The Financial Advisor Guide to Understanding Errors & Omissions Insurance Self Study Course # 18

Transcription

1 The Financial Advisor Guide to Understanding Errors & Omissions Insurance Self Study Course # 18

2 INTRODUCTION Liability Dangers & Public Awareness More and more people today have become increasingly aware of their legal rights. There are many reasons for this increased awareness. For one thing, there are more articles published in newspapers, magazines and periodicals about common legal problems a person may face. In addition, there are television programs dealing with many legal issues. To add to this we have lawyers advertising their services. The result of this available information is somewhat knowledgeable consumers who are more likely to sue someone if their service or product does not fulfill the consumer's expectations. Many of today's consumers are ready to go to court at the slightest dissatisfaction resulting in a number of groundless and frivolous lawsuits. We could say this is a negative result of increased knowledge and even term it as a "sue happy" society. Even so, there is a positive side of increased public awareness. This willingness to sue when dissatisfied is good since the so-called "little man" is no longer being intimidated. Professionals often feel that they do such a good job that they are immune from the threat of lawsuits, but that certainly is not the case. The 1970s saw the beginning of the trend to sue professionals for negligence or malpractice. The definition of a professional was broadened in the 1970s to include not only doctors and lawyers, but also architects, engineers, accountants, stockbrokers and insurance agents. It also expanded the definition to include such diverse groups as real estate agents, management consultants, crop dusters, data processors, printers, employment counselors, translators and telephone answering services. In this text, we will refer to all of the above professions as "professionals." Perhaps the newest professional field to be classified as a profession is that of financial planning. Along with the benefits of being recognized as a profession comes the burden of stricter standards of conduct. This also increases the chances of being sued for malpractice. If the financial planner performs poorly in the mind of his or her client, a lawsuit can definitely result. This makes the financial planner especially susceptible since views of good and poor performance are often hard to verify. Clients are very skeptical about any loss of money regardless of whether or not the financial planner acted in good faith. 2

3 The financial planning industry, overall, has very few guidelines for avoiding malpractice suits. We would hope that all financial planners have a code of ethics, of course. Being personally ethical, however, is not guaranteed protection. There are various organizations, such as the Financial Advisors Association of Canada (Advocis), Certified Financial Planner (CFP), Financial Planners Standard Council (FPSC), and the Independent Financial Brokers of Canada (IFBC), that have published codes for financial planners to follow. In fact, many Provinces over the past few years have implemented continuing education requirements for their agents. The FPSC has even made it mandatory that their members have at least one CE credit in an approved course dealing with Code of Ethics. The individual codes published by these organizations provide ethical guidelines, not rules of law. Lawyers have been guided by years of numerous legal cases to which they can refer in order to help determine a course of action along with their detailed code of ethics. The longer the financial planning industry exists, the more guidelines the financial planner will have in terms of more case law, established precedents and definitive regulations. Even without established legal precedents and definitive regulations, it is still possible for a financial planner to take affirmative measures to avoid a malpractice suit. The most obvious and important key is awareness. Through this awareness, an insurance agent or financial planner can achieve a set of standards by looking at the standards of care required by other professionals, particularly those professionals who comprise the majority of the financial planners today. These would include insurance agents, insurance brokers, accountants and stockbrokers. Since the financial planner's duties often include many of the responsibilities of these professionals, looking at how the courts have treated their cases can be helpful. THE MOST OBVIOUS AND IMPORTANT KEY IS AWARENESS This acquired awareness would also include understanding and knowing the duties of a financial planner. A financial planner seldom wears "one hat. Rather he or she is also an insurance agent, a tax advisor, a retirement advisor, and an estate planner. The financial planner must always be conscience of what role they are currently playing in order to avoid any potential conflicts of interest. For instance, an insurance agent/financial planner has to be careful not to recommend excessive life insurance. If his or her recommendations appear excessive or inappropriate, it could be viewed as self-serving (to obtain excessive commissions, for example). 3

4 On the other hand, if too little insurance is recommended, this could be considered negligence. At all times, it is important for the insurance agent/financial planner to document why such recommendations have been made. This documentation should be dated and kept in the client's file. In past years we have also seen a rise in the number of larger judgments being awarded to plaintiffs who sued professionals. Not only were courts awarding judgments in excess of the professional's insurance policy limits, but punitive damages were being awarded as well. Normally the courts motivation behind punitive damage awards is to punish the wrongdoer. It is questionable whether punitive damages can be paid out of an insurance policy's fund. However, since punitive damages are awarded only in cases where punishment is required, a financial planner has hope of avoiding this if he or she tries to adhere to industry guidelines and does not intentionally do anything illegal or improper. As stated, documentation of all financial recommendations is extremely important. Many financial planners believe they will be sued for malpractice at least once in their professional career. Two issues must be addressed: 1. What can a financial planner do to try to avoid a malpractice suit? 2. What should a financial planner do to mitigate the harm of a malpractice suit if one is filed? If a malpractice suit is filed, it does not necessarily matter whether or not the professional is found innocent. The harm to the professional is simply the filing of the suit and the publicity that nearly always comes with it. Many people may know of the malpractice suit and yet not many will know if the professional is found innocent. Damage to the professional's reputation has occurred. To add injury to insult, it is a time-consuming process to be involved in a malpractice suit. During that time, the professional may lose clients simply because they are the target of such a lawsuit. The numerous hours spent in court and giving dispositions will take the professional away from work and result in further decrease in productivity and thus, income. Of course, there will be legal fees as well. With typical professional liability insurance, the insurer cannot settle a claim without the insured's consent. 4

5 Malpractice insurance policies also referred to as Errors and Omissions insurance or E&O insurance will be discussed later, but it needs to be mentioned because this type of policy contains a unique settlement clause in favor of the insured. With typical professional liability insurance, the insurer (insurance company) cannot settle a claim without the insured's consent. In typical property and casualty insurance policies, the insurer is given the right to settle the claim in whatever fashion they feel is reasonable. Because the professional's reputation is involved, it is important that a suit not be settled if it lends further damage to the individual's future. Any settlements made on behalf of the professional could be construed as an admission of guilt. Even with this provision, however, the majority of claims against professionals are settled rather than taken to court. This is true because of the time and expense involved in litigation, the adverse publicity that accompanies a lawsuit and the negative effect the suit can have on the professional's practice. Many professionals opt to settle a claim against them, whether it is valid or not, rather than experience the above stated consequences. STANDARD OF CARE One of the first steps to avoiding a professional liability lawsuit is to understand what is required of a professional when dealing with a client. In legal terminology, the professional should know the applicable standard of care owed to a client. A claim based on liability imposed by law develops as the result of the invasion of the rights of others. A legal right is more than a mere moral obligation of one person to another, for it has the backing of the law to enforce that right. Legal rights impose many specific responsibilities and obligations. Some of these are obvious in a general sense, such as not invading the privacy or property of others or not creating an unreasonable risk or actual harm to others. TORTS & THE BASIS FOR LIABILITY CLAIMS Question: What is the legal basis for a liability claim? Answer: A claim that is based on a liability imposed by law, which develops as the result of the invasion of the rights of others. This legal right is more than a moral obligation of one person to another. This legal right has the backing of the law. Legal rights impose many specific responsibilities and obligations. The invasion of such legal rights is deemed a legal wrong. 5

6 The legal wrong may be: 1. Criminal (public), or 2. Civil (private). A criminal wrong is an injury involving the public at large and is punishable by the government. The action on the part of the government to effect a conviction and impose fines or imprisonment is termed a criminal action. A civil wrong is based upon two things: 1. Torts, and 2. Contracts. Torts & Contracts Torts are wrongs independent of contract wrongs. In other words, they involve actions of the agent or others but not the contract. This includes false imprisonment, malicious prosecution, trespass, conversion, battery, assaults, defamation (libel an/or slander), fraud, and negligence. Contracts may involve legal wrongs when implied warranties are violated or contract obligations are breached. Liability Under Torts As stated before, torts include all civil wrongs not based on contracts. As a result, they are a broad residual classification of many private wrongs against another person or organization. Torts occur independently of contractual obligations and may result from: 1. Intentional acts or omissions, 2. Strict (or absolute) liability imposed by statute law, or 3. Negligence. Most torts are based on negligence.. 4. Liability consequences of a crime are usually uninsurable. 5. Liability consequences of a civil wrong are usually insurable. Torts are wrongs independent of contract. Examples of these would include false imprisonment, assault, fraud, libel, slander and negligence. 6

7 Contracts may involve legal wrongs when applied to warranties, which are violated, responsibilities, which are not fulfilled, or contract obligations that are breached. For liability insurance, the emphasis is on civil wrongs and particularly on the many legal wrongs based upon torts. Of the greatest importance are torts resulting from negligence (unintentional acts or omissions). Negligence is the failure to exercise the proper degree or standard of care required by circumstances. Torts include all civil wrongs not based on contracts. As such, they are a broad residual classification of many private wrongs against another person or organization. We are going to concentrate on the negligence portion Negligence is a tort; a civil wrong not based on a contract. Most of the liability imposed by law stems from accidents attributable to negligence. If negligence can be shown to be the proximate cause of an injury or loss to another, the negligent party is liable to the injured party for damages. Negligence is the failure to exercise the proper degree or standard of care required by circumstances. It may consist of not doing what is required under the circumstances, or doing something that ought not have to have been done. Behavior in any circumstance, which fails to measure up to, that expected of a careful, prudent person in like circumstances constitutes negligence. Faulty judgment may result in liability for negligence, even though the motive behind the act was the best. Behavior in any circumstance, which fails to measure up to, that expected of a careful, prudent person in like circumstances constitutes negligence. In an ordinary negligence case (not involving a professional), the standard of care required of the defendant pivots on the questions of whether or not the accused behaved as "an ordinary reasonable prudent person" would have behaved under similar circumstances. In addition, the defendant is required to use any special knowledge they may have obtained through education, training, or experience. This obviously affects insurance agents, since they have received special training and education and probably have some type of experience as well. 7

8 When it comes to the professional The required standards of care changes. If a person offers professional service to the public, it is presumed that the person possesses some degree of special skill and knowledge. Unlike the ordinary negligence cases, where special skill and knowledge is considered only if the accused in fact possesses it, a professional negligence case imposes a certain level of skill and knowledge on the defendant whether or not they actually possess that skill or knowledge. Anytime an individual displays any assumption of professional skill, it is assumed to be real. This would include such things as having business cards printed which read "financial planning. Having such cards printed indicates training, education, or experience. It does not matter whether or not the individual actually has any training, education or experience. It will be assumed that he does. It is the learning and skill ordinarily exercised by members of the particular profession stated. Since this standard of care applies to the profession stated on the business card, in a lawsuit the individual will be expected to have performed to the level of that profession. That is why it can be very dangerous to allow clients to assume training, education, or experience that does not actually exist. Since just about anyone claims to be a financial planner, it may be hard for the average person to know if one is qualified or not. There has been much attention given to this matter by individual provinces requiring specific knowledge of those who profess financial planners. With increased regulation of the financial planning industry, many provinces are attempting to clarify who can and who cannot make such claims. The lawsuits against financial planners will likely increase as well, encouraging the establishment of legal precedents. Attorneys now have the option of attending classes on how to sue insurance agents and financial planners. It is something that every agent should consider before stepping into dangerous situations. GENERAL LIABILITY Industry Variety The financial planning industry has one characteristic that is unique to this industry: its members come from a variety of other industries. Financial planners can be accountants, stockbrokers, or insurance agents. It may be possible to predict the future treatment in the professional liability field by looking at the treatment of these various professions. We have also seen the banking industry go into the financial planning field, as well as other industries not otherwise considered a financial planning field. 8

