Your Four Obligations under NAIC’s “Best Interest” Model Regulation

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Editorial Note: Please note that information in this blog is not meant to address all aspects of the Model Regulation, or any variations in individual state laws or regulations, and should not be considered legal advice. View additional resources, including an FAQ for the Best Interest Model Regulation on DMI’s My Back Office.

In February of 2020, the National Association of Insurance Commissioners (NAIC) adopted changes to the Suitability in Annuity Transactions Model Regulation (“Model Regulation”), sometimes referred to by its number which is 275. The revisions included a best interest standard of care to replace the suitability standard of care.  Unlike the DOL’s Fiduciary Rule from recent years, the NAIC Model Regulation has generally been accepted by the industry, so it doesn’t appear that there will be much, if any, resistance from industry groups as it is adopted by the states and implemented. Some NAIC model regulations are more popular than others and this one appears poised to be adopted by states very quickly.

As of the date of this blog, five states – Iowa, Arizona, Arkansas, Michigan, and Rhode Island – have adopted a version of the Model Regulation. Iowa and Arizona became effective on January 1, 2021 and Rhode Island will become effective on April 1, 2021.  Arkansas and Michigan will likely take effect within the next six months. At least six other states are actively looking at it, and it is anticipated that several additional states will act in 2021.

So just what does this Model Regulation mean for the insurance industry? Let’s look at a few key components in detail.

Producer Obligations

The Model Regulation requires that you not put your financial interests or the insurance carrier’s financial interests ahead of the consumer’s interests.  It includes four obligations that must be met in order for you to act in the best interest of a client: care, disclosure, conflict of interest, and documentation.

1.    Care

When making a recommendation, you must exercise reasonable diligence, care, and skill to know the consumer’s financial situation, insurance needs, and financial objectives. You must make reasonable efforts to gather Consumer Profile Information from the consumer.  Consumer Profile Information (which is basically expanded suitability information) is considered the minimum amount of information you should gather before making a recommendation.

You are also required to fully understand the annuities that you can offer and have a reasonable basis to believe the recommended annuity effectively addresses the consumer’s financial situation, insurance needs, and financial objectives over the life of the product.

This does not mean that you have to examine every possible annuity in the market. Rather, you can recommend one that you are currently able to offer, as long as the recommended annuity is in the best interest of the consumer. There is no requirement to obtain additional licenses, analyze or consider products you are not authorized to sell, or to recommend the lowest commission product – but the recommendation must be in the best interest of the consumer.

An Example– To see how the suitability standard of care and the best interest standard of care differ, let’s consider the following scenario:

Under a Suitability standard of care, you can recommend any annuity that is suitable. For example, you determine that Annuity A is the best choice for a consumer based on the consumer’s Financial Situation, Insurance Needs, and Financial Objectives.  Annuity B is not as good of a choice as Annuity A for the consumer but is still suitable and pays a higher commission. You’re free to recommend Annuity B under a suitability standard of care.

Under a Best Interest standard of care, this will likely not suffice, as you are required to make recommendations that put the consumer’s interests ahead of your interests and the interests of the insurance carrier. In addition, you are obligated to make recommendations that are in the best interest of the consumer. You will first need to determine if an annuity is in the best interest of the consumer.  If so, you must consider all of the annuities available to you at the time of the recommendation and determine which annuity is in the best interest of the consumer and recommend that annuity. The analysis of determining the annuity that is in the best interest of the consumer should be completed holistically and not based on any single factor.

2.    Disclosure

To comply with the Model Regulation, you must prominently disclose certain things to the consumer. For starters, you must have a belief that the consumer has been adequately informed of the various features of the annuity. Some other items that need to be disclosed include the scope of your relationship with the consumer and your role, a statement of whether you are licensed and authorized to offer certain products, a range of how many insurers you sell products for, a description of the sources and types of cash and non-cash compensation you receive, and a notice of the consumer’s right to request additional information about cash compensation. The consumer can then also request additional information about the cash compensation you receive, which you must provide. The Model Regulation does provide a sample form that can be utilized.

