Disability Insurance

Chapter 7 - Ethics

eth'ics (eth'iks) n. pl. (1) the principles of honor and morality. (2) accepted rules of conduct. (3) the moral principles of an individual. ---eth'ic, adj. pertinent to morals.

The New American Webster Dictionary

  In today's lawsuit-prone society, the insurance agent or broker has a difficult line to walk. No matter how careful an agent tries to be, every presentation has the potential of an errors or omissions claim. These claims are often brought against the agent by the families of the client, rather than by the client themselves. This point is not brought out to cause alarm, but rather to stress the need for good judgment on the part of the agent.

  Ethics are defined as "formal or professional rules of right and wrong; a system of conduct or behavior." Ethics are standards to which an insurance agent or broker must aspire to, feeling a commitment to each client. Every type of profession generally has an informal "code of ethics," which may be more understood than written.

  Ethics are a means of creating standards within any given profession to upgrade it and give it honor. It is a means of measuring performance and, in some cases, acknowledging outstanding individuals. Ethics often are a means of providing priorities and building traditions based on integrity.

  We would not wish to do business with many professions if ethics did not play a part. Can you imagine turning over your financial control to an attorney who had no ethics? The same would be true for an accountant and many other professionals. Ethics add an element of trust to many industries.

  In many industries, the professionals have knowledge that other individuals do not. Individuals who seek out professional help must rely upon their honesty and integrity. As a result, a feeling of ethical standards must exist. It was the potential for abuse of power (which comes from knowledge not possessed by the nonprofessionals) that provided a set of rules or ethical guidelines. Sometimes, ethics are written standards and may even involve laws that must be followed. The premise upon which practical ethics must be based, according to Stephan R. Leimber of the American College where he is a professor of taxation and estate planning, is that power must be exercised in the interest of the clients who seek the professionals out and may not be exercised solely in the best interest of the professional themselves.

  Practical codes of ethics must, of course, be balanced. If they are so restrictive that the professionals may not earn a living, then such ethics would not be workable. Generally speaking, most insurance agents or financial planners know if they are being ethical. When an agent picks up a check from a client hoping that the client does not "learn about the omitted facts," then surely that agent was not ethical. When an agent attempts to imply that he or she has more education or knowledge than actually exists for the sake of a sale or other personal gain, that is unethical. Even reporting one's earnings fairly to the IRS is a matter of ethics.

  Competency can also involve ethics. Of course, most people would not view themselves as incompetent. Sometimes the industry itself must remove those within it that are incompetent. Sometimes, competency is merely a matter of obtaining required education within your given industry on a timely basis (and taking responsibility when it is obtained past time requirements). All too often, insurance agents tend to take the easiest route when it comes to education. It is not unusual to take on a new type of insurance product or to begin selling some type of service without the proper schooling. That in itself can promote a lack of competency. To be ethical, you must also be competent.

  Ethics often involves due diligence; a term familiar to insurance agents. Due Diligence involves doing what was required in a reasonably prompt manner. It also means knowing enough about the companies represented to feel comfortable about their financial strength.

  One area of ethics often overlooked is confidentiality. It is very easy, in the excitement of selling, to tell some bit of information about someone else. While we might assume that one client does not know another, that is not always the case. Especially in small communities, people often know each other for miles around. If a client discovers that an agent is sharing information they consider private, that agent is sure to experience trouble.

  Ethics often involves conflicts of interest. While this is less likely to happen in the insurance field, it does still apply in some cases. Some actions could border on or involve fraud. For instance, if an agent were to draft some type of legal paper or contract giving him or herself, or any member of their family, an interest in a client's estate or assets, that would most certainly involve a conflict of interests. In many cases, it would also be illegal.

  Sometimes estate planners could become involved in what is called simultaneous representation. This means they are representing two different parties who have, or may have at some future date, conflicting interests.

  Most often, ethics simply means being honest. It is representing each client without regard to personal financial gains, but rather with the client's welfare in mind. It is the act of full disclosure on all products represented.

  It is not enough to voice an opinion that ethical behavior is desired; such ethical behavior must be exercised on a daily basis in all business functions. It is the insistence that others in your profession do the same. It is often stated that any given professional occupation will not "turn in" their own kind, whether it be a doctor, attorney or an insurance agent. Ethical behavior would actually dictate that a professional must turn in another member who is not ethical in their professional manner or ability. This is harder to do than it sounds. Where commissions are involved, turning in another agent could probably be considered a way of "beating out the competition." Therefore, it can be very difficult to police the industry. That is where the State’s Insurance Commissioner's office comes in. They are charged with removing the unethical agent. Whether or not they are successful may be a topic in itself.