9 Three professions from which the majority of financial planners come This would include insurance agents, accountants, and stockbrokers. The financial planner's duties often include many of the duties of these professionals. Looking at how the courts have treated these professionals can help us determine how the courts will treat the financial planning field. It is particularly relevant since the duties of an insurance agent, for instance, parallels those of a financial planner - preparing and analyzing financial statements, determining risk exposures, determining adequate insurance amounts, investing the client's money, and planning the client's retirement and estate planning needs. In recent years, we have also seen cases establishing a standard of care for investment advisors. Certainly financial planners would fall into the category of investment advisors, as do some insurance agents. Looking at these cases also offers a means of predicting how a financial planner will be treated in court. INSURANCE AGENTS Insurance agents are in the ranks of other professionals in the quest for risk avoidance, which means that liability insurance is necessary. Physicians have had to pay plenty over the last years for professional liability insurance. Attorneys joined physicians as liability risks, followed by accountants, then insurance agents and financial planners. Insurance agents are further faced with limited liability insurance coverage and increasing premiums. Add to this the national awareness about potential liability risks, making clients more apt to litigate in the event of a mistake on the part of the insurance agent. It is safe to say that liability insurance is a necessary part of doing business for insurance agents, just as it is for physicians and attorneys. Liability of Agents and Brokers What an agents says in terms of "puffing" or exclaiming the virtue of a policy is often not actionable except in the circumstances where an agent assumes additional duties, has a special relationship of trust with the buyer, or holds himself/herself out as having special expertise. Then a special duty arises. However, when an insurance agent gives assurance of proper coverage and it turns out to be false, that agent will be held liable for negligent misrepresentation. 9

10 That is not to say that an insured can remain intentionally ignorant of the terms of a policy. An insured is not required to independently verify the accuracy of representation made by the agent regarding the policy and an agent can be held liable for intentional or negligent misrepresentation. As we stated, there could be a conflict of interest for an insurance agent who is also a financial planner. The two roles need to be separately maintained to some degree. Of course, all industries that deal with finances must consider how the various roles interact. The insurance agent who is also a financial planner will want to market their services, but each type of service must be correctly handled. The ethical standard in these circumstances must always consider the client first and commissions second. We could use the example of a young family, both parents are age 26, with one child, age three, who comes to an insurance agent/financial planner wanting life insurance. It is determined that the family needs at least $250,000 life insurance coverage. However, the family cannot afford the cost of a permanent life policy. Should the insurance agent sell them less insurance coverage and receive higher commissions? Alternatively, should the agent sell the family a less expensive term policy covering the family the way the financial planner saw fit? Naturally, this potential conflict of interest exists for the insurance agent who is not a financial planner, but the problem seems to increase in severity for the agent who is also a financial planner since their primary function is not to sell a product but to provide financial advice. Some industry experts feel consumers should seek out a financial planner that does not sell products of any kind; they merely advise consumers. Insurance Agents' Professional Negligence Conflict of interest is one of many professional liability problems facing insurance agents or brokers. They, like other professionals, can be found liable for negligence, violation of a statute, and breach of contract. Negligence is the broadest field of exposure for an insurance agent Negligence is the broadest field of exposure for an insurance agent. Negligence is a tort - a civil wrong not based on a contract. Negligence is often the result of carelessness, thoughtlessness, forgetfulness, ignorance, or just plain stupidity. It involves errors and omissions made by the insurance agent. The majority of the liability imposed by laws stem from accidents derived from negligence. 10

11 If negligence can be shown to be the proximate cause of an injury to another, the negligent party is libel for the injuries or damages sustained. We tend to think of negligence and damage to others to be physical, but financial damage is also possible. Negligence could be defined as the failure to exercise the proper standard of care required by the circumstances. Negligence never involves intent. A negligent act may include not doing what was required under the circumstances, or doing something that fails to measure up to what would be expected of a prudent person in like circumstances. Faulty judgment may result in liability negligence, even though the motive behind the act was purely innocent. This point is very important when it comes to anything financial. A financial loss does not necessarily mean faulty judgment; no one has a crystal ball when it comes to investing. However, if the advice given is indeed found to be faulty, then a malpractice lawsuit is possible. There are laws that require all persons to use prudence in their actions so that others will not suffer bodily injury or property damage. Failure to heed such prudence gives the injured party a right to action against the negligent party for damages. "Prudent behavior" is based upon what society expects of the individual. The conduct must be reasonable in light of the risk involved. Insurance Agent's and Broker s Presumed Negligence Ordinarily the burden of proof lies on the plaintiff (claimant) in a negligence case. The plaintiff must prove that the defendant failed to exercise the reasonable standard of care for a prudent person. However, this may not always be the case. If the facts presented justify a reasonable form of judgment of negligence, the courts may lift the burden of proof requirement by applying the common law doctrine of res ipsa loquitor (meaning the thing speaks for itself). Negligence is presumed without the plaintiff having to prove it. The burden of proof is then shifted to the defendant. Under this law a legally sufficient case of negligence can be established and referred to the jury if the: Plaintiff s injury was caused by a defective object, Injury could not have occurred without the defendant's negligence, and The defendant controlled object causing the injury. 11

12 Conditions that establish presumed negligence The law of presumed negligence applies when an accident causes an injury preventable by the use of prudent care and/or safety inspections. Presumed negligence has been applied to a number of accidents, which occurred without witnesses: railroad or aviation injuries, medical malpractice claims, and/or damages from defective products for example. The last example of product liability has some difficulty applying res ipsa loquitor in the courts. That is because the claimant, not the defendant, controls the product. The control of the product lies in how it was used: properly or improperly. However, the courts have held defendants in control of the product if it has not been changed since leaving the manufacturer. The courts are not consistent with these decisions, though. Insurance Agent's and Broker s Contributory Negligence When negligence is presumed, the plaintiff must not be guilty of contributory negligence. The circumstances of the accident must be unquestionable as to the negligence. Presumed negligence does not exist if the accident results from circumstances beyond the control of the defendant. The accident must be such that the injury could not have occurred ordinarily without the negligence of the defendant. An accident resulting from a third person's involvement or from any physical or mechanical action is also not applicable. Insurance Agent's and Broker s Imputed Negligence Imputed negligence makes an individual responsible for negligent acts of others. Employers may be liable for the action or negligence of their employees, as well as the employees themselves. If an employer uses independent contractors whose employee negligently causes an injury, that employer could be held liable if it provides faulty instructions or tools. Imputed negligence can occur even to unaware individuals. Property owners whose tenants cause an injury from a negligent act could be held liable. Parents could be held liable for the actions of their children. Vicarious liability Vicarious liability laws impute liability to automobile owners even though they are not driving or even riding in their cars. Even if a friend borrowed the car, the owners of the vehicle could still be liable for the actions of the driver. 12

13 Under the family purpose doctrine, liability applies particularly to the automobile owner whose family members negligently use the car. Although presumed negligence may not apply if a third person is involved in the negligent act, imputed negligence does apply to third persons who may not be directly involved. Insurance Agent's and Broker s Negligence in Tort Liability Where allegations of negligence are made lawsuits present major issues in tort liability. There are typically specific things, which must apply. Before a court will award damages for negligent liability to a plaintiff: Four requirements must exist. 1. A legal duty to protect the injured party. 2. A breach of that duty or wrong. 3. An injury or damage to the plaintiff's person, property, legal rights or reputation. 4. A reasonably close proximate relationship between the breach of duty and the plaintiff's injury. Defenses in a negligent action. Since there are never absolutes, a plaintiff may prove all four elements (legal duty, breach of duty, the injury and proximate relationship) of a negligent act and still not be awarded damages. The defendant has several successful defenses available. Two principal ones are: 1. Contributory negligence 2. Assumption of risk. Contributory negligence means that the plaintiff is also negligent and that negligent action contributed to the loss incurred. If the plaintiff is guilty of contributory negligence, they may be denied damages. Contributory negligence does not relieve the defendant of duty to the plaintiff. Instead, it denies the award of damages to the plaintiff if both parties are at fault. In a strict sense, the doctrine of contributory negligence does not always produce equitable results. A slight degree of responsibility, (negligence) on the part of the plaintiff could result in no award of damages. 13

14 There are two substantial variations of contributory negligence rules: 1. Comparative negligence. 2. Last, clear chance. Under comparative negligence, the court, often the jury attempts to scale or diminish in proportions the awards according to the comparative degrees of negligence of the parties involved. Partial comparative negligence statutes are more common. Under the last clear chance doctrine, the defendant is able to prove that the plaintiff had the last clear chance to avoid the accident. The last clear chance doctrine states that the defendant with the last clear chance to avoid the accident is guilty of contributory negligence by failing to avoid the accident. If both the plaintiff and defendant were inattentive, this doctrine does not apply. Statutory modifications of the common law on negligence. The most common type of negligence for insurance agents is failure to place necessary insurance, failure to obtain proper coverage, failure to properly advise of the company's rejection or lack or coverage, failure to cancel a policy at the insurer's request, and failure to fully disclose the nature of the risk. In addition to this, the agent may be liable for giving unauthorized instruction to insured s or unauthorized interpretations of coverage, delaying the underwriting or claim information, or binding an unacceptable risk. We can look at some examples of an agent protecting him or herself from a liability claim by informing the client of their options completely. Many property and casualty agents are expected to mention the availability of umbrella liability insurance when they are selling an auto or homeowners policy. This is not done for receiving higher commissions. Umbrella liability policies do not offer the agent particularly large commissions. The agents who do this are doing it to protect themselves in the event that the insured suffers a loss greater than the amount of liability protection provided under the auto or homeowners policy. By informing their clients of the option of buying more liability coverage, the agent is preventing the insured from filing a suit against them for failing to provide adequate coverage. Of course, this insurance offer should be documented, perhaps even obtaining a reject signature from the consumer. 14

