A Sticky Issue: Illegal or not, this questionable tactic continues to pose an ethical dilemma for the life insurance industry.

Any insurance professional worth their salt knows that rebating— the act of giving something of value to an applicant in return for purchasing a life insurance policy (e.g. sharing commissions)—is illegal in 48 states. California and Florida are the only two states that legally allow insurance agents to engage in rebating. Yet, even agents practicing in those two states risk losing their carrier contracts if they get caught offering rebates. So, why on Earth would anyone feel compelled to use this method?

“It’s a quick buck,” says one BGA professional who prefers to remain anonymous. (We’ll call him Joe Schmo for simplicity’s sake.) “It’s just not that hard to do, and it’s very profitable if an agent gets enough applicants to do it.” However, Schmo vehemently opposes the practice of rebating, saying it’s downright bad for the insurance industry. “If you don’t have a rule against rebating, you really upset the marketplace, and make it difficult for honorable people to make an honest living. When you get someone who’s willing to give away commissions to do a piece of business, it’s like a car dealer selling cars below cost.”

Read on to learn more about rebating laws, regulations and the ethical dilemma behind this prickly practice.

Florida & California: Where Rebates are as Plentiful as Sunshine? Not So Much.

Florida was the first state to legalize rebating in 1984. That year, the Dade County Court of Appeals struck down Florida’s anti-rebating statute stating it violated the due process clause of the Florida constitution. “Florida did something interesting,” points out Richard M. Weber, MBA, CLU, AEP®, President and primary consultant for The Ethical Edge, Inc., an Insurance Fiduciary in Pleasant Hill, CA. “The state said agents may rebate; however within a ‘broad class of client,’ whatever you do for one, you must do for all. So, the first time you offer or arrange a rebate for a client, then you must do that for all clients that broad class”

A few years later, in 1988, California’s anti-rebating law was repealed by a voter initiative (Prop 103). Unlike Florida’s rebate ruling, Proposition 103 came with no restrictions attached. “So, rebating in California was suddenly like the Wild, Wild West,” Weber explains. “California had no restrictions, which theoretically meant agents would not have to offer the same rebates for everybody, and they could do whatever they wanted.”

Yet, within about 12 hours of the passage of Prop 103, all of the major insurance companies issued edicts to their insurance agents prohibiting rebating. “Although rebating was technically legal in California, the carriers immediately told their agents, ‘If you rebate and we find out about it, we’re going to cancel your contract,’” Weber says.

So to this day, although the practice is legal in California and Florida, insurance rebates are certainly not as abundant as sunshine in the two fair states. “I know of no carriers that allow rebating,” says Schmo. “Even in their California and Florida contracts, carriers specifically state, ‘It may be legal, but we do not allow rebating. If you do it, we will terminate you.’”

“ING U.S. does not condone rebating, even in the two states without laws,” confirms ING U.S. Insurance’s CEO Butch Britton. “We believe the practice is unethical, and we have written policies that will take action against any agent we determine is engaged in rebating in any state.”

The Major Malfunction

Since rebating is technically legal in Florida and California, why do carriers forbid their agents use this effective sales tactic? “For insurance companies, the issue with rebates is a very legitimate concern,” Weber emphasizes. “When you complicate the solicitation and underwriting process with what appears to be a meaningful incentive, you alter normal conditions, causing the actuarial science to be thrown off kilter.”

In other words, when agents offer rebates, they throw a wrench into the underwriting formula. “Out of a group of a million 43-year old females in good health, we know with extraordinary accuracy how many will die this year, and next year and the year after that until they all have died,” explains Weber. “The fear is if you introduce a financial incentive to buy insurance, you introduce a different sort of population into the mix—one that is buying insurance for the wrong reasons.”

To top it off, with the promise of a rebate, consumers may buy more life insurance than they would typically purchase.  For example, a producer may tell an applicant if she doubles the amount of life insurance she buys, he’ll rebate the commissions on the second half as an incentive.  “If that additional insurance wasn’t part of the original conversation, if it was just inspired as a way to generate more commissions, that introduces what’s known as a moral hazard”, says Weber.  “And it is generally believed that there is additional risk to the insurance company when moral hazard is at play.”

Despite all these major malfunctions, Joe Schmo says he understands why the consumer movement in California and Florida voted to allow rebating. “Their attitude is, ‘If I want to sell somebody insurance and I want to give them back my commission, who are they to say no?’” he says. “How can you tell a person how much they have to make on the sale of a product? I can certainly see their point, but they’re not necessarily looking at it from the perspective of how destructive it can be to an insurance company. A lot of damage can be done.”

Schmo says rebating can take a seriously sinister turn when an agent calls up a friend or another potential customer, and says something like this: “I’d like to give you a million dollars worth of life insurance for a year for free. Not only will I give it to you for nothing, but I’ll give you a hundred dollars if you take it. I’ve got a sales contest going, and it won’t cost you anything. I’ll pay the premium. But if you’ll take this million dollars worth of term insurance, I could win the contest.” So of course, the agent’s friend agrees to take the free life insurance for a year—and that’s where things get ugly. “Let’s say the total compensation on the sale is 140 percent, and let’s say the premium is $5,000,” Schmo explains. “The agent pays the $5,000, gets $7,000 and puts $2,000 in his pocket. A year later the policy lapses, and the insurance company takes it on the chin.” Ouch.

