough analysis across multiple factors. This assessment helps ensure that the product aligns with the client’s long-term goals, financial situation, and preferences. Here are five primary factors that influence life insurance suitability:

1. Client’s Needs and Objectives: Understanding the client’s goals is paramount. Life insurance can serve various purposes, from wealth transfer and estate planning to business succession, income replacement, and tax planning. In the case of TOLI, a client may aim to cover estate taxes or provide a legacy for beneficiaries. Suitability hinges on aligning the policy’s purpose with the client’s objectives.

2. Client’s Financial Situation: A client’s financial health, including assets, liabilities, income, expenses, and existing insurance, must be evaluated. A high-premium variable life insurance policy, for instance, may not be suitable for someone with limited cash flow or a conservative risk tolerance.

3. Product Features and Benefits: Different life insurance policies offer various features, such as guaranteed death benefits, cash value accumulation, loan provisions, and surrender values. Advisors must evaluate which product features best support the client's objectives and financial circumstances.

4. Product Costs and Charges: Life insurance products entail various fees, including mortality and expense charges, administrative fees, fund management fees, and loan interest rates. Transparency is essential, as clients must understand the costs involved. Advisors should assess these costs relative to the product's benefits to ensure suitability.

5. Performance and Reliability of the Insurer: The financial strength of the insurer is crucial, as it affects the likelihood of fulfilling future claims. Ratings from agencies such as A.M. Best, Moody’s, and Standard & Poor’s offer insights into an insurer’s stability. Additionally, examining the insurer’s claims-paying history and customer service record is an integral part of the suitability evaluation.

These factors collectively determine the suitability of a life insurance product. No single factor alone can dictate suitability; rather, a balanced assessment across all five areas is essential to make an informed recommendation.

Each factor contributes uniquely to the overall suitability of a product recommendation, and overlooking any one of them could lead to suboptimal decisions. Unlike many consumer products where price is often a primary quality indicator, life insurance suitability is multifaceted. For instance, a high-cost policy is not inherently more suitable than a lower-cost alternative, and insurers with superior financial ratings do not always offer the highest-priced policies. The goal is to balance cost with quality, reliability, and alignment with client objectives.

In permanent life insurance, for example, the lowest premium or the highest illustrated cash value does not necessarily indicate the best product for a client. Regulatory bodies consider comparisons of hypothetical policy values to be potentially misleading, as illustrations can mask hidden costs or be based on unrealistic performance assumptions. Instead, suitability should be assessed based on the insurer's cost structure, pricing stability, and real-world performance.

Life insurance products should meet suitability objectives that align with both client needs and competitive industry benchmarks. A suitable product is typically characterized by the following attributes:

1. Cost-Competitiveness: Insurers’ cost structures, including cost of insurance charges (COIs) and administrative fees, should reflect realistic expectations based on historical experience. Products built on assumed improvements in mortality rates or speculative future gains may pose greater risks. A product with stable, predictable costs is generally more suitable.

2. Access to Cash Values: Cash value accessibility may or may not be important, depending on the client’s objectives. Some clients prioritize cash values for liquidity, while others focus on death benefits. If a product’s design sacrifices cash value for cost advantages and the client does not need liquidity, this may be suitable.

3. Actual Historical Performance: For policies with cash value components, the historical performance of invested assets is a critical consideration. Clients are unlikely to invest in a mutual fund without past performance data, and the same principle applies to life insurance products. Products with a track record of solid investment performance are generally more reliable.

4. Alignment with Risk Tolerance and Guarantees: Products with guarantees are often more suitable for conservative clients who prioritize stability over potential for high returns. Conversely, clients willing to assume more risk might find products with lower costs but fewer guarantees more suitable.

By assessing these objectives, advisors can ensure that they are recommending products that align with their clients' values and financial aspirations. Suitability, in this context, is not just about matching products to needs but optimizing recommendations based on the client’s full financial picture and risk profile.

With regulatory scrutiny increasing, maintaining suitability standards is no longer optional—it is essential for financial advisors to remain compliant and reduce liability risks. Advisors must stay informed about regulatory updates and ensure that their practices are aligned with the latest standards. This may involve ongoing training, revisiting product knowledge, and adopting technology solutions that streamline compliance tracking and documentation.

The best interest standard, which is now at the core of suitability regulations, means advisors must go beyond merely avoiding unsuitable products. They must proactively recommend the most suitable product among all available alternatives. This requires not only a deep understanding of the market but also a commitment to ongoing client engagement, as suitability can change over time with shifts in the client's financial situation or life stage.

Suitability has become an essential concept in the financial services industry, especially within the life insurance sector. As regulatory expectations evolve and consumer awareness grows, the industry is likely to see even greater emphasis on ensuring that products meet the unique needs of each client. Financial professionals must continue to adapt to these changes by enhancing their knowledge, refining their assessment processes, and consistently placing their clients’ interests first.

By following the principles outlined in this white paper, financial advisors, agents, and brokers can build stronger client relationships, minimize legal risks, and ultimately contribute to a more ethical, transparent, and consumer-centric financial services industry. Suitability is more than a regulatory requirement—it is a pathway to building trust and delivering meaningful, lasting value to clients.