15 Another example of agents protecting themselves from lawsuit is the practice of giving complete information. For example, the insurance agent who informs the policyholder of the minimum insurance coverage required by the needs analysis, but, given the client's assets, suggests a larger amount of coverage as appropriate. The client then has the option of declining the additional coverage, thereby, releasing the agent of a negligent act. The agent should then document that the coverage had been discussed and refused by the client. The agent may go as far as having the client sign a form acknowledging this denial of additional coverage. In this way, the client will not be able to claim that the agent failed to offer the adequate coverage needed. Insurance agents and brokers can be held liable for a vast array of actions. It should be noted that they could be liable to both the client and to the insurer for which they work. We should also make a distinction between agents and brokers. Agents are considered representatives of the insurer. Brokers are considered representatives of the insured. The broker's primary allegiance is to the client. Knowledge of the broker is not considered knowledge of the insurer. The agent and the insurer are deemed to have the same knowledge. Express Authority & Ostensible Authority Identifying the distinction of knowledge could be critical if an insured chose to sue both the agent or broker and the insurance company. Normally, if the broker is involved the insurance company can escape liability. As with anything, there are always exceptions. Sometimes when dealing with the agent, the insurer can still be held liable even if the agent oversteps their express authority. Express authority refers to the powers given to the agent in the agency agreement or contract. In addition, the agent also has certain implied powers. The courts have used the doctrine of ostensible authority to give agents those powers the public reasonably expects them to have. An example of liability would be that of a life insurance agent who accepted the premium for a life insurance contract with a company for which he was not contracted. The insurer had not given the insurance agent the authority to accept the premium. The insurer could be bound since it is reasonable for the public to believe that an agent has the authority to accept premiums. 15

16 Another example where ostensible authority can be invoked is when an agent is told by the insurer that the company will not write homeowners coverage on homes over 50 years old. Assuming the agent writes a policy on a home over 50 years old, the insurer could still be liable to the insured if any claims arose since there would be no reason for the insured to know the issuance of such policies was forbidden. Of course, in these situations, the insurer may have recourse against the agent for the actions they took. In many situations, the agent/broker distinction can become less critical. Instead, the facts of the situation will be looked at to determine whom the agent or broker was representing: A. The insured, or B. The insurer. In any case, the agent or broker must and is expected to act with reasonable care and diligence when representing the insured or insurer. Another aspect to look at is how the courts view the insurance agent. Assuming the court views the insurance agent as a professional, the applicable standard of care would be that of the skill and expertise of the average professional in that industry. We all know, of course, that some agents are more expert than others. Those who overstep the bounds of common sense cause the entire industry to experience change, as provincial legislation changes to protect the consumers. We can look at court cases that discuss the implied law duty of good faith and fair dealing that is imposed on agents and insurance companies. In a documented court case, standard duty of care is mentioned: Where an insurer fails to deal fairly and in good faith with its insured by refusing without proper cause to compensate its insured for a loss covered by the policy such conduct may give rise to a cause in action in tort for breach of an implied covenant of good faith and fair dealing. The duty violated arises not from the terms of the insurance contract but is a duty imposed by laws, the violation of which is a tort. The courts here are referring to insurers in speaking of the duty of good faith and fair dealing, but it is also applicable to the insurance agent. Typically, if the insurance company is sued for bad faith, the agent will also be named as a defendant. 16

17 INSURANCE AGENTS' AND BROKER S CIVIL & CRIMINAL VIOLATIONS Insurance agents can also be found liable for statutory violations, both criminal and civil. For insurance agents whose livelihood is dependent upon their employment, this is an especially serious form of liability since criminal violations can require a conviction and impose fines or imprisonment or both, depending on the severity of the crime. Sometimes the insurance agent is given the option of having a hearing before the Provincial Insurance Commissioner rather than appearing in court. In other instances, if the agent surrenders their license voluntarily, no further action is taken. Fraud is perhaps the most common crime committed by insurance agents. We have probably all heard of stories of unscrupulous agents taking advantage of their clients. Provinces pass legislation in the hope of reducing fraud, but it is unlikely that laws will ever be entirely successful. What the examples above show is that an agent can receive criminal punishment for acts of fraud they commit. Unfortunately, for many agents who commit fraud, no physical punishment is ever experienced, although they do commonly loose their license to sell insurance. Some agents, however, will simply move to another province and hope that their past does not catch up with them. It has been said that an ethical code of conduct cannot be mandated. An agent is either ethical or not, and laws merely point out those who are not. While this may be true, laws (and resulting punishment) do at least prevent those who lack any ethics from continuing in the profession. Unfortunately, consumers will remember the unethical far longer than the hardworking ethical agent and financial planner. It has been said that an ethical code of conduct cannot be mandated. An agent is either ethical or not, and laws merely point out those who are not. INSURANCE AGENT'S AND BROKER S BREACH OF CONTRACT Contracts may involve legal wrongs when implied warranties are violated or contract obligations are breached. An insurance agent would likely not be sued individually for breach of contract. 17

18 The insurance companies and agencies themselves are more likely to be sued for such a lawsuit since they would be viewed as responsible for denial of a claim or violation of a condition. However unlikely it is that an agent or broker would be sued for breach of contract, it is possible It is also possible for the agent and the insurance company to be sued for failing to act promptly on an application for insurance. This is sometimes presented as a negligent cause of action, but it has also been presented as a breach of an implied agreement to act promptly or as breach of contract. Breach of an Implied Agreement Theory Under the theory of breach of an implied agreement to act promptly, it has been found that the course of conduct of the agent, including solicitation of the application and acceptance of the premium, constitutes an implied agreement that the insurance company will act upon the application without unreasonable delay. Breach of Contract Theory Under the theory of breach of contract, it has been found that the application is the offer and silence on the part of the insurance company or silence coupled with retention of the premium forms a contract. This makes the insurance company liable for any unreasonable delays in acting on the application. Legally Binding Insurance Contract It is important to understand exactly when an insurance contract becomes legally binding. As stated before, the application is considered an offer of insurance. The acceptance occurs when either the agent binds coverage or the policy is issued. By law, an insurance contract does not actually have to be in writing. However, it is normally in written form. While there are many reasons for this, one main reason is to determine when the contract was formed so that one may know when a loss is covered. For example, client ABC applies for coverage with XYZ insurance company on his car. By accepting the offer of the client, the agent creates a written contract. If client ABC is involved in a car accident before he receives a written contract, the loss is still covered by XYZ insurance company. By accepting the offer of the client, the agent creates a written contract. 18

19 If the client is involved in a car accident before he receives a written contract, the loss is still covered by the insurance company where application was made. Relevance The relevance of determining when a contract comes into existence relates to when and if a breach of contract occurs. It is obviously stated that no breach of contract can occur unless a binding contract actually exists. In the past, a life insurance agent could not bind the insurance company. However, a court has stated this opinion: "... An ordinary person who pays a premium at the time he applies for insurance is justified in assuming that payment will bring immediate protection, regardless of whether or not the insurer ultimately decides to accept the risk." In another case, the court s opinion was: "... The very acceptance of an advance premium by the carrier tends naturally toward an understanding of immediate coverage though it is temporary and terminable... In short to the ordinary layman, payment of the insurance premium constitutes payment for insurance protection..." A Contract of Adhesion In the first case mentioned, payment of the premium had been made. The courts are leaning toward viewing the insurance contract as a contract of adhesion and tend to be harder on the agents and insurance companies in finding a contract early in the negotiations. A contract of adhesion means that the insured has no option to change or negotiate policy terms. The policy is presented to the insured on a take it or leave it basis. In viewing courts cases and decisions, it can be understood that any ambiguities in the insurance contract will be construed against the insurance company. ARE YOU DOING MORE THAN JUST INSURANCE OR FINANCIAL PLANNING? Many financial planners start out as insurance agents or brokers and continue to sell insurance after they move into the financial planning field. For this reason, financial planners will have the same liability problems that they did in the insurance field as well as additional liabilities as financial planners. 19

20 Even if the financial planner did not start out in the insurance field, they would be involved in providing clients with the risk management advice and even perhaps, would begin selling insurance products. This would thus mean that a financial planner would need to know their liabilities in this field they are expanding to. Financial planners can look to court cases involving insurance agents to gain a better idea of how their field will be likely treated in the courts. Like the insurance agent, the financial planner will be viewed as a fiduciary, holding themselves out to the public as having special skills and/or knowledge. Like the insurance agent, the financial planner can be held liable for negligence, breach of contract and statutory violations. Accountant's Liabilities Looking at how accountants open themselves up to different liabilities will accomplish two things: 1. Help determine the liabilities that need to be covered. 2. If an insurance agent is an accountant also, it will help them determine where they may need to provide adequate coverage for themselves. Quite often, accountants expand their field and become financial planners. Accountants deal with the finances of clients and performing such tasks as analyzing financial statements and preparing tax returns. However, unlike insurance agents and stockbrokers, accountants do not sell products, unless they have obtained a license to do so. It is their services that they sell. An accountant's services involve the use of judgment when deciding what to do with the numbers. It is not hard to understand, then, that an accountant that negligently makes an error in the figures can be found liable. There have been two important developments in the area of accountant liability: 1. The courts increasingly have become willing to find accountants liable to their clients for their negligent acts. Before the 1950s, the courts were much stricter in awarding damages to clients. 2. Accountants are now being held liable to third parties. These third parties represent non-clients and people with whom the accountant has not contracted. Because of this liability, the exposure to liability claims for an accountant has significantly increased. 20

21 When Are Accountants Not Liable to Third Parties? An accountant's full liability exposures can be understood by reviewing a few court cases that deal specifically with this issue. In a court case from 1931, where the defendants were Certified Public Accountants who audited a company and supplied the company with 32 serially numbered copies of a certified balance sheet. The defendants knew that the company to obtain future loans would use these copies. The balance sheet showed a net worth of more than $1 million when actually, the company was insolvent and later had to declare bankruptcy. As a result, the plaintiff, who was considered the third party and relied on the balance sheet of the company, sued the accountants for negligently and fraudulently performing the audit. The court decided that the accountants could not be held liable for negligence to a person or people who were not parties to the original contract. On the surface, the decision appears to be very straightforward. If a person is not a party to the original contract, they cannot claim damages for negligence. However, the court did go on to state: Our holding does not emancipate accountants from the consequences of fraud. It does not relieve them if their audit has been so negligent as to justify a finding that they had no genuine belief in its adequacy; for this again is fraud. The court went on to state that an accountant could be liable to a third party who had not entered into the contract if the involvement of the third party was foreseeable. For example, if a client asks an accountant to prepare financial statements for the client to show a specific party with whom they do business, the accountant then knows a third party is involved and this involvement could be considered foreseeable. This case states two distinct views. On the one hand, it states that an accountant is not liable to third parties with whom they have not contracted. On the other hand, the accountant can be liable to a third party if it is foreseeable that a third party will be involved or if the accountant acts in a fraudulent or grossly negligent manner. Since it is not always clear when a third party involvement is foreseeable, or when the accountant has acted in a fraudulent or grossly negligent manner, this case precedent could be followed by various courts, yet very different judgments could be reached. 21

