In search of suitability
January 21, 2015 by John Olsen
Every advisor who sells financial products must wrestle every day with the concept of suitability. We may be (and should be) held accountable for demonstrating that the sales we make are appropriate and that they meet the needs of our clients. But how do we do that?
Most, if not all, insurance companies provide tools for this purpose and require that we use them. Every application for a life insurance policy, annuity, or investment instrument contains a section in which the seller must declare that he has determined, on the basis of facts revealed by the applicant, that the product is “suitable.” Often, there is a separate suitability questionnaire” in which certain information must be disclosed. Most such forms now address the 12 factors (or concerns) listed in the NAIC Suitability in Annuity Transactions Model Regulation No. 275 of March 2010, which regulation has been adopted by most states. These factors are:
- Age
- Annual income
- Financial situation and needs, including the financial resources used for the funding of the annuity
- Financial experience
- Financial objectives
- Intended use of the annuity
- Financial time horizon
- Existing assets, including investment and life insurance holdings
- Liquidity needs
- Liquid net worth
- Risk tolerance
- Tax status
A serious consideration of all of those factors prior to making any sales recommendation is likely to produce a sale that is defensible, both to a compliance officer prior to transmission of the application and, later on, to a regulator or (God forbid!) a jury in a trial brought by a dissatisfied policy owner. More importantly, it’s simply good business. No one (except plaintiffs’ attorneys) profits from bad sales.Moreover, the process of determining, right up front, that a proposed sale is suitable need not be difficult or complicated. It’s really quite simple. You start, not with a product — a financial tool — that you’d like to sell, but with the prospect’s needs, wants and concerns. In short, with the job to be done. What does this person want to accomplish? Let’s look at an example:
George and Martha Washington, a married couple in their early 50s, are worried about whether they’ll be able to retire comfortably. They ask Bill, their advisor, how much money they’ll need “to retire on.” What does that mean? The size of their retirement portfolio on the day they retire? The amount of monthly income they’ll need? Bill won’t know unless he asks. If they tell him it’s the former, the capital sum they’ll need on day one of retirement, Bill will see that they’re in an accumulation mindset. They’re thinking about a future lump sum. That’s OK, but it calls for some clarification and mental positioning because “retirement income” is, by definition, a series of payments over time.
Over what period of time? That’s the biggie, because it gives rise to some further questions. How long do they expect to live? Do they understand that “life expectancy” is that age at which half the people their current age will still be living? Will the retirement fund be needed for anything other than income (such as a legacy to their kids)? Must that income keep pace with inflation? If they’re thinking of a target income that’s some percentage of their current one, have they considered the impact of medical care costs once they’re elderly? Questions like this can reposition the discussion from one of accumulating a lump sum to one of ensuring income. If a legacy for their kids or a lump sum to purchase an RV is a concern, that’s really another issue (other jobs to be done, perhaps calling for different tools).
As Bill raises and discusses these questions with George and Martha, they’re all talking about needs, the jobs to be done. Nobody’s mentioning a particular tool (product) yet. Indeed, as the discussion progresses, it may become obvious to Bill that certain products reveal themselves to be appropriate or inappropriate. They move themselves in or out of Bill’s tentative recommended list. Do these folks carry enough life and disability insurance in case one or both don’t make it to retirement, or will they have bills that will persist in retirement? Bill can’t know unless he asks.
Now, consider this scenario as if Bill had begun the discussion by describing a particular product. No matter what that product is, it would focus the Washingtons’ attention on what that thing does and does not do, rather than on what they’re trying to accomplish. To the extent that the product doesn’t do that thing (or, more likely, those things) well, Bill will end up having to defend that product for its demonstrated drawbacks. The result will not be pretty.
But if Bill proceeds with the discussion of needs, the product — or, more likely, products — that will best meet those needs will be revealed, and when Bill recommends it (or them) the Washingtons will see clearly that his intention was to put their needs first and it will become obvious to everyone why his recommendations are suitable.
It really is that simple. Suitability starts with identifying the job. Plugging in the right product to do that job is now limited only by what Bill is able to recommend.