  Ethics involve not only individuals but businesses as well. Every business, individual insurance agency and brokerage has a responsibility to develop a code of ethics for their employees or agents. If such a code of ethics is not consistently applied, not only may state regulators be paying them a visit, but also agents within the company may find themselves in a position of fighting each other for commisionable sales. Aside from the in-house problems this would create, honesty for the sake of honesty is reason enough to develop a code of ethics within the workplace.

  Any industry involved with the public's money (as the insurance industry is) suffers when scandals occur. Public confidence is eroded and business is affected. Therefore, it is in each insurance agent's interests to promote ethical activities within the industry.

  Some types of unethical actions are common place. It is not unusual for signatures to be forged on insurance forms. Commingling funds also happens routinely. While no agent would likely admit to such actions (because they know they are wrong), most businesses are aware that they are occurring. By not addressing the issue, those businesses are not only allowing unethical behavior among its agents, but also condoning it.

  Sometimes deciding if an action is actually unethical is not an easy determination. Sometimes it is merely a matter of opinion. Replacement business is one area where a variety of opinions exist. The senior market, for example, has seen much news coverage in recent years concerning policy replacement. If a new Medicare Supplement policy appears to be better to an agent, is it always wrong to replace an existing contract? Legally, a Medicare Supplement policy may be replaced if the new policy would:

1. lower premium rates and/or

2. increase coverage (benefits).

  Where replacement is clearly a matter of opinion, it is probably best to simply outline the features of both policies to the consumer and then let that consumer make the choice.

  Sometimes a simpler method of determining replacement may be asked in this form: if it were my personal policy, and I would not receive any commission at all, would I still replace the policy?

  Most presentations involve a few "set" items, which includes premium rates, benefits, agent services, and company stability. Of these, premium rates should be the least important. However, our clients often do not allow that to be so. As a result, rates often take up the majority of the presentation; yet an errors and omissions claim has never occurred due to the premiums quoted. Probably 98 percent of the E&O claims filed relate to the benefits of the program and how those benefits were discussed. Obviously, more time needs to be devoted to that aspect. Then, as an agent, you must hope that the client remembers what was said! That is why documentation is so important. As each segment of the contract is presented and covered upon delivery, it would be a wise idea to have the client initial it.

  The insurance contract is intimidating to many of our clients. Technical in nature, complex in its subject matter and seldom read in full by either the policyowner or the agent, it is bound to be misunderstood at some point.

  To our clients, the most important part of a policy is the part that begins "We promise to pay . . ." In reality, all other parts are, in fact, limitations or conditions on the policy.

  A life insurance policy is one of the more easily understood products. If the insured dies while the policy is in force, the promise of a payment is kept. There are no gray areas (such as Usual, Customary or Reasonable). The insured is either dead or alive. Medical policies are not nearly as simple. There are co-payments, stop-loss provisions plus any number of other confusing and easily misunderstood clauses. All of the provisions can create dissatisfaction which can cause questions regarding an agent's diligence in presenting the policy and providing services. This is not to say that a life policy should not also be clearly explained to a potential client. Any policy can cause a misunderstanding if not fully covered.

  There are steps that an agent can follow to minimize any possible misunderstandings:

1. Full Disclosure is always necessary in any type of policy being recommended to a client. Where different interpretations are possible between a brochure and the actual policy, the policy always wins. The policy is the final word! A brochure is simply a selling feature; never the final authority. The statement the agent received over the telephone from the home office always takes second place to the contract. The policy (which is the contract) is the final word every time. An agent who has not read the contracts he or she is selling is an agent waiting for a lawsuit to happen.

2. An agent should always be slow to replace an existing contract. That is not to say that an existing contract should never be replaced. However, to do so without fully examining what is currently in place would be foolish. The agent should first be fully informed of pre-existing conditions, take-over provisions and limitations that may exist in the new plan. Health problems of dependents should also be reviewed.

3. Sometimes owners/employers may not be enrolled in and paying premiums for workers compensation coverage. It is important to know whether they are or not. Often they do not know themselves whether or not they are enrolled in the program.