22 The two most common trends resulting from this case are as follows: 1. Accountants can be held liable to a third party lender since they prepare financial statements for their client knowing they are to be used by the lender. From this, one could assume that a duty of reasonable care is owed to all actually foreseeable third parties. Alternatively, the accountant must actually know a third party will be using the documents. This is a narrower view of third party liability, and has been the most common view held by the courts. 2. Accountants can be liable to all reasonable foreseeable third parties who will rely on the accountant's work. This is a broader view of third party liability. As the court stated, the accountant can be found liable when he or she "knows the recipient intends to supply the information to prospective users. This allows anyone who might rely accountant's work product to have a financial interest. Courts are now becoming increasingly likely to follow this broader view of liability. ACCOUNTANT NEGLIGENCE The area of liability for professional negligence is more relevant than is liability for breach of contract. This is particularly true since many of the duties required to meet an accountant's professional standard of care are the same duties required for financial planners. The most basic duty of these is the fiduciary duty. Like the financial planner/client relationship, the accountant/client relationship is "one founded on trust or confidence reposed by one person in the integrity and fidelity of another. The fiduciary must always place the interests of the client above their own. If a potential conflict of interest arises, the client must always be informed and be given opportunity to seek another accountant. This duty would include reporting to the client signs of such things as embezzlement, check kiting (in commerce, this means any negotiable paper not representing a genuine transaction, so check-kiting might be thought of as "flying a check before funds are available"), and cover-ups of delinquent accounts. However, the accountant as fiduciary is not required to be a police officer or a detective. He or she is a watchdog, so their duty is more like an auditor. As such, they are required to alert clients to suspicions, but if nothing seems suspicious then he or she is not required to track down each element involved. 22

23 Insurance agents are required to have continuing education in most provinces to keep their insurance license active. The accountant has a similar requirement in that they have a duty to keep current or abreast of recent developments in accounting and auditing practices. To help provide guidelines to accountants, there is the Generally Accepted Accounting Principles (GAAP). This standard states the minimum professionally acceptable conduct for accountants. This means that if the accountant does not follow these standards, it could be viewed as evidence of negligence. However, the fact that an accountant follows these standards does not necessarily prove that they are not negligent. One of the most difficult areas for an accountant and agent alike is that of providing tax services. With all the various changes in the tax laws, it is an enormous responsibility to be aware of these changes and their impact on clients. It is not hard to understand that if an accountant is not careful in giving tax advice to a client, Canada Customs and Revenue Agency could audit the client and additional taxes and penalties could be paid. If this is a result of the accountant's negligence, the accountant can be held liable for the financial losses that the client incurred. Typically, the accountant is not responsible for the actual taxes due, but only for interest or penalties levied. All professionals must avoid overstepping their boundaries of authority. The accountants and financial planners must not practice law, for example (give legal advice). If this happens, civil and criminal penalties could be the result. Offering tax advice is the most likely area of stepping over the boundaries of expertise. Accountant Breach of Contract Breach of contract is perhaps the most straightforward of the three areas of potential liability. It is imperative for the accountant to be as clear and specific as possible in order in a contract of service. If this is done, the likelihood of a lawsuit for breach of contract based on a misunderstanding or difference of interpretation is reduced. However, the accountant's failure to perform a duty that is specifically named in the contract would also be more obvious thus making it easier to prove a breach of contract in court. 23

24 Most of the breaches of contract lawsuits have been brought against accountants due to vague or ambiguous wording in their contract and situations in which failure to perform is not quite so obvious. As well, many breach of contract lawsuits have been brought against accountants due to vague or ambiguous wording in their contract and situations in which failure to perform is not quite so obvious. Accountants' Civil & Criminal Violations The final areas of potential professional liability for an accountant are violations of a statutory duty. This is very important to the accountant since it typically involves the imposition of criminal sanctions against the wrongdoer. The obvious areas of criminal liability for accountants would be embezzlement, check kiting, fraud and similar crimes that could result from having access to a company's books. To add to this, an accountant can also be found guilty of violating the securities laws if they give a client investment advice. We can see how this situation might arise quite easily if an accountant receives a fee or commission from a dealer for recommending certain securities. The Canadian Institute of Certified Public Accountants views this as a conflict of interest on the part of the accountant and will subject them to professional discipline. INVESTMENT ADVISOR'S LIABILITIES The term "investment advisor" covers a broader range of activities than those performed by a stockbroker. It does not cover as broad a range of activities as those performed by a financial planner. It must consider, however, that since most financial planners would be deemed investment advisors, the court's treatment of investment advisors clearly points out the standard to which a financial planner is likely to be held. STOCKBROKER'S LIABILITY Stockbrokers' or security dealer's professional liability problems are particularly relevant to financial planners. Since financial planners wear many hats, including insurance agent, investment advisor and even security dealer on occasion, it is very important to understand the liability problems faced by security dealers. When a client goes to a financial planner, he or she typically goes for receiving investment advice. This is viewed as the primary function of a financial planner - to help the client handle their money and invest it wisely. 24

25 This includes providing insurance coverage, solving tax problems, saving for retirement, and planning one's estate. When a client purchases cash value form of insurance, they are investing in an insurance policy. When a client invests money in a tax shelter, they are investing their hopes that at the same time, a tax problem is being resolved. The same is true for retirement and estate planning. In order to plan for these things, it is necessary to invest the money for those goals. Many stockbrokers have moved into the financial planning field in the same way agents have, so their potential problems reflect those of insurance agents. Initially the majority of financial planners were either insurance agents or stockbrokers. Stockbrokers were already involved in the business of investment planning, so it easily expanded into financial planning for their clients. One of the primary functions of a financial planner is to invest the client's money or to provide the client with an appropriate plan to invest their money. Therefore, even if a financial planner did not start out as an insurance agent/stockbroker, they would still be involved in recommending and/or selling such investments. Some areas of products may require specific licenses and it is understood that agents must obtain these. Like an insurance agent or broker, the stockbroker must be extremely careful to avoid potential conflicts of interest. In addition, like the insurance agent, the stockbroker will be making a commission on the sale of a product. The stockbrokers could be in a more precarious position than agents since the products they recommend have a greater chance to lose large sums of money. Insurance agents tend to deal with products that do not loose money; rather they "insure" some element of the client's life against loss. Even so, insurance products do have what is termed a "guaranteed loss. Do you know what that is? If you said premium payments, you were right. Stockbroker Negligence The courts continually refer to the terms "willful" and "reckless" when describing what behavior on the part of a stockbroker would be responsible for wrong. Mere negligence of a broker or his agent in a sale of stock, or a mere breach of fiduciary duty without deception does not always constitute a violation. 25

26 The distinction between negligent behavior and willful or reckless behavior can be illustrated in the following two hypothetical situations: Let us assume that Mr. ABC places an order with his stockbroker to buy 50,000 shares of a limited offering. His stockbroker misunderstands him and instead purchases 5,000 shares. A week later, when Mr. ABC discovers the error, the offering is no longer available. Mr. ABC could claim that his stockbroker's negligence resulted in a monetary loss to him since he is not longer able to add the offering to his investment portfolio. Let us also assume that Mrs. XYZ, a 63-year-old widower who plans to retire in two years, explains to her stockbroker that her major concern is with safety and provision of a steady income flow for her retirement years. In response, her stockbroker purchases aggressive growth stocks and speculative common stocks. As a result, Mrs. XYZ loses a major portion of her investment. In both these situations, the stockbroker lost money for the client. There are, of course, situations where the stockbroker acts in good faith and the client still loses money. Of course, stock investments are risk vehicles to start with. The stockbroker cannot guarantee what the market or stock performance will do. In both the situations listed above, the clients lost money due to the stockbroker's actions. In the first situation, the stockbroker did not intend to act negligently. There was no intent to deceive or defraud. In that situation, it is unlikely that the court would find his behavior willful or reckless. In the second situation, the stockbroker knew that his client had a low risk tolerance and that she needed the income for her retirement goals in a couple of years. The stockbroker completely disregarded her needs and placed the client's money in an inappropriate investment vehicle. It is possible that a court would find the stockbroker's behavior to be willful and/or reckless. In some circumstances, the brokerage firm employing the stockbroker may repay the monetary loss to the client. This might happen when an incorrect number of shares were bought even though, in order to purchase the correct number, additional costs are involved because the price of the share has risen since the time the original order was placed by the client. In many situations, the monetary losses are too great for the brokerage firm to absorb voluntarily. In this instance, the client may opt to sue. 26

27 The broker would likely be deemed a fiduciary of the client since the stockbroker holds themselves out to the public as having special skills and knowledge and therefore will be held to a higher standard of care. This standard of care would make it easier for a client to prove the stockbroker was negligent. Stockbroker Breach of Contract When a stockbroker is sued, it is usually for violations of a statutory duty, although it is certainly possible to be for breach of contract also. In the previous hypothetical situations, Mr. ABC wanted his stockbroker to purchase 50,000 shares of stock, but instead the stockbroker only purchased 5,000 shares of stock. He could claim that the broker breached their oral contract even though it was unintentional. Stockbroker breach of contract is similar to insurance breach of contract. With insurance agents, the client's offer is the application. The acceptance comes when either the agent binds coverage or the policy is issued. With a stockbroker, the offer is made when the client requests a particular stock and the acceptance occurs when the stockbroker agrees to buy the stock or actually purchases it. It is very difficult to prove exactly what was said in oral contracts. It usually comes down to one person's word against another, or one person's perception of the facts against another. For this reason, the client may find it preferable to sue for a statutory violation. Many breach of contract situations are simply sub-categories of a broader statutory violation. In a case where a financial planner relies on a broker-dealer to actually handle any securities transactions, the financial planner has recommended, an interesting problem occurs. Is it sufficient for the financial planner to rely on the broker-dealer's due diligence? Should the financial planner also perform due diligence? Who is ultimately responsible for this task? Certainly, the financial planner wants to use only individuals they trust to complete their client recommendations. Even so, the recommendations should only be made where the financial planner feels confident. How can confidence exist if the planner has not personally performed due diligence? 27

28 SO YOU WANT TO PROVIDE STOCKBROKER ADVICE? Key areas to remember: 1. The biggest problem for stockbrokers is violation of statutory duty. Stockbrokers are regulated by the different Provincial Securities Commissions, such as the Ontario Securities Commission (OSC) in Ontario and the Alberta Securities Commissions (ASC) in Alberta etc., and can be convicted of violations of the Securities Act under each jurisdiction. 2. The stockbroker can also be found guilty of breach of contract, though this is less common. 3. Third parties can also sue the stockbroker if their fraudulent statements were made to the public at large, and not to just individual clients. 4. If the brokerage firm is sued because of the actions of the stockbroker, like the insurance agent, the firm may sue the stockbroker if the firm itself was neither involved in the wrongdoing nor negligent in hiring or supervising the stockbroker. 5. It is important to realize the relevance of accountants', insurance agents' and stockbrokers' liability problems to financial planners. These three professions presently make up the majority of practicing financial planners and the individual duties of each profession, when combined, comprise many of the duties of a financial planner. PREVENTATIVE MEASURES Public Harm Even the most careful person may eventually face a lawsuit. Even so, it is worthwhile to take any steps, which may reduce the likelihood of such an event. If a person is actually sued, the fact that they have taken these precautions can help. How? They show the financial planner's due diligence and good faith and sometimes this can provide a satisfactory defense against a malpractice suit. A professional liability or malpractice lawsuit is traumatic in that much of the harm is done the moment the suit is filed. Unlike most legal claims, the situation is not over once the lawsuit is resolved. Harm to the professional's reputation has occurred simply because the suit was filed: consumers will remember the occurrence. However, no one may remember if the professional was found guilty or not. For this reason, it is important to try to prevent malpractice claims from being filed in the first place. 28

