What Is Suitable?

Posted at Advisors4Advisors.com on February 21, 2010

Many suitability tests exist in regulations, in articles and in advisory services. But there is only one test of suitability that makes any sense: Will my purchase decision change if I receive additional information that is practical to obtain?

Suppose a product passes some other suitability test, but it turns out that I would have decided not to buy it if you had given me additional information. Are you going to tell me that the product is suitable for me when I say that I don’t want it? I’ll just laugh at you.

The consumer must be the final arbiter of what is suitable and what is not. We don’t need imposed suitability standards. We need checklists of things that can cause decisions to change. (Note to self: Read Atul Gawande’s The Checklist Manifesto. This book sounds useful.)

Consider these three cases:

Case #1

In 1991 a member of the Society of Actuaries Task Force for Research on Life Insurance Sales Illustrations explained why they didn’t use focus groups to find out what consumers think about sales illustrations:

“I'll respond briefly to the suggestion that we use focus groups to get the consumer point of view. We did consider that early on in our work and rejected it for a couple of reasons. One was the time constraints we were under and the cost of doing focus groups. But probably the most important reason is that if you get 15 people in a room who are recent purchasers of life insurance and then spend an hour or two dissecting the sales process and the use of their illustrations in that sales process, you’re likely to have 13 people coming out slightly or greatly disillusioned over what they just did. We found that our field force and our marketing department didn’t like that idea at all.”

Case #2

Several years ago a client asked me to review a whole life policy issued by a large mutual company. During the review, I explained that his policy values would be higher if the agent had used a lower-commission blend of whole life, term and paid-up additions. He was so angry about this that he contacted the Connecticut attorney general’s office.

Case #3

With some no-lapse universal life policies, you’re throwing your money away if you follow the illustrated premium schedule. You can get the same lifetime guarantee at a lower cost by using the mechanics of the no-lapse feature to your advantage.

In each case, the buyer’s decision seems fragile; additional information could easily cause the decision to change. And yet, can you imagine a suitability standard that these three cases would not pass?

Efforts to define suitability may be well-intentioned, but they seem to be ineffective at promoting robust consumer decisions. Even worse, they can give legitimacy to sales practices that only pay lip service to informed decision-making.

What do suitability standards really accomplish? Their main result seems to be that they let regulators think that they’ve done something to protect consumers, while not gumming up the wheels of commerce too much.

The good news is that some suitability guidelines can provide a starting point for developing useful checklists. Charles L. Ratner’s “The Estate Planner’s Guide To Product Suitability” in the January 2010 issue of Trusts & Estates is one example. Someday, perhaps, no translation will be needed.

February 22, 2010 update

An attorney pointed out to me that a suitability standard has to be objective to be workable in litigation. Fair enough. You can’t have consumers suing whenever they feel like it with a made-up story about what they would have done if they had only known something that wasn’t disclosed.

I’d settle for an empirically-based information set that has been found to cause decision changes. Regulators throughout the world are willing to set insurance policy reserves and risk-based capital at a defined threshold, such as 99.5% Value at Risk. A suitability standard could be set at a threshold such as 0.5% chance of causing a decision change.

The negotiated process of coming up with this information set would confirm that suitability standards are not really about making good decisions. They’re about feeling that you’ve accomplished something without really changing anything.