4. Whether you are dealing with a health program or a disability program or a life program, be sure that health questions are clearly understood and correctly answered. A term that has come into use in recent years is "Clean Sheeting." It means that an agent fails to correctly record an existing health condition of an applicant. The agent is presenting a "clean" application. Obviously, this is illegal and will not be tolerated by any insurance company. Sometimes, an agent simply is not aware of existing health conditions. If the applicant does not fully understand a health question, it may be incorrectly answered. This will not alter the insurance company's view of it. A policy may be rescinded (taken back) by the insurance company for incorrect or undisclosed information. This may occur, for instance, on a question asking if the applicant has high blood pressure. Since the applicant is taking a medication that keeps his or her blood pressure under control they may answer that question "no". In fact, they DO have high blood pressure; it is simply controlled. The question should have been answered "yes". Since these types of misunderstandings can easily happen, an alert agent will want to closely monitor the questions and how they are answered by the applicant.

5. Eligibility of applicants is always a concern when replacing an existing coverage. Do not overlook the eligibility of dependents as well. Employees or persons nearing retirement are especially vulnerable.

6. Any time one coverage is being replaced with another, continuity must be considered. One plan should never be dropped until the new plan is firmly in place.

  It can be very difficult for the consumer to sort through all of the various ratings given an insurance company. The big question is "Do you, as an agent, understand it?" It is not unusual for even an experienced agent to feel foggy about much of the financial terminology.

  As we know, agents have an ethical obligation to describe accurately to the client the financial strength (or weakness) of the insurance company being proposed. This is true of any insurance policy being proposed or replaced. In fact, it has been held that an agent has a legal obligation to accurately describe such financial data. A lawsuit could be brought against an agent who causes a client to suffer financially as a result of the agent's failure to fulfill these "due diligence" responsibilities.

  We believe that an agent wishes to give his or her client the best products available. Certainly a career agent would want to do so simply to remain in business. Often, it is the agent's lack of understanding of or attention to some of the technical terminology used in documents pertaining to the financial strength of insurance companies that causes the agent problems down the road. In other words, many agents either do not understand or fail to read much of the material that is available regarding the companies they deal with. Terms such as admitted assets, consolidated assets, projected mortality plus many others do not completely register understanding. The agent may have a vague idea of what the terms mean, but not an actual understanding. Certainly, much of the printed material available is not stated in a way that makes the information easily readable.

  Many of the terms used are associated with the company's balance sheet, its statement of assets, liabilities, and the owner's equity.

  Admitted Assets are those assets the company is allowed by state regulatory authorities to include in its statutory annual balance sheet. Some of a life insurance company's assets may be excluded in the interest of balance sheet conservatism, although most assets are admitted. If an asset is a nonadmitted asset, it is generally regarded by regulators as a bit less sound than admitted assets. Nonadmitted assets are typically thought to provide less security for the company's policyholders. Nonadmitted assets include such things as the agents' balances owed to the company, office furniture and mortgage loan interest income that is overdue by more than a specified length of time.

  Consolidated Assets are the total of the assets of the parent insurance company and all the subsidiary companies, if more than 50 percent of the voting stock is owned. Even though the assets are owned by two or more separate companies, for the purpose of the balance sheet, the assets are combined and treated as if they were owned entirely by the parent company. This is due to the voting control the parent company has. Even the assets of subsidiaries not engaged in the life insurance business are included in the consolidated assets of the parent company.

  Investment Grade Issues are something often seen in percentage forms. These are bonds whose insurers have been evaluated by a recognized rating agency who has placed them in one of the agency's few highest quality rating classifications. Generally speaking, the higher this percentage is, the greater the safety of the bonds in the portfolio. Therefore, the greater the insurance company's financial soundness. Even so, the rating assigned to any particular bond issue can be lowered without warning as a result of many circumstances or events.

It is common for insurance companies to advertise that their assets exceed large quantities of money; for instance $2-billion may be stated. While it is important to have sufficient quantities of assets, the amount of those assets will mean nothing if the company's liabilities equal or top the amount of assets. The size of a company's assets are less important than the percentage of liabilities to assets. There is a basic balance sheet equation:

Assets = liabilities + owners' equity.

  All three components must be considered before the strength of a company may be correctly judged.

  Owners' Equity is the amount of the insurance company's assets that are financed with funds that were supplied by owners rather than by creditors.