It may sound like a scene out of an insurance horror movie, but Schmo says it’s a real-life ruse that he has seen firsthand. “It’s very unhealthy for the industry because you could beat up an insurance company badly; and I’ve seen more than my share of producers use that exact scheme,” Schmo adds. “From an insurance company perspective, that’s a very frightening proposition.”

Schmo equates this type of rebating to going to the store, buying a suit, wearing it to an important meeting and then returning it. “It’s just not the way the world is intended to work, and it drives the costs up for everyone else.”

Britton echoes this sentiment. He says if the insurance industry wants to remain committed to ethical and transparent conduct, producers, BGAs and carriers must fight this dubious practice. “It is important to put the interest of the policyholder at the center of our activities while ensuring the market remains healthy and competitive,” he emphasizes. “Life insurance is a long term commitment, so it is critical for the industry to foster trust and to remain financially stable. The practice of rebating undermines both of these factors. Rebating creates imbalance in the industry. It allows unscrupulous and dishonest agents to increase their compensation and gain unfair advantages over agents trying to do business the right way.”

Blanket Rebates

Weber says if rebating is going to be legal, he prefers Florida’s approach to the issue from an ethical standpoint. (Again in Florida, if an agent offers a rebate to one client, she must offer the same rebate to all of her future clients.) “I think it’s a really huge dilemma to situationally rebate, which is what California allows,” says Weber.

Look at it this way: Let’s say a California agent named Andy wants to win the business of Mr. Moneybags, a high-profile, wealthy executive. Mr. Moneybags says, “I’ll consider buying life insurance from you, and I’ll even refer all of my rich friends to you—but you’ll have to make it worth my while.” So Andy offers Mr. Moneybags a large rebate in exchange for purchasing a life insurance policy. The next day, Andy sells a life insurance policy to his best friend Jack, but he doesn’t offer Jack a rebate. After all, Jack wouldn’t dream of buying life insurance from anyone else, and he’d never consider asking his buddy Andy for a rebate. Seem a little shady?

“I think this creates an ethical dilemma,” says Weber. “When you step back from it, you say, ‘Wait, I’m willing to offer a rebate to someone I hardly know versus my best friend. What’s that all about?’ So, if there’s going to be rebating, I think Florida’s approach was more well-considered. The initiative in California simply left too many opportunities for inappropriate behavior.”

Britton points out that one of primary reasons most people purchase life insurance is to protect their loved ones. “However, if certain clients are afforded rebates, that will prevent all policyholders from receiving the same benefits,” he adds.

“Rebating is just not good for the industry,” Schmo stresses. “There’s the consumer issue, the orderly markets issue and the insurance carrier issue. It’s just not a healthy practice.”

Under the Table Kickbacks

Considering that rebating is frowned upon throughout the industry—even in California and Florida, where the practice is legal—producers wouldn’t dare use this tactic, right? Think again.

“I’d say the vast majority of Florida and California producers don’t offer rebates,” says Schmo. “But as in any industry, particularly one where there’s a lot of money involved, some folks are going to break the rules. They may be thinking, ‘You know, I could make a nice piece of change and win a nice trip to wherever the insurance company sends me for the year by rebating.’”

In fact, he points out a recent rebating scheme that caused major harm to one unlucky insurance company. “It happened in California, of all states, and it was to the tune of $900,000 worth of commissions when they caught it,” Schmo says. “It became very obvious. The agent got his commission, and he’s gone. Good luck finding him. It cost the carrier a lot to put the policies on the books, and then they don’t get the second premium. That’s a lot of money.”

Weber says he doesn’t have a sense that rebating is a major problem in California, but that’s not to say it isn’t happening under the table. “The insurance company’s standard and concern is still there, but it’s much harder to enforce these days,” he says. “So there certainly could be an agent or groups of agents who might choose to use rebating to differentiate themselves, and the BGA is probably not going to know much about it.”

Britton points out that the vast majority of life insurance producers are honest, ethical and hardworking. “Unfortunately,” he adds, “we know that some producers engage in rebating. We’ve seen a slight uptick recently in activity, possibly driven by the economic environment we are in.” He says ING U.S. is taking every step possible to combat the unsavory practice.

Take a Stand

Unfortunately, there’s not a whole lot brokerage agencies can do to prevent rebating altogether. However, Weber says NAILBA members should take a stand on this issue and make it clear that they do not allow the practice.

“A BGA should make it very clear and prominent in broker communications that if you’re in the other 48 states, rebating is not legal and we do not promote or endorse any form of rebate that is contrary to state regulation,” he says. “It doesn’t have to include a threat because it’s not necessary. Just take your stand and say, ‘Here’s what we stand for. We do things the right way, and we will not process business that appears to have any aspect that is in violation of regulations, including rebating.’ In Florida and California, I think you specifically have to say, ‘Of the 37 carriers with which we have a formal arrangement as a BGA, we are aware that most of them have an explicit prohibition, notwithstanding state law, against commission rebating. If you have any questions, please talk to us.’”

Britton also urges brokerage agencies to remain vigilant when overseeing the work of their individual producers. “We strongly encourage every agency to carefully review any cases that are susceptible to rebating schemes and tactics,” he says. “One area of focus is examining cash flows and understanding where premium money is coming from, especially the sources of first-year premiums. Another is looking closely at unusual ownership arrangements, such as trust and trustees situations that have no logical business relationship to the transaction itself.”

By Amy Bell for the Sept/Oct 2012 issue of Perspectives Magazine.  Amy Bell is a professional freelance writer and owner of WritePunch Inc.

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