29 What "triggers" a liability claim? To prevent lawsuits, it is necessary to first understand what actions or omissions can trigger a professional liability claim. Then we can determine what preventive actions may be taken to avoid the situation. There are many reasons for lawsuits from outright fraud to simple misunderstandings. For simplicity sake, the following are broad categories: 1. Omissions, which is an intentional or unintentional failure to provide full disclosure (all the necessary facts). 2. Failure to detect a potential problem. 3. Bad advice. 4. A potential conflict of interest. 1. Omissions can be anything from a minor point to a major issue. It might be a failure to provide the client with a prospectus for a new issue of securities, failing to explain the risks involved with the purchase of speculative stock, or any other omission that the client might deem important. Some omissions may be more a matter of opinion than fact (the agent says the issue was discussed and the client says it wasn't). 2. Failure to detect a problem is often a failure to use a comprehensive data gathering form. As a result, the financial planner does not have a full and complete set of facts. More often, it results from an agent trying to do more than he or she is qualified to do. 3. Bad advice can be due to many reasons, but often it reflects a lack of agent knowledge. Obviously if the advice is thought to be bad, there was also probably a loss of funds. Why else would the advice be considered bad? Loss of money is the number one reason for being sued. 4. Failure to disclose a potential or real conflict of interest can be remedied by practicing full disclosure. The most common conflict of interest is representing two or more people who have a financial interest in each other, such as a divorcing couple. To represent both could present problems if there are legal difficulties in terms of property division, life insurance beneficiaries, and the like. Again, this problem can be avoided simply through complete disclosure and common sense. 29

30 FINANCIAL PLANNING IN THE REAL WORLD As most financial planners realize, it is the recommending and carrying out of investments that has the greatest potential for dissatisfied customers. Those who are new to the financial planning world may overlook some very important aspects of financial planning: documentation. Even when the professional has done all that is in his or her power to recommend successful companies, losses can happen. Any financial planner is foolish if they do not clearly state this fact. For some, it may seem uncomfortable telling a client that they may loose money on their investment. Certainly, it does little for client confidence, especially if the client is new. However, if the financial planner has already outlined risk and how it relates to earnings, this disclosure should not pose a problem. No client should believe that some types of investing are foolproof. In fact, there is not any type of investing that is 100 percent safe. Sometimes the risk is less obvious, such as the effects of inflation, but all investments do contain risk. At one time, it was thought that investing in annuities through insurance companies was foolproof. A few company failures proved this thought wrong. While annuities still provide one of the safest vehicles for those with a low risk tolerance, as we stated, no investment is foolproof. Once a consumer understands risk, they are often open to a larger variety of investment vehicles. There are ways to minimize risk, if that is the desire. The first step, however, is understanding risk. Once a consumer understands risk, they are often open to a larger variety of investment vehicles. More importantly for the financial advisor, though, once the consumer understands risk there is less likelihood that the investor will blame their professional advisor for losses that happen to occur. Every profession has specific terminology. Words that may have simple meanings in our every day language often have other meanings when used in the context of specific professions. In the profession of insurance, risk is the basic problem with which insurance deals. In the profession of investments, risk is the element that provides a profit or loss, including the size of the profit or loss. With insurance policies, the desire is to cover the potential loss so that it shifts from the insured to the insurance company, either in part or in full (in part means the insured must pay part of the loss themselves). 30

31 With investments, there is no other entity to shift losses to. Should a loss occur, the entire loss belongs to the investor. There is no one else to shift a loss to, except through lawsuits. Firstly, the term "risk" seems simple enough. When someone says risk is involved, the listener understands what is meant: there is uncertainty. Something bad might happen rather than something good. When economists, statisticians, theorists, and insurance underwriters discuss risk and uncertainty, they do so with the objective of definitions, which will help them in their analysis in each field. The insurance underwriter, for example, wants to cover losses effectively for the company and, if applicable, their stockholders. Underwriters know losses are part of doing business as an insurance company. The public does not want to "cover losses. They want to totally avoid them if possible. As a result, how the consumer and how the insurance underwriter views risk is different. Because each industry has a different perspective on risk and uncertainty, definitions also have a different perspective. The financial consultant should never assume that his or her view of risk matches that of their client. There is another problem with the term "risk" in the insurance industry: it is used two different ways. In one usage, risk is a peril to be insured against. This comes mainly from the property/casualty field. For example, fire is a peril to be insured against. As a peril, it is termed a "risk. The words risk and peril are typically interchangeable. Secondly, insurance professionals use the term "risk" to mean an abstract situation where there is the possibility of a financial loss or gain. Either situation is possible. Because the financial planner cannot say an investment is absolutely going to increase (make money), the planner explains the amount of risk involved; the amount of uncertainty. The actual definition of risk may include the following: 1. The chance of loss, 2. The possibility of loss, 3. An uncertainty, 4. The dispersion of actual from expected results, and 5. The probability of any outcome difference from the one desired or expected. 31

32 While each definition is similar, and can mean almost the same thing, there are still variations, which will depend upon the context in which risk is used. Primarily, at least for our purposes here, risk is the possibility of loss financially. The foolish financial planner will minimize the possibility of loss to their clients, especially if it is only a potential client. An agent once stated about risk, "We can't guarantee the rate of return; it might be as high as 15 percent or as low as 5 percent. That is the risk you take. No statement could be worse. The agent completely passed over the real life definition of risk: the possibility of financial loss. The real life definition of risk: the possibility of financial loss Risk always means an element of unknown. The outcome cannot be certain. It is true that some situations have more probability of loss than others, but anytime risk is an element, the outcome is not completely known. When the words "chance of loss" are used, they are generally expressed as a percentage or a fraction. "Chance of loss" is not the same thing as "risk" although they are often used to mean the same. A chance of loss is typically defined as the probability of loss, whereas risk is not a probability, but rather a possibility. There are situations where the chance of loss is 100%. When this occurs, there can be no risk involved because the loss is certain. Risk involves uncertainty. It is understandable that these two things are used together. Writers may feel that the distinction is not enough to spend time on. The statisticians and economists go crazy over the incorrect usage. Our point, however, is that how words are viewed do vary among people. Agents and brokers should never think that definitions are not important, especially as they relate to risk. The Degree of Risk It is likely that consumers are most concerned about the degree of risk. Luckily for the insurance professional, most consumers are aware that risk is part of investing. What they may not be fully aware of is the degree of risk involved. All investments have risk; there are no exceptions. 32

33 Even such minimal thing as a passbook savings account carries risk: inflation. By 1999, inflation has seen all-time lows. That in itself is a risk for some investors. As far back as baby boomers can remember, Canadians was coping with much higher rates of inflation. By 1999, inflation had virtually disappeared in comparison with past years. All investments have risk; there are no exceptions. INFLATION Consumer prices in industrial countries raised less in 1998 than any year since Because inflation lowered so gradually, most people were unaware of exactly how they had been affected. What they did notice was the loss of big wage increases and lowered interest income. However, even though raises are much smaller during low inflation, buying power is greater. Therefore, those smaller raises are buying more goods. This fact, even when stated, may not be a comfort to our workers. Half the people surveyed by a major University Economy Professor in 1996 said a raise would give them greater job satisfaction even if prices went up the same amount. It is not only the younger citizens that feel cheated by less raises and interest income. Senior citizen cost-of-living adjustments, tied to the economy, also seem very small. No one should think that inflation will stay low. Currency devaluations in Asia and Latin America are causing higher inflation in those countries. In Canada, the luxury of low unemployment and robust economic growth could actually spark the reoccurrence of inflation at some point. Some economists now feel that high rates of inflation eventually damage an economy by distorting certain markets, undermining public confidence in their government, and forcing all sorts of hoop jumping to stay ahead financially. In the early 1980s, most union contracts called for cost-of-living adjustments, but that is down 60 percent today. Why? Our cost-of-living is increasing so little, it just is not worth the effort or the pay it would bring. When inflation was high, there were certain benefits for some groups of people, primarily the retired population. Their investments earned enough interest that they could hope to live off it, sparing their principle from expenditure. With low inflation rates, that may not be true. 33

34 More and more retirees say they must tap into their principle just to make ends meet. Even though the cost of living is stable, they failed to save enough to support them during low inflationary periods. Of course, high inflation will also affect those who saved too little, but it is easier to blame it on low interest rates than it is to blame it on saving too little too late. Home buying brings about an oddity when inflation is low. In the past, many people bought houses with payments higher than they should be for the income they had. They did so because large raises allowed them to "grow into" their mortgage payments, which stayed the same on a fixed rate loan. With low inflation, the advent of high raises is much less likely. Therefore, it can be a foolish move to purchase a house with payments that are too high for one's income. On the other hand, more people can afford to buy a home when rates are low. The lower interest rates keep payments lower as well. Other types of purchases happen when interest rates are low, which further pushes our economy ahead. Especially car sales increase when interest rates are low. Even people with modest incomes can often afford the purchase of a new car when interest rates help to keep the car payments affordable. There is also another point of interest during low inflationary periods: corporate executes are much less likely to show sales and profits that are record setters. During inflationary periods, both sales and profits seem larger because inflation boosts the numbers. Loss of record setting sales should not be a negative factor, however, because low inflation also allows corporations and shareholders to pay fewer taxes. Because of the length of our lower inflation rates, the federal government is finding it necessary to address some new concerns. Can inflation be too low for our country's good? What happens if short-term interest rates get so close to zero (as they have in Japan) that they cannot go any lower, even if a recession sets in? We were outraged during high inflation at the prices we paid for goods and services. Quickly increasing paychecks often kept pace, but we never really got ahead. Sometimes, we continued to sink as costs outpaced income. Even so, it seemed that our rising pay was a "pat on the back" for a job well done. Comparing paychecks was the worker's way of feeling they were compensated for their efforts. 34

35 When inflation rates stay low, employers may not be offering the same sort of worker raises, even when the worker performs well. When companies see the prices of their goods staying the same or even going lower, they may not be encouraged to raise the worker's pay. Our federal government is concerned in their own way, that workers will rebel as low inflation causes low pay raises as well. The government has good reason to worry. It is likely that one of the targets will be the tax we pay. When raises do not happen, the taxes we pay tend to stand out. In some ways, with these lower inflation rates, the investments that are low risks are actually great performers. Annuities with a guaranteed rate of 4 or 5 percent are performing better than many other investments, which have greater risk. LIKELIHOOD OF LOSS Many things besides inflation affect the degree of risk. Primarily, the likelihood of loss relates to the degree of uncertainty. Let us examine the Russian game called Russian Roulette. Out of six chambers, the chance of loss depends on how many bullets are inserted. If three of the six chambers were filled, the chance of loss would be 3 out of 6, or 50/50. There is an even chance that one will either win or loose. Risk is highest at this point because there is no way to calculate which way events may go. The chances are even. Risk is actually easier to determine when they go higher or lower. Then the investor, or risk taker, is more likely to be able to see what might happen. That means that it is actually better to fill 4 chambers with bullets than three because the risk taker is better able to determine their chance of loss. The investor, or risk taker, can easier decline when the risks are clear. It is harder to decide whether or not to participate when risks are less defined. Using this example, if only one chamber of the gun is filled with a bullet, the risk is very low; the risk taker (investor) has one chance out of six that he or she will fail, but there are five chances out of six that he or she will win. Therefore, this would be the lowest risk. As more bullets are put in, the higher the risk of failure. Degree of risk is associated with the likelihood of an occurrence This likelihood does not necessarily mean that the investor will win. It may also mean that he or she is likely to loose (depending on whether one bullet or five are used). 35

