Coming to a Market Near You: an effective, practical product disclosure and suitability framework could usher in a new environment for the industry and consumers.

Conflict of interest, compensation disclosure and product suitability issues have roiled U.S. financial markets and institutions in recent years. If regulators took the next logical step and examined life-insurer practices, what would be the outcome? And what might a logical framework for disclosure and suitability look like--one that is effective and practical for both consumers and the industry?

In the United Kingdom, regulators have enacted broad-scale changes spelling out the information companies and agents must provide to prospective buyers, including disclosure of the compensation the agent receives and how it compares with the market average. Agents also must provide the client with a "suitability letter" explaining why the transaction is appropriate for the buyer in his circumstances. Australia has adopted similar requirements to ensure that buyers can make an informed decision and are aware of any potential conflicts of interest that may lead an agent to favor one product over another.

In the United States, the National Association of Insurance Commissioners has addressed the disclosure issue, but seems to have concluded that it isn't necessary to provide complete transparency in all situations. Currently under consideration is a requirement that would have agents disclose the compensation they receive, but only when the compensation comes from both the customer and the insurer--a situation so rare as to preclude meaningful disclosure.

From the buyer's perspective, any disclosure/suitability framework should assure that a buyer is adequately informed about the product and its role in his Financial plan and is protected against conflicts of interest that might bias the agent's recommendation. From the standpoint of the agent and the industry, the framework should be sound, practical, and useful, creating ancillary benefits such as higher closing ratios, increased persistency and less litigation.

An overly rigorous framework would involve so much subjective interpretation and such an onerous compliance burden as to be counterproductive. Moreover, requiring agents to go beyond providing consumers with the information they need to make reasonably intelligent decisions is likely to result in even less service of the middle market and a commodification of what is now a rich and diverse offering of products.

The fundamental components of an effective disclosure framework are suitability, product transparency and competitiveness, and disclosure of compensation and conflicts of interest. Therefore, a baseline approach to this framework would include a U.K.-style suitability letter explaining why the policy is right for the buyer, a full description of how the product works (with the usual illustrations), some evidence of the product's competitiveness in its peer group, and disclosure of potential conflicts of interest.

This approach would go a long way toward helping the buyer understand what he/she is buying and why. It would also increase agents' proficiency at evaluating client needs, describing life products, and establishing credibility, while helping them stave off competition and avoid allegations of misselling.

With respect to compensation disclosure, several thorny issues must be resolved. First, just what is included in compensation? Is it just the agent's first-year commission and subsequent trails? Or, does it also include any expense allowances, company trips, pension/deferred compensation, and health insurance benefits the agent receives? Another troublesome area concerns the agent's ability to "dial down" the commission on a given product, depending on how it is structured. Buyers generally are not aware of this process, but it can significantly enhance product value.

Conflicts of interest also must be dealt with decisively. Consider the tied agent who discloses his contractual relationship with the carrier, but then tells the buyer he is willing and able to show more than one carrier's product. Absent underwriting issues, the buyer is not likely to get the broadly independent product recommendation he expects to receive. Or, consider the agent who professes to be independent but in fact has production requirements from a carrier.

Whatever framework is eventually developed, either by the industry or for the industry by the courts and regulators, agents will be forced to do more to justify their product recommendations than they do today. Developing a meaningful disclosure framework will take time, but the industry should at least begin to address the core training needs of its agents who will live in a new environment--one that may take some time to arrive, but that will surely come.

Robert W. Stein, a Best's Review columnist, is chairman of Global Financial Services for Ernst & Young. He may be reached at [e-mail]. Charles Ratner of E&Y contributed to this column.