New York Court Overturns “Best Interest” Rule

On April 29, 2021, the New York Supreme Court, Appellate Division, in the case, In the Matter of Independent Insurance Agents and Brokers of New York, Inc., et al., v New York State Department of Financial Services, et al., held that Regulation No. 187, as amended, is unconstitutional.

What is Regulation No. 187?

Regulation No. 187 is a rule promulgated by the New York Department of Financial Services to govern the conduct of insurers and their producers in connection with the sale of life insurance and annuity products.  Prior to the amendment at issue in the court case, it covered the sale of annuity contracts only and required that annuity recommendations be suitable for the client.

What is the Amendment to Regulation No. 187?

In December, 2017, the Department of Financial Services proposed an amendment to Regulation No. 187.  The purpose of the amendment was to extend the reach of Regulation No. 187 to the sale of life insurance contracts, in addition to annuity contracts, and to impose a new, higher standard of care in connection with the sale of both life insurance and annuity contracts.  The new standard of care proposed in the amendment required insurers to establish procedures to ensure that their producers are acting in the “best interest of the consumer” when making recommendations for life insurance and annuity products.  As the Court stated:

The amendment was promulgated to address concerns with respect to the growing complexities involved with life insurance and annuity products, the corresponding need for consumers to increasingly rely on the advice of professionals in order to comprehend the widening market of products available and to mitigate abuses with respect to the compensation of agents and brokers . . .

The amendment was to take effect in August, 2019, with respect to annuity contracts and in February, 2020, with respect to life insurance contracts.

The Lawsuit

Before the amendment could take effect, the plaintiffs filed suit claiming that the Department of Financial Services had exceeded its authority in promulgating the amendment.  The plaintiffs further claimed that the amendment “lacked a rational basis, was arbitrary and capricious and otherwise constitutionally vague”.

In August, 2020, the trial court ruled in favor of the Department.  It found that the Department had “complied with the State Administrative Procedure Act in promulgating the amendment, that it did not unlawfully usurp legislative authority when it did so and that the amendment was not arbitrary and capricious, irrational or unconstitutionally vague”.

This appeal followed.

The Ruling

The Appellate Division reversed the trial court and found that the amendment to Regulation No. 187 was unconstitutionally vague.  The Court wrote that a two-part test is used when evaluating vagueness.  “First, a court must determine whether the regulation is sufficiently definite so that individuals of ordinary intelligence are not forced to guess at the meaning of the regulatory terms.”  “Second, the court must determine whether the regulation provides for clear standards for enforcement so as to avoid resolution on an ad hoc and subjective basis.”

On the first test, the Court found that the amendment “fails to provide sufficient guidance for producers to know whether their conduct, on a day-to-day basis, comports with the amendment’s corresponding requirements for making recommendations and compiling and evaluating the relevant suitability information of the consumer”.  In other words, the amendment did not set forth a definite standard of conduct for producers to know what they can say or do in connection with the sale of a life insurance or annuity product.

On the second test, because the amendment to the Regulation No. 187 failed to provide a clear standard of conduct, the Department had “virtually unfettered discretion in determining whether a violation has occurred”.  In other words, producers could never know when they might be subject to discipline.

What Comes Next?

New York is a leader in imposing standards on the sale of life insurance and annuity contracts.  However, it is not alone.  Many other states have acted or are considering action.  This case will not end the efforts of the states to regulate the conduct of insurance producers.  And most insurance producers are not averse to reasonable regulation, as long as they know what standards will apply.  This case recognizes dual interests – the interest of the state to protect consumers and the interest of the producer to have a clear understanding of what is required.