36 By knowing the degree of risk, however, the investor (risk taker) can decide to go with or against an investment. The degree of probability for a win or a loss is what makes an investment a high or low risk vehicle. As we have stated, any investment can suffer a loss. Degrees of risk are not sure things. Even if there is only one bullet in the gun, thus giving a low degree of risk, it is still possible that some unlucky Russian will fire that chamber. Some of our readers may object to the illustration we have used. We realize that the vision of Russian Roulette is perhaps extreme, but it is an example that probably all people understand. In our history, Russian Roulette has been the ultimate gamble. The loss of finances is not as absolute as the loss of life, but it can be very devastating. When a financial planner is not well educated in their profession, they are playing Russian Roulette with the life of their clients. Degree of Loss Besides the degree of risk, there is also the degree of loss to be considered. An individual will think longer about risking $1,000 than he or she will about risking $10. Each amount may be experiencing the same degree of risk, but the degree of loss has changed. When gambling at a casino, the rule of thumb is never to bet more than one can comfortably afford to loose. While we would never want to suggest that investing is the same as casino gambling, there is nevertheless a degree of gambling to it. Every individual must plan to invest if they want a secure retirement, but it is important to know one's limitations; especially if investing involves a high amount of risk. The degree of loss is not an absolute figure. The amount depends upon the person and their own situation. For one, a loss of $1,000 might be a major setback while for another, it is a minor thing. Each investor must determine their ability for loss. Of course, no one wants to imagine that loss will be the result of an investment, but since it is a possibility, one must know their limits for loss. Much of this decision has to do with age. The older one is, the less ability they have to loose and still reach their goal. Therefore, the older one is, the safer their investments need to be. In other words, their tolerance for risk decreases as their age increases. 36

37 RISK CLASSIFICATIONS Different professions may classify risk differently, depending upon their particular needs. For insurance distinctions, there are some specific classifications: 1. Financial and non-financial risks This includes all situations where there is an exposure to adversity. In our context, this adversity would involve financial loss, but that would not necessarily be true in all cases. 2. Static and Dynamic Risks These distinctions, as made by Alan H. Willett in The Economic Theory of Risk and Insurance, state that dynamic risks are those, which result from changes in the economy, such as consumer product desires, technology, advances, or changes in price levels. These are not the only changes possible, but they are some of the more common ones. These types of risks normally benefit society eventually, but they may cause losses to some investors at the beginning. 3. Fundamental and Particular Risks The differences between these two are based on the origin and the consequences of the loss. Fundamental risks are losses, which are impersonal because they involve groups. They tend to be caused by economic, social, and political causes, although they can also be caused by physical occurrences. Fundamental risks involve large segments (groups) of the population. In contrast, particular risks involve individuals and events, which are felt by them individually. Fundamental risks would include events such as widespread unemployment, war, inflation, or floods. Particular risks would include the burning of a person's house, a car wreck, or a bank robbery. The bank robbery may affect more than one person, but it still is based on a few individuals rather than a large group. Fundamental risks tend to be caused by events, which are beyond the control of those individuals affected. These events are not the fault of and cannot be prevented by those who suffer the losses. Because of this, we tend to feel that society should take responsibility for them. Usually some sort of social insurance is purchased for such events, or federal funds are used to repair the damages. 37

38 Particular risks are the responsibility of the individual since it is the individual that is affected by them. That is why we insure our homes against damage by fire, insure our vehicles and ourselves (liability insurance) against car wrecks, and bank where our funds are covered by guarantees. 4. Pure and Speculative Risks Every investor should understand these terms. Pure risk is a term used to designate those situations, which involve only the chance of a loss, or no loss at all. Speculative risk also involves a chance of loss, but more importantly, it also provides a chance of gain. Therefore, pure risk is a gamble between no loss and some loss, but speculative risk is a gamble between loss and gain. With speculative loss, risk is often deliberately created in the hopes of gain. Gambling is an example of this. So is the creation of one's own business. Typically, only pure risks are insurable. When a person buys a home, they also purchase fire insurance. The homeowner does not know that a fire will occur, but he purchases insurance for the possibility of it. In other words, it is a gamble between no loss and loss. The fact that the homeowner may make a profit in later years when he sells the house is not a factor. The only issue is whether a loss may occur. Of course, not all pure risks are insurable, but speculative risks seldom are. Speculative risks are viewed to be voluntary because of the two dimensional nature of them (the possibility of gain as well as a loss). As so often is true, each type of risk often has sub-categories. For example, pure risk would include (1) personal risks, which includes premature death, disability, sickness, retirement or old age as it is commonly called, and even unemployment; (2) property risks, which includes the loss of property or the loss of its use, such as direct damage from another, loss of rental income, or other expenses related to property and its use; and (3) liability risks, which includes the possibility of loss of present assets or future income as a result of damages assessed or legal liability arising from an intentional or unintentional act or an invasion of the rights of another. Insurance agents might think of other areas that they feel should be included, but these are the widely accepted types. 38

39 WHO SHOULD CARRY THE BURDEN OF RISK? No matter how risk is defined, someone must carry the burden of it. For the policyholder, the risk is transferred to the insurance company. If the policyholder's house burns down and he or she had a policy, which covered it, the insurance company will pay to replace the home. Therefore, through premium payments, the burden of the risk is transferred to another entity. Who should carry the burden of risk in investments? Since it is a speculative risk, normally the investor carries the burden. It is the investor who carries the burden of risk investment, except in the following situations: 1. When the professional advisor gave bad advice despite obvious signs; 2. When the professional failed to fully disclose all the risks involved; 3. When the professional cannot document that such disclosure was given; 4. When any investor can prove fault on the part of the financial planner. So, who carries the burden of risk for the financial planner? If he or she is prudent, E&O insurance will. With this insurance, when the planner is legally obligated to pay damages arising from their performance of professional services, caused by error, omission or negligent acts, the insurance company will cover the cost, in part or whole, depending upon the terms of the policy. Ironically, it tends to be the most reliable financial planners that buy E&O insurance. That is not surprising since those who are reliable are reliable in all areas, including the protection of themselves. Does this mean that potential clients should ask their financial planner if they carry E&O insurance? Absolutely! All insurance companies actually mandate that those agents who license with them be insured. Most insurance agents and financial planners do not believe that they will ever be sued. Of course, most consumers also do not believe that they will ever be disabled or need large funds set aside for retirement. Canadians are a positive thinking bunch of people! It will be the other person who ends up in a nursing home. It will be some other family that experiences a disability that financially drains them. It will be some other agent who is sued. 39

40 Most insurance agents really do try to do a competent job. What they may fail to realize is that simple competency is not always enough anymore. Therefore, you tried to place that nursing home policy, but your clients just would not pay the high cost. Therefore, you advised the young family that more life insurance was needed, but they failed to purchase it. Therefore, you told the businessperson that he needed key man insurance, but he never called you back. When you end up in court, will anyone remember that you gave good advice? Can you even prove that you did? Most lawsuits are not brought by your client themselves. Their family members will file them. Without signed documentation you might be left out in the rain. The daughter and her husband knew that their parents trusted their financial planner. They talked about you often. The daughter knew her mother was considering Long Term Care insurance. So, if you are so efficient, why didn't you place such a policy and save the family thousands of dollars in health care costs? When that nice young man was killed in a car accident, his wife and three children only collected $50,000 in life proceeds. You know she must remember that you advised her husband to buy a larger amount. How can she say she doesn't remember that conversation five years later? Without documentation, there is no proof No matter what the situation, lawsuits happen. Even to nice people. If you cannot produce the signed refusal form for the nursing home policy, how can you prove to the daughter and her husband that you did advise the purchase of protection? How can you prove to the widow that you did point out the shortage in life insurance protection five years ago? Without documentation, there is no proof. What Type of Documentation? Forms vary and there is no "right" documentation form. There is one requirement for documentation, however, that is necessary: your client's signature. It is not unusual for agents to think their personal notes are adequate. In some cases, they may be. Certainly, they are better than nothing. In fact, agent notes are worthwhile for many reasons, but when it comes to lawsuits they are not enough. Always require a refusal signature for any product that is presented. Keep those refusal signatures forever. Lawsuits do not necessarily happen immediately. 40

41 Provincial laws do vary and there are time requirements on many things. For most agents, however, constant calls to their attorney are not productive. It is simply easier to keep all refusal signatures, even past the client's death. Many legal advisors recommend a 3X5 card format for the refusal signatures. These can be easily filed by client name, taking up little space. Each refusal card should state the policy that was presented, the date presented, the amount of time spent on the subject (mere product mention is not a presentation), and the reason given for refusal. If the client indicates that he simply does not want the product "at this time" the agent should put a revisit reminder in his or her calendar and be sure to follow up on it. Otherwise, the refusal signature is not necessarily valid. Can an agent be sued for being too poor a salesperson? In other words, can the family argue that the agent did not present the product vigorously enough? In this day and age, perhaps so. However, it would seem unlikely that an agent could be sued for not being persistent enough. Certainly documentation would lessen the possibility of it. CLAIMING UNEARNED EDUCATION OR EXPERIENCE Many types of sales do not require provincial specified education. Any person can list any type of education or experience, even if it does not actually exist. Such claims do not necessarily have to be expressed; they may also simply be implied. There are always enough foolish salespeople around who take advantage of that ability. Sometimes it is even promoted by the agency for which they work. Of course, the thought is that more consumers will buy from them. Actually, that might even be true. Consumers do want to deal with people who know what they are doing. The danger lies in the increased possibility of lawsuits by clients and their families once the misrepresentation is discovered. At the very least, the policyholder will drop the coverage and go with someone they feel is more honest. FULL DISCLOSURE No matter what type of insurance is being sold, full disclosure is an absolute must. Many agents and financial planners consider full disclosure to simply be what is in the written plan, very often there are important details regarding risk or tax shelters that will not be found in the policy or proposal itself. When the client knows what to expect or what might be a possibility, there will not be any surprises. Avoiding surprises also avoids malpractice suits since it is the surprises that cause unhappy clients. 41