  Contingency Reserves are accounts (from owners' equity) that are voluntarily set aside by the insurance companies for the possibility of unforeseen future adverse circumstances. Usually the board of directors will not pay dividends from these reserves.

  Unassigned or Permanent Surplus is the amount of the mutual insurer's owners' equity that has not been set aside for any specific reserve or purpose.

  Common Stock that is referred to in financial statements are the total number of shares of common stock outstanding. They are usually valued at an arbitrary (and usually low) dollar amount. This may be called par or stated value per share.

  Additional Paid-in Capital and Contributed Surplus is the same thing. It is the excess of the selling price of the stock at the time it was issued over its par value. Neither the amount of the capital stock account nor the additional paid-in capital account has any relationship to the present value of the stock life insurer's common shares.

  A balance sheet also contains a section on the company's liabilities. The largest amount listed will be for amounts owed to policy-owners and the beneficiaries of the life insurance policies. There may be (though not always) the normal borrowed funds and accrued expenses payable.

  Mandatory Securities Valuation Reserve is also generally listed in the liability section. This is a reserve (as the name implies) of some of the assets (not necessarily cash) which is set aside to prevent changes in the amount of the company's unassigned or permanent surplus which may result from fluctuations in the market value of other assets such as bonds, preferred stock and common stock.

  Even though the Mandatory Securities Valuation Reserve is listed in the liability column of the balance sheet, it is not a true liability. It is more like a reserve for amounts owed to others. State regulatory authorities decide the size the reserve must be which is determined by a number of factors.

  Capital Ratio is the portion of the company's total assets that are financed by owner's funds. This is often the measure used to determine the insurance company's financial strength. It may also be called Capital-To-Assets Ratio or Surplus-To-Assets Ratio. The higher this percentage is, if all other things are basically equal, the greater the company's financial strength is thought to be.

  Notice that the previous statement said "if all other things are basically equal." Since the Capital Ratio is so often used to compare the financial strength of companies, it is important to realize that different ingredients may be used in determining the ratio.

  Sometimes an insurance company will make reference to its income statement as a basis of financial strength. Income is only part of the picture, of course. A company's direct premium income does not show any premium income or outlays resulting from reinsurance transactions, for example.

  Net Premium Income is typically defined as its direct premium income plus premiums it earns from reinsurance it assumes, minus premiums it gives up due to reinsurance that it transfers to another company.

The equation is basic:

Direct premium income

+ (plus) premiums earned from reinsurance it assumed

- (minus) premium it gives up due to reinsurance it cedes to other companies

= (equals) Net Premium Income.

  Even though this formula may be used by an insurance company to suggest its financial strength, it really is only about half of the needed information to make a sound judgment call. In fact it is more likely to tell an agent the size of the company, rather than its financial strength.

  Surplus Reinsurance is the transfer of a portion of the amount of coverage under a life insurance policy to a reinsurer. The ceding or surrendering company then is allowed, if regulatory requirements are met, to also transfer to the reinsurer a corresponding portion of the aggregate reserve liability under the policy. The ceding company (transferring company) receives a credit against its liability for the portion transferred. Some feel the use of surplus reinsurance may be a sign of an insurance company's financial weakness.

  The terms from the balance sheet that we have discussed here generally are overlooked by most agents. Typically, agents are more concerned with a company's rating from the rating firms, such as A.M. Best. That information is certainly easier for the agent to obtain and understand. It is also probably easier to relay to a potential client in a sales situation. However, it is becoming increasingly evident that such rating firms are not infallible. There are also differing opinions among rating firms. Which one is the correct rating? There have been insurance companies who enjoyed a high rating and yet ended up in financial trouble. A career agent simply must look beyond the rating of the companies he or she chooses to recommend.

  Some states have noted that agents tend to ignore such things as balance sheets when their state has a guaranty fund. Not all states have such funds. Many agents probably are not aware that such state guaranty associations typically cover only the guaranteed values of the policy, not the projected, assumed or illustrated values.

  There are so many things that play a part in an insurance company's financial strength. Things such as underwriting standards, how reserves are set up, risk spreads, management and reinsurance practices are a few of the things that will affect a company's financial strength. An agent cannot know all that is involved in a company, but an agent can look past the surface of the brochures put out. Remember that any given company is selling itself not only to policyholders, but to the agents as well.

