Lynne Rae Zlotnik had insurance in her blood.
Her father, Harold, began selling policies in 1945 and eventually she followed in his footsteps. "Insurance," Harold Zlotnik liked to say, "is the business of financing dreams."
But when insurance regulators began looking into Vancouver-based Lynne Zlotnik Wealth Management Inc. this year - a firm she created in 2006 to sell life insurance and other investment products - they were troubled by what they found.
Several of her clients had invested a total of more than $1.4-million in her company on the promise of a lucrative return. The clients included 96-year-old Katie Sturhahn, who cashed out a $200,000 segregated fund, an investment fund that comes with insurance guarantees, and instead put her faith in the insurance agent.
It was a questionable financial strategy, since the payout on the fund - which she intended to leave her five children - was assured. Soon after the elderly woman died in March, the agent declared bankruptcy, and the money was gone.
"That was our inheritance," says her son, 71-year-old Walt Sturhahn. "We've got none of it."
But an even more disturbing discovery had yet to be made: When regulators went looking for someone responsible for overseeing such a risky financial transaction, there was no one to answer for it. The regular checks and balances that are designed to oversee an insurance agent had failed.
The insurance company that administered the policy had no direct oversight over Ms. Zlotnik. In a practice that is increasingly common throughout the industry, she dealt with a middleman company called a Managing General Agent, or MGA, which is an unregulated wholesaler of insurance products to independent agents that few consumers know about. That made it difficult for regulators to scrutinize her conduct.
The case exemplifies a problem that's emerged as the insurance industry becomes increasingly complex. As the sale of life insurance has evolved over the past decade - designed to sell more policies and maximize profits for insurers and agents in an already-mature market - it has also placed consumers at risk.
A Globe and Mail investigation has uncovered a gaping hole in Canadian insurance regulation: Cases like the Sturhahns' are not isolated events. Instead, nearly half of all individual life insurance policies in Canada are now being transacted through MGAs, which often undertake little - if any - oversight of agents in the market.
Though consumers place trust in their agents and increasingly look to them for financial advice and to explain complex policies and products, insurance regulation hasn't kept pace with the industry, and doesn't take these wholesalers into account. Across the country, MGAs operate beyond the watch of regulators - leaving consumers exposed.
Though regulators can revoke an agent's licence - Ms. Zlotnik lost hers in April - by that time it's too late for the consumer. The damage can't be undone and the money may be unrecoverable. With closer oversight, the sudden cancellation of insurance policies such as Ms. Sturhahn's or decisions resulting from poor financial advice would be detected earlier, when the moves could still be reversed in the consumer's favour if questionable circumstances were found.
"[My brother]said 'Just forget it, forget it,' " said Mr. Sturhahn, who is wheelchair-bound and suffers from asbestosis after a career as a carpenter. "And I'm trying, but it's hard to forget when you're living on a shoestring and something like that happens."
When Gerald Matier, executive director of the Insurance Council of British Columbia, which licenses agents in the province, looked into the matter, he was stunned: Since Ms. Zlotnik was working through an MGA, no one was directly responsible for overseeing the agent.
When he asked the MGA whether anyone thought to question the cashing in of an insurance product by a 96-year-old woman, he learned that no one had, because there are no regulatory requirements for MGAs to police life insurance agents.
It was a problem that no one, not even regulators like Mr. Matier, saw coming.
Twenty-five years ago, most insurance agents were contracted directly by the insurance companies whose policies they sold. Agents were in-house representatives of firms such as Manulife or Sun Life and employers were responsible for keeping tabs on their sales forces.
"When there was a problem, the regulator would know, 'Well, this is a London Life agent,' so they would contact London Life's compliance department … because it was that company's responsibility," says Peter Lamarche, president of the Canadian Association of Independent Life Brokerage Agencies, a growing MGA industry group. "In the new environment, the regulator doesn't know who to call."
Today, most agents are independent, and can sell policies from multiple insurers.
As a result, the new breed of managing general agents has quickly sprung up. And in the span of a decade, these agencies have quietly grown into one of the most powerful forces in Canada's life insurance industry by offering to help insurers deal with a large roster of independent agents, while helping agents obtain access to various policies sold by insurers, in exchange for a cut of the action.
According to Investor Economics, a financial industry consultancy, the MGA channel is now responsible for at least 44 per cent of the new life insurance policies sold to individuals across the country.
That means nearly half of all policies are being sold with serious gaps in regulatory oversight.
The MGA explosion has severed the chain of oversight between insurance companies and agents, but the full effect of that development is hard to quantify. Regulators are, at best, only beginning to grapple with the sector's fast rate of growth.
Those watchdogs are painfully behind the curve.