42 Again, document the information given and have the client sign the documentation. It should be pointed out that any ambiguities in the form would likely be construed against the planner. All documentation forms must be clearly written. When investments go down instead of up, clients invariably begin to worry. This worry can prompt calls to the financial planner. At this point, the planner should again go over all the details of the investment, including risk factors. Often, the client merely wants reassurance. Going over the details confirms for them what their buying decision was based upon. Most financial planners should be using a release of liability form stating that if the rate of return on the investment does go down, they will not be held responsible. Even if this form is used, however, it is always necessary to reaffirm for the client what they have invested in, how it works, and why returns might be down now. WHAT IS DUE DILIGENCE? Due diligence means a wide variety of things. It can be as simple as returning a client's telephone call or as complex as checking out a company's stability. Primarily, at least in this context, it means knowing whom you are writing business for. Agents who choose their companies by the amount of commission paid are not practicing due diligence. There are companies that specialize in due diligence research, especially those firms who practice ethical investing. Ethical investing means investing only in companies approved of by the client. For example, if the investor does not want to invest in any company that participates in animal testing, then they would seek out companies which follow their views. Some companies seek out this type of data for financial planners and their clients. In fact, there is much more data than one might imagine on the companies offering stocks for sale. There is also lots of data on insurance companies. Virtually any company which the financial planner might be interested in has data available. There are companies that specialize in due diligence research, especially those firms who practice ethical investing. It would perhaps be impossible for an agent or financial planner to personally investigate every company or corporation he or she recommends to his or her investment clients. Rather it makes sense to simply research those companies who investigate other companies. If their research appears to be thorough, knowledgeable, and reputable, then it would seem reasonable to simply rely thereafter on their research when selecting companies. 42

43 From a legal standpoint, it is not clear how much due diligence is legally expected. There will have to be more case law before a clear standard emerges. However, past lawsuits have been won based on too little due diligence. If an agent or financial planner relies on a company known for their due diligence studies, it would seem reasonable that he or she would have a fair measure of protection. Of course, this is speculation since there is not wide spread case law in this area. FIDUCIARY DUTIES Every professional owes his or her client a fiduciary duty. The professional, by stating or implying special knowledge, education, or experience not held by the public, becomes a fiduciary to the client. This statement cannot be stressed enough. An insurance agent has knowledge not held by the public. Therefore, he or she does have a fiduciary duty each time they sell or service a policy. The professional, by stating or implying special knowledge, education, or experience not held by the public, becomes a fiduciary to the client. A fiduciary must put the client's interests first and act in the best interests of the client at all times. This means thinking of policy benefits over commissions, for example. Insurance agents often do not think of themselves as fiduciaries, but as lawsuits become more common, they will begin to. Learning to think of oneself as a fiduciary will minimize the possibility of a lawsuit. Does an agent have a duty to consult others if he or she is unsure of the correct path to follow? We believe he or she must do so. This only makes sense, since most agents and planners begin with expertise in only one or two given areas. It is critical that an agent or planner be aware of their limitations. There is certainly the urge to "do it all. The truth is, few agents or planners are trained by schooling or experience to "do it all. Anytime an agent or planner is unsure, he or she is wise to check with someone who is considered "seasoned" in the area being dealt with. Many financial planners consider themselves a coordinator for the client. The planner s role, as they see it, is to bring together the experts needed to do a full and complete job. The planner himself is not expected to perform every task. 43

44 If the agent or financial planner works in this manner, it is wise to explain this to the client so that he or she will be more receptive to the other experts involved. While the people involved will vary with the situation, commonly they include the insurance agent, a stockbroker, an accountant, and an attorney. Many times the insurance agent and the stockbroker will be the same person. It is possible that a financial planner will take on all the roles, but unlikely. Certainly, no financial planner should ever do a task for which he or she is not suited by schooling or experience. Some tasks require specific licenses and it is understood that no insurance agent or planner should ever overstep these bounds. Financial planners must be very careful to fully disclose which areas are commissionable. Since many planners sell no products, they are paid by the hour or by the task; not through commissions. Therefore, if a planner switches roles from that which the client would assume, the planner must disclose this. In other words, if the financial planner typically works by the hour, when he or she sells their client a life insurance policy, which will pay a commission, this must be told to the client. There is a definite distinction between consultation and commissioned sales. KEEPING CURRENT ON NEW TRENDS Although the insurance field tends to stay stable, new products do emerge. Of course, any agent or planner who wishes to be successful long term knows that knowledge is the only option. No one expects any agent to know everything in all fields, but in the field of their expertise, they must keep current. Some fields of insurance and financial planning overlap, so that the agent and planner must know more than one area. Financial planning sees frequent changes. Often those changes involve the law and tax consequences. Perhaps that is why some financial planners are also Certified Public Accountants. Financial planners must know how changes in the law would affect any financial plans that he or she is recommending or developing. He or she must also keep abreast of changes that will affect those financial plans already in existence. The planner's clients will surely expect this from them. It has been suggested that financial planners are wise to have established "periods of service. Insurance agents are accustomed to initiating an insurance policy and considering that policyholder theirs for as long as the policy stays in force. For financial planners, the safer course of action is one-year service contracts (there is no fee for this contract). 44

45 At the end of each year that contract is renewed and there follows a review of the financial plan that has been placed. In this way, the financial planner can address any changes that have taken place in the tax laws. For financial planners, the safer course of action is one-year service contracts (there is no fee for this contract). At the end of each year that contract is renewed and there follows a review of the financial plan that has been placed. Financial planners with designations in this area need to have a specific amount of hours of continuing education in order to keep those designations current. Most provinces also require insurance agents to obtain education at specified times (such as yearly or every two years, for example). The professional realizes the protection this offers them. It is a way of validating their desire to stay current on new laws, policy offerings, and so forth. Industry magazines are also very worthwhile. Obviously, if the reader is taking this course, they are probably doing so to meet their provincial requirements. However, we would recommend that you go one step further. Once the test is completed and your province is satisfied, sit down with a desire to see what you might have missed the first time, do it for the enjoyment rather than the requirement. THE POLICY BY ANY OTHER NAME Insurance agents know the policy by the name of E&O insurance. Doctors and attorneys call them malpractice policies, and security dealers call such insurance a blanket bond policy. Whatever the name happens to be, it is liability protection for professionals. Financial planners have less to choose from when obtaining liability protection for their role as a professional. Currently, few companies who market the products used supply some of the liability coverage. The problem is the narrowness of these policies. Insurance agents, for example, are covered for the actual insurance policies sold under E&O insurance, but not for sales of products that are not specifically insurance. This is an important point. We have seen lawsuits filed against agents who were selling revocable living trusts. Their E&O liability policies would not cover any liability, which resulted from these sales because it was not an insurance product. 45

46 For any risk to be insurable, certain elements must exist. A very important element is the ability to determine what the loss could be. As a result, early E & O policies had so many restrictions that they were nearly worthless. A similar situation existed for financial planners. Until the E & O companies had more information and experience, financial planners and insurance agents who dealt with financial planning elements had little options for their liability coverage. Today, this is not the case. There are some good policies available. An insurance company looks at several elements when putting together an E & O liability Insurance policy for sale: 1. A marketplace that will support the existence of the policy (enough people who will purchase it). 2. The loss must be able to be measured; the insurance company must be able to tell when a loss has happened, and the size of that loss. 3. The loss must be unintentional. No insurance company wants to issue a liability policy for intentional acts! Herein lies one problem. While the financial planner would surely say an error or omission was unintentional, the client may still sue on the basis that they consider it intentional. Intent could be a vital issue. 4. The quantity of losses must be measurable. In other words, the insurance company must be able to know that most financial planners will not be sued. If there is the possibility that large quantities of planners will experience a lawsuit, it is not likely that an insurance company would want to develop such products. After all, the end goal of the insurance company is a profit. They want to end up with a profit after all losses have been paid. If too many lawsuits are likely, the risk becomes uninsurable. Financial planners can find liability protection, but there are fewer policies to choose from. Insurance agents (who are not financial planners) have more options, since E&O insurance has been marketed for many years. There are two basic types of professional liability policies 1. Claims-made. 2. Occurrence policies. A financial planner is most likely to find a claims-made policy than an occurrence policy. A claims-made policy is more rigid since it covers only claims filed during the time the policy is in force. This is an important point, since many lawsuits are filed years later. 46

47 Even if the claim is based on a date during the time in which the policy was in force, once the policy has lapsed, it will no longer cover the claim. An occurrence policy covers any occurrence during the time the policy was legally in force, even if that policy has now lapsed. A concern with may agents and brokers is having trailer coverage s to maintain in force after they have left the business. Even though an occurrence policy is harder to come by, some professionals consider the value of them better. Most lawsuits do not happen immediately. They happen much later when the client or their family sees results that surprise or disappoint them. Since the 1970s, most liability insurance written for doctors and attorneys are claims-made policies. If the professionals keep themselves insured, a claims-made policy will be adequate. The secret to being protected, of course, is continued coverage. Primarily, policies now tend to all be claims-made policies. Why would insurance companies prefer claims-made policies to occurrence policies? While there are differing opinions, many feel claims-made liability policies offer more protection for the insurance companies. Such policies limit the duration for which the insurance company is liable. With an occurrence policy, the liability for the insurer could potentially go on forever, unless a clause limited it in some way. The asbestosis class action suits especially demonstrated this point. People who had been exposed 30 years ago were winning settlements against corporations exposing their insurance companies to huge payouts through occurrence policies. While asbestosis is a well-known case, any product liability suit can develop at any time. We have seen many examples of this over the years. There are likely to be many more cases in the future as today's products experience results that were not anticipated. Insurance companies face another problem: the exposure theory. This holds that an insurance company can be held liable once a person is exposed, regardless of when the disease or disability actually becomes recognizable. Another theory is the manifestation theory, which states that the insurance company cannot be found liable until the disease can be diagnosed. Yet a third theory, called the triple trigger theory, states the insurance company can be found liable from the time of exposure all the way through manifestation of the disease. 47

48 Obviously, the triple trigger theory is the most damaging for the insurance company. Of the three, insurance companies would prefer to deal with the manifestation theory. Because the courts place blame based on the exposure of many conditions, insurance companies face the problem of determining exactly when the occurrence happened. For the insured, this can also be a problem if they must prove coverage during occurrence. Since professionals need to be covered continually, in many ways it can be easier to simply deal with claims-made policies. Different professions have different policies. Each profession must be covered for the perils their profession faces. There will be similarities and differences in the various types. As previously stated, liability coverage for insurance agents is called E&O policies. E&O stands for errors and omissions. Such policies pay on behalf of the insurance agent or broker should a lawsuit arise. The policy, within the bounds of policy limits, will pay all sums for which the agent is found legally responsible due to any negligent act, error or omission of the insured or, if applicable, their employees in the scope of business conduct. It is important to note that this applies only to business as general agents, insurance agents, or insurance brokers. It absolutely would not apply to business that was not related to insurance products. While this might seem selfexplanatory, many agents now also deal with non-insurance products. These include such things as prepaid legal, and revocable living trusts. Even when the issue is an insurance product, the policy will not cover lawsuits under all conditions. Some things are still excluded. Exclusions would include such things as dishonesty, fraudulent, criminal or malicious acts, libel, and slander. Of course, E&O policies do not cover such things as physical injury, sickness, death of any person, or property damage. This would be true even if injury or property damage happened directly due to the actions of the agent. E&O policies directly relate to the sale of insurance products in the scope of statements made or implied, and omissions of necessary information. The agent can be covered for liability to the clients themselves, to third parties who are involved, and to the insurance companies for which they work. Liability amounts vary. Obviously, the agent is covered only to the limits of the policy they own. Policies can vary in amounts. The standard in the financial services industry is from $1 million to $5 million, but it is best to carry as much as you can. 48