3.    Conflict of Interest

You must identify and avoid, or reasonable manage and disclose, any material conflicts of interest. A material conflict of interest is defined by the Model Regulation as a financial interest of the producer in the sale of an annuity that a reasonable person would expect to influence the impartiality of a recommendation.

Material conflict of interest does notinclude cash compensation or non-cash compensation under the Model Regulation. Here are just a few examples of potential conflicts of interest:

  • having an ownership interest or serving as a board member or officer of an insurance carrier
  • giving or receiving loans with the consumer
  • acting as an investment adviser, attorney, CPA, or other professional with the consumer
    being listed on the annuity contract as an owner, beneficiary, etc.

4.    Documentation

You must document any recommendation that is made and the basis for the recommendation. This requires you to document your analysis of the consumer’s financial situation, insurance needs, and financial objectives, the analysis to determine what product or products to recommend, how the recommended product meets the financial situation, insurance needs, and financial objectives of the consumer, and why it is in the best interest of the consumer.

Documentation is one of the most important aspects of the Model Regulation for producers. Yes, it’s required – but it has the added benefit of providing evidence that you complied with the requirements. You may already be going through the above steps in your practice, but perhaps haven’t documented your thought process and the analysis that you performed to arrive at the recommendation. Regulators are essentially wanting you to “show your work” in writing now, rather than just taking your word for it. Remember, one of the foundational tenets of compliance is, “If it isn’t documented, it didn’t happen.”

Additional Considerations

The requirements of the Model Regulation also apply to all producers who have exercised “material control or influence” over the making of a recommendation and have received direct compensation as a result of the recommendation or sale, regardless of whether or not the producer has had any direct contact with the consumer.  For example, if two producers work on a case and split the commission, both producers are required to adhere to the requirements of the Model Regulation, even if only one of the producers met with the consumer.

There is also an additional one-time, one credit training requirement focused on appropriate sales practices, replacement, and disclosure requirements under the Model Regulation.

What Should I Do Next?

Potential consequences of non-compliance with the new requirements include, but are not limited to, regulatory investigations and enforcement actions (fines, loss of license, etc.), commission chargebacks, loss of insurance carrier appointments, and loss of new/existing clients due to reputational damage.  As a result, you should consider the following:

  • Seek qualified training and guidance on how to comply with the Model Regulation. You must fully understand the requirements and how they apply to your practice in order to comply with the requirements.
  • Develop a documentation process (or evaluate your existing documentation process) to help ensure that the necessary documentation requirements are met. “Process is good if the process is good.” Having a poor process ensures the wrong thing is done every time. More rigorous documentation procedures will likely be necessary to demonstrate that you met the best interest standard and complied with the requirements.
  • Understand and manage different insurance carrier requirements which, are likely to differ significantly, especially in the short term as the industry works to establish best practices.
  • Identify, and avoid or mitigate, all conflicts of interest.  You should seek qualified guidance if uncertain whether something is a conflict of interest or for help determining how to avoid or mitigate a conflict of interest.
  • Advertising (seminars, social media posts, mailers, radio shows, charts, etc.), sales tools (calculators, financial software, spreadsheets, illustration tools, etc.), and sales practices may need to be modified to account for the requirements, and as always, should undergo an advertising compliance review by a qualified compliance expert. You should seek qualified guidance to help protect yourself and your practice. 

Conclusion

Adjusting to new regulatory requirements is never fun but it doesn’t have to be overwhelming. Some training and a few process tweaks can go a long way toward creating evidence that you took reasonable measures to comply and help keep you off the radar of regulators in this enhanced standard of care environment.

Additional Resources are available from DMI as you navigate the Best Interest Model Regulation including Frequently Asked Questions within My Back Office.

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