Have you ever replaced your smartphone before you really needed to? Then you fell victim to the high-tech equivalent of churning.
Churning in this context is perfectly legal, and brand marketers like Apple and Samsung depend on it.

Churning exists in financial services, too. It occurs when an advisor sells consumers a product and then gets them to replace it with another one, to generate an additional commission. As you know, each churn generates not only commissions, but also surrender fees and other penalties. So if there’s no material gain to the client after the transaction, complaints and lawsuits often ensue.

Churning has been with us forever. Yet despite compliance departments’ diligent efforts, advisors continue to succumb to its allure. Why?

For one thing, it’s easier to churn an existing account than it is to create a new client. And when an existing client trusts you, replacing multiple contracts without cause (other than making more money) can be child’s play. But just because churning is simple doesn’t make it right. Here’s why:

  • Churning is illegal. One of the quickest ways to lose your license is to churn your clients’ holdings. (Example in a second.)
  • Churning is unethical. It dramatically violates the spirit of the fiduciary standard of care. Even though non-Series 65 agents aren’t true fiduciaries, we believe they should still uphold the spirit of that license.
  • Churning is a reputation killer. Once it gets out that you’ve been sanctioned (or worse) for churning, clients and potential clients will realize you aren’t worthy of their trust. And they’ll share that knowledge on the Internet.
  • Churning can get you sued. When clients wise up to an advisor’s unnecessary transactions, they’ll tally up their losses and take their grievances to court.

Case in point? An Illinois advisor found himself in the headlines recently for falsely claiming to be a fiduciary when in fact he was allegedly all about selling—and replacing—equity indexed annuities.Despite claiming not to sell investments on commission and claiming he operated under a fiduciary standard, he nonetheless replaced prior contracts he sold with 31 new EIAs. As a result, the advisor received roughly $160,000 in commissions, but his clients lost nearly $265,000 in surrender penalties and other fees.

For his efforts, the advisor is now looking at potentially losing his securities and investment-advisory licenses, as well as paying substantial fines. Plus his state’s attorney general has brought fraud charges against him. And time will tell how many clients sue him. So who needs this kind of trouble, not to mention a ruined reputation?

Don’t let this happen to you. Protect yourself (and your clean errors-and-omissions record) by following these pointers:

  • Never initiate a replacement unless there are tangible client benefits for doing so.
  • “Taking the money because you can” is not a sustainable business strategy. Instead, strive to build life-long mutually beneficial relationships.
  • Don’t just give lip service to “client’s best interests.” Live that principle every day.

Because churning isn’t earning a living . . . it’s burning your clients.

For more information on reducing your errors-and-omissions insurance liabilities, please visit our E&O Headquarters at EOforLess.com.

The Incident

An agent writes a $1 million life insurance policy on his then 36-year-old male client. The client requests a premium waiver in case he ever gets disabled. The agent assures the client the policy will be issued with the rider. However, the policy is issued without one. The client receives the policy, never looks at it, and places it in a drawer for safekeeping.

Years go by and the client pays his premium faithfully. One day, on his way home from work, he loses control of his car on the highway due to an oil tanker spill. He’s seriously injured. Ultimately, he loses use of an arm and goes on long-term disability.

Months pass and the client still can’t work. Since he can no longer afford to pay for his life insurance, he tells the company he wants his premiums waived. The company responds that the policy has no such rider. The policy lapses due to non-payment of premium.

Eventually, the client dies from his injuries. The client’s beneficiaries file a death claim with the insurer, which is denied because the policy is no longer in force.

The Claim

The client’s beneficiaries sue the agent and the carrier for negligence, breach of contract, bad faith, misrepresentation, and violation of consumer protection laws.

The Outcome

The agent insists the client never requested a premium waiver. But he has no proof of this.

The client’s beneficiaries claim their loved one asked for the rider in the initial sales interview and that he always believed he had one.

Because the claim is a he-said/she-said scenario, backed by conduct consistent with the client’s believing he had the rider, the insurance company is unable to defend the agent. It settles the claim out of court.

The Takeaway

Agents can avoid such E&O claims by:

• Documenting all client requests in writing.

• Filling out the application line by line during the sales interview.

• At the end of the meeting, confirming what the client bought.

• At policy delivery, reviewing the policy benefits one more time.

• Always encouraging clients to ask questions about their coverage.