49 It is not at all unusual for an agent to carry policies with limits in the millions of dollars. Some license lines of insurance tend to be insured more often than other lines. Property/casualty lines generally must carry professional liability insurance in order to work. The same is holding true with many life insurance companies, as more provinces are now requiring E & O Insurance in order to be licensed. The insurance companies they contract with require it in most cases. In addition, because E&O policies are a type of property/casualty coverage, these agents better understand how they work. Property/casualty agents are accustomed to the terminology, whereas life/health agents may be less schooled in the types of benefits offered by E&O policies. Property/casualty companies may offer policies only for their agents, with policy clauses relating directly to this field of insurance. Life and health agents may need to contact their companies for professional liability policies, which relate to their areas of business. Such policies can be quite specific, so it is important to understand whom the policy is intended to benefit. WHO DOES THE POLICY BENEFIT? Insurance Agents Insurance professionals are realizing how vulnerable they are when it comes to professional liability. The legal profession moves from occupation to occupation in their quest for lawsuits. Insurance and financial planning is sure to be hit massively within the next few years. Some of the suits will be well deserved since there has been little regulation enforced in some areas of financial planning. Other suits will be frivolous and undeserved. Industry experts have not missed the coming trend. An analysis done by an Errors and Omissions Insurance company makes this point clear. Their analysis revealed that three fourths of all liability claims fell into three categories: 44 percent resulted from failure of the agent to place coverage correctly; 22 percent resulted from not placing insurance coverage where it was needed (none at all); and 9 percent resulted from the failure to forward and/or process a renewal of an existing policy. Seven percent of the claims resulted from agent failure to advise the insured of a pending cancellation of an existing policy. 49

50 Only 1 percent of the claims came from dishonesty or fraud. This study shows that agent judgment is a primary cause of lawsuits. Financial Planners In the beginning, financial planners had difficulty obtaining adequate coverage. Today, there are policies to choose from, although perhaps not in the quantity offered to insurance agents. Financial planners, as a profession, have only been in existence since the early to mid-1980s. That is not to say that there were no financial planners before that time; rather they were not recognized as a profession until that time. There have actually been financial planners, for as long as insurance has been in existence. Once financial planners were viewed as professionals, liability protection became a necessity. Confusion in the Canadian Financial Service Industry It really does not matter where you purchase your E & O insurance, but the bottom line is that you better have it in place. E & O insurance can be purchased up to $5 million worth of coverage. The agent or broker should decide what is the right amount of coverage for them. Remember, that it is always prudent to have too much than not enough at the time when it is required. Some providers require membership in their association to be eligible for the reduced premium rates for coverage s. No one can tell you what association or organization to join, but we all agree that you should be a member of some support organization. INDUSTRY ETHICS Each industry needs to practice a code of ethics and insurance and financial planning is no exception. Of course, the hope is always that there will be self-regulation. To some extent, that has happened. Advocis, Financial Planners Standards Council (CFP), and The Independent Financial Brokers of Canada (IFBC) have helped to keep an ethical awareness in the industry. All of these associations deal primarily with increased education, but with that, education also comes an increased awareness of ethical requirements. 50

51 The primary concern when regulation is considered is consumer protection. The truly competent agent and financial planner is not the problem. Rather it is the person who professes to have education or training that does not actually exist. Other reasons for regulating the financial planning industry: A. To specifically state what designations or training must exist before a person can claim to be a financial planner; B. To give the industry a sense of professionalism and high reputation; C. To prevent duplication of services, inconsistent services or incomplete services. The primary concern when regulation is considered is consumer protection. Pro-Seminars International has provided as a resource for our readers, a typical Statement of Principles and Code of Ethics adapted by the IFBC and Advocis. The Independent Financial Brokers of Canada (IFBC) Statement of Principles of Independent Financial Brokers of Canada The Independent Financial Brokers of Canada is an Association created to represent licensed professional financial brokers and to provide a forum for them to develop opinions, recommendations and programs. What the Independent Financial Brokers of Canada stands for: 1. The Independent Financial Brokers supports a neutral law controlling differing systems of distribution, excluding none. 2. The Independent Financial Brokers seeks a regime in which members of all distribution systems are licensed and subject to licensing controls. 3. The Independent Financial Brokers affirms that its members are able to undertake any other occupation, when necessary, within the requirements of the licenses held. 4. Within the limits allowed by law, members of the Independent Financial Brokers are required to maintain an arm's length relationship with all insurers with whom they are contracted. 5. The Independent Financial Brokers supports improved levels of education for all agents, and particularly, expects its members to be thoroughly trained and knowledgeable in insurance. 6. The Independent Financial Brokers believes that all life brokers in Canada should be subject to a Code of Ethics. 51

52 7. The Independent Financial Brokers supports the promotion and preservation of the common and specific interest of Association members as a professional body with full support for the principle of freedom in their business operations. 8. The Independent Financial Brokers seeks to foster a co-operative relationship among the Association, the public, the provincial authorities and all other organizations associated with life insurance and financial planning in order to contribute to the successful development and continuation of high standards in the life insurance industry in Canada. Code of Ethics for Independent Financial Brokers of Canada We, as an Association, are proud to introduce our own Code of Ethics. You may note numerous similarities between the proposed Ontario Code of Ethics and ours, but they are not the same, as ours will apply to all Independent Financial Brokers of Canada members across Canada. This Code will hopefully serve as a guide to help get our members through difficult situations that they might face. Any broker who endorses the principles of this Association, and lives by this Code, can expect the full support of this Association in any difficulties he or she may face with the regulators or companies. The Code is intended to be simple, explicit and workable. Brokers who cannot abide by it are asked not to join, or will be asked to leave. Duty of Care - Before giving advice or making recommendations, a broker shall make a diligent effort to learn the client s needs, objectives and circumstances. A broker shall place the interest of his/her client ahead of all other interests. Confidentiality - Client and policy information may not be disclosed to any individual or company without the express written permission of the client. Disclosure - A broker must disclose to a client all fees, premiums and costs associated with a proposed transaction. When recommending an insurance policy or course of action to a client, a broker must disclose all the relevant facts, considerations and risks reasonably available to the broker necessary for an informed decision. This disclosure should be in writing, and be receipted by the client. 52

53 A broker must advise a client, in writing, if an issued policy is materially different than the policy applied for. A broker must deliver all policies, amendments and other documents in a timely manner. A broker must disclose to a prospective buyer of life insurance all conflicts of interest associated with a recommendation. Behaviour - A broker may not misrepresent his/her education, qualifications or experience. A broker may not be misleading as to the terms, costs, benefits or risks of any proposed course of action. A broker may not recommend the replacement of any insurance policy unless he/she believes that such a replacement is in the best interest of the client. A broker may not knowingly submit information on an application for insurance to an insurer that is inaccurate or misleading. A broker may not engage in behaviour that is likely to be detrimental to the public professional image of insurance brokers. A broker must actively represent, by contract, two or more insurance companies, and may not have an exclusive contract with any company. The Financial Advisors Association of Canada (Advocis) An ADVOCIS member shall offer and provide services with integrity. An ADVOCIS member shall provide services competently. An ADVOCIS member shall provide services in a diligent matter. An ADVOCIS member shall not disclose any confidential information without expressed consent. An ADVOCIS member shall strive to provide services that meet a client s best interests. An ADVOCIS member shall disclose any conflict of interest in providing services. An ADVOCIS member shall reflect positively upon all other ADVOCIS members. An ADVOCIS member shall respect and protect the privacy of others. An ADVOCIS member shall respect the spirit and the letter of the law. 53

54 PROFESSIONAL DESIGNATIONS ALSO CARRY A CODE OF ETHICS The one that comes to mind is the Elder Planning Counselor Designation program the most sought after Elder designation program in Canada today. Code of Professional Conduct The Canadian Initiative for Elder Planning Studies and its member Elder Planning Counselors stand for the highest of professional principles and standards regardless of their profession. This Code of Professional Ethics sets forth the minimum ethical conduct for all members. Voluntary compliance at the very highest levels is our expectation. The EPC designation is an earned privilege and CIEPS reserves the right to deny anyone membership for behaviour it determines detrimental to its members and principles. Elder Planning Counselors will at all times: 1. Place the needs, objectives and interests of their clients, customers, patients and prospects above their own at all times. 2. Protect their clients, customers, patients and prospects from unscrupulous business and professional activities. 3. Give clients, customers, patients and prospects the same advice and service they would expect themselves if the circumstances were the same. 4. Keep confidential all personal and business details of their clients affairs they become aware of during the course of their work. 5. Keep the quality of their recommendations high through continuing education and training. 6. Abide by the letter and spirit of the law or any applicable regulations or professional codes in all their business or professional activities. 7. Shield the CIEPS and fellow EPCs from dishonour by agreeing to immediate suspension of their membership if charged with a criminal offense or professional misconduct. 8. Charge a fair and appropriate fee (If on a fee for service basis) based on the time, skill and expertise required. 54

55 PERSONAL ETHICS We would hope that each individual, regardless of their profession, has a personal desire to demonstrate honesty and competency. Unfortunately, few people would consider themselves either dishonest or incompetent, even if they were. As a result, it is often left up to legislative measures. Most regulations come from the individual provinces. The provinces themselves are not uniform; laws vary from province to province. Whatever the laws happen to be, however, they are aimed at protecting consumers. Although legislation is a necessary part of keeping the industry ethical, the most effective avenue is education. Educated agents and financial planners are less likely to make the types of errors that cause harm to consumers. One way to maintain education in the Financial Services Industry is to use Pro-Seminars International 55

56 RELEASE OF LIABILITY FORM There is no specific release of liability forms. It does not tend to be something that can be purchased at the local stationary store. Agents and financial planners typically make up their own. The wording will depend largely upon the products that are marketed, for example. Wording which is appropriate for one agent may not be for another. We have included a sample Release of Liability that can be adapted for any marketing situation. SAMPLE RELEASE OF LIABILITY FORM I, NAME OF CLIENT have been informed that consultation with my Life Insurance professional is essential to the proper handling of my life insurance matters and the following points were discussed with me. 1. The surrender of my current Life Insurance policies may result in the receipt of taxable income, which I will have to declare and pay incomes taxes on in the year that I surrender my policies. 2. My existing Life Insurance Policies may be able to be kept in force without further premium payments by use of the equity accumulated in the policy and the equity that increases in the policy as premium payments are credited even if such credits are the result of policy loans. 3. Any company issuing new life insurance on my life may be able to deny paying a claim to my beneficiary under the "Incontestability Clause" contained in the life insurance contract. 4. The performance of the insurance being purchased to replace my current coverage, may or may not, be up to expectations based upon the company's investment management and the results of any of their accounts in which my policy is participating. Tax law changes, increased mortality and expenses, and many other factors may change the future benefits expected from any life insurance policy. I hereby release NAME OF AGENT / BROKER, and NAME OF COMPANY, of any and all investment risk, there are no exceptions. All liability or responsibility that results from my decision to change my existing life insurance is solely my own. By signing this release, I acknowledge receiving a copy of this Release of Liability Form signifying understanding and agreement. Signature of Policy Owner Signature of Beneficiary Date Date Witness Date 56