  With the realization that the insurance companies are also selling the insurance agent (so that insurance agents will sell their products), an agent can take a common sense approach to due diligence. For a busy agent, it can be difficult to follow through on all financial details involved in an insurance company's financial report. While the technical analysis is certainly important, such analysis is not always possible.

  When using a common sense approach to determine financial solvency there may be a combination of factors to consider. A company that makes one or more obviously big financial mistakes may end up with financial problems. An example of this is the companies that invested in junk bonds. Although the bonds looked good at the time, there was no lack of warnings from the professionals about the problems that could occur.

  Watch out also for losses within a company that exceed the gains. While this may occasionally happen, it is most definitely a warning signal. Losses eat up capital and surplus funds. In fact, if money is going out faster than it is coming in, for whatever reason, a red flag should go up.

  Sometimes a lack of public trust can cause problems. If the consumers perceive a problem within a company, they will begin to withdraw funds or quit paying premiums. A company that is trying to hang on may be pushed over the edge when such actions occur.

  Perhaps the best common sense approach is simply looking at the products being offered. If any given product seems to give much, much more (commissions plus high interest rates for the policyholder, for example) than other similar products, then it is possible that trouble is waiting down the road. Product design may also reflect the company's outlook and philosophy. If gimmicks rather than sound design seem to hold the product together, that could well be the philosophy of the company. Is the product set up to "catch and hold" a policyowner rather than benefit them? Could you find yourself in an embarrassing situation down the road when your client requires service or benefits?

  If a company is not a mutual company, then it is often a good idea to know who owns the company. The company's owners will reflect their own values and ethics throughout the company itself. While it may not be possible to know what the values and ethics are of any given person, the agent can look to their past history. Do they come from the insurance field? What financial education do they have? Looking at their backgrounds can give the field agent a general idea of what to expect.

  The object of using these common sense approaches is not necessarily to find the best companies, but rather to weed out the worst of them. An alert insurance agent must keep their eyes and ears open. Listen to other agents. Follow the service given to clients from the home office. Does service start out well, but then steadily decline? These are signs of problems. While it may be something as simple as a poorly managed department within the company, it may also be something as major as an entire company ran poorly.

  Probably every agent alive has ran into the client that is sure that he or she knows more than you do. Generally, what it really amounts to is an underlying mistrust of insurance companies and their agents as a whole. Such people will often bring up the stories of the "pending disasters" in the insurance industry. Is this really a worry?

  Some have compared the insurance industry to the savings and loan industry and that is absolutely not a valid comparison. The financial strength and condition of the insurance industry (especially the life insurance portion) is one of the most financially solvent industries in the United States. One major difference between the insurance companies and the savings-and-loan institutions, as pointed out by Frederick L. Huber who is the administrator and assistant to corporate counsel of Brokers Marketing Service in Los Angeles, is that the insurance industry has never been subsidized by the taxpayers.

  Certainly, there is concern in any industry if the number of insolvencies dramatically increase. Currently, about 30 insurance companies become insolvent each year. The majority of those companies are in the property/casualty field. An insolvency usually reflects poor management and/or the amount of claims incurred. Natural disasters can contribute to property/casualty failures.

  Real estate investments have haunted the insurance industry to a certain degree. However, when you look at the types of loans made by insurance companies when compared to the savings and loan industry, the differences cannot be overlooked. Most of the commercial real estate loans made by the S&Ls were for new construction. The primary loans made by insurance companies were on completed projects which were occupied and do, therefore, have a cash flow. In 1989, the delinquency rate on real estate loans by life insurance companies was around 2.47 percent. That represented about .5 percent of their total assets.

  There is one area where many businesses, including the life insurance industry, have attempted to divert attention. In the past, debt levels were highly stressed. We are now seeing the emphasis placed more on returns and profitability. An S&L may boast about the amount of deposits they have. What they fail to mention is that deposits are actually considered liabilities; not assets. An insurance company may flaunt the amount of insurance in force. Again, this is a liability; not an asset. Financial strength is based upon assets and profitability.

  Persistency of in force policies is one of the best indicators of strong products and good service. Persistency is a measure of marketing strength and service effort. It is also a measure of how well the agents have matched products to a client's needs.

  It is never an easy task to be both a successful agent in the field and an ethical person as well. Over the long run it will pay off, however. Think of each contract (policy) as a personally signed document. You place your name on each policy you write. Do you want your name on anything less than the very best?

End of Chapter 7

United Insurance Educators, Inc.

2012