Mr. Matier tried to find a solution, but could barely find agreement on what the role of an MGA should be inside the industry - a disinterested middleman, or a key link in the supply chain that should be responsible for the agents it supplies with policies. It is an issue in all provinces. But rather than spring into action, regulators have been blindsided.
Meanwhile, there are signs the MGA industry itself is trying to stave off regulation, worried that new rules will be bad for the bottom line.
As for the insurance companies themselves, which have made Canada an exportable brand name in reliable life insurance, they also have yet to reckon with the unintended consequences of a revolution they encouraged in order to save trouble and expense.
And the stakes are getting higher for insurers as products become more complex and therefore more difficult for consumers to understand.
Facing a mature market for life policies, insurers are looking to increase business by developing a dizzying array of new offerings, from critical illness coverage to living benefits products. Insurance agents are increasingly involved in wealth management, and advise people on tax and estate planning - functions that require careful oversight.
Prices on many products are going up, largely because low interest rates have been eating away at insurers' profit margins. Insurers have also been reducing benefits on some products.
The dollar amounts spent in the insurance sector are staggering. Canadians bought $311.6-billion worth of life insurance in 2009, bringing the total value of life insurance they own to $3.47-trillion.
In total, almost 21 million Canadians own life insurance, an average of $169,000 per person. They paid $15.1-billion worth of life insurance premiums in 2009, according to the Canadian Life and Health Insurance Association. Of that, at least $1-billion comprises life insurance policies sold directly to individual consumers.
The evolution of a new model
The life insurance industry is built on trust, and consumers put their faith in the agent they deal with to navigate a series of choices about complex products.
As Ms. Zlotnik said in a promotional video: "What I'm passionate about is to make sure that each person that I advise has a level of financial literacy. I explain all the terms [in]fairly easy digestible ways."
The video featured a number of her clients, including Gabe and Greta Milton, a retired Vancouver couple. "She makes a person feel totally comfortable, and really Lynne's explanations are so clear," Ms. Milton said. She and her husband are listed as creditors in the bankruptcy, having invested $23,000 with Ms. Zlotnik's business.
Though her case exposed a serious weakness in oversight of the MGA channel, Lynne Zlotnik maintains she did nothing wrong. She says she is the victim of an overzealous regulator and intends to appeal its ruling. She also says that a serious illness that had hospitalized her prevented her from dealing with the regulator.
"I was trying to develop an agency like my successful father," she said in an e-mail denying the allegations. "I've been in business 23 years, never had a complaint against me."
But the trust that consumers place in the life insurance industry reaches beyond the independent agent they deal with. Canadians assume that regulators are also keeping an eye on those agents, and that insurers have a stake in overseeing the way their products are sold.
Canada is known for its financial regulation, and when it comes to insurance, Ottawa watches over the capital structures of underwriters, while provincial watchdogs are responsible for policing how policies are sold.
Traditionally, life insurers assumed responsibility for the agents who sold their products and gave advice to clients. The market was dominated by insurers' in-house career sales agents, whom they recruited and were responsible for training and supervising. While oversight of agents was not embodied in law, it was enshrined in corporate practice because the insurers knew their brands were at stake if customers had problems with their agents.
The directness of the chain of responsibility from insurer to agent is clear from the industry jargon for these agents: "captives."
"Everyone worked for a company," says Kevin Cott, president of a Toronto-based MGA, Qualified Financial Services, who joined the insurance business in the early 1980s. "Advisers, training, financials, paying of commissions, monitoring, mentoring - the whole nine yards - were the responsibility of the insurer."
The life insurance industry began undergoing a low-profile but massive transformation two decades ago as the independent agent distribution model, sometimes called the broker channel, started taking hold.
The channel flourished because it helped consumers shop around without having to visit an agent at each insurer. But insurers were also enthusiastic as they realized that using independent agents would be easier and cheaper than employing a captive sales force.
Insurers generally tried to do some homework on agents before signing contracts with them, and still had a vested interest in ensuring that their advice to customers and sales tactics were up to snuff.
But as the independent sales channel grew, a problem emerged that would ultimately lead to the creation of MGAs.
To learn the ins and outs of complicated products, independent brokers were forced to deal with multiple insurers. And the insurance companies had to spend time dealing with legions of independent agents to keep them up to date. This proved unwieldy. Hence, the new corporate middlemen that evolved to fill this need.
Some MGAs were started by former career agents who saw an opportunity and wanted to branch out on their own. In some cases, career agents were pushed by the insurers themselves to start up a shop.
As the insurers wound down their own internal agent systems, Mr. Cott says, "they would often tell managers, 'Listen, we're closing down your office, but what we'll do is we'll give you a direct contract, an MGA contract if you will, for you and your people.'"
The shift to outsourcing is reflected in the career agent population, which is tracked by the Canadian Life and Health Insurance Association.
The numbers show a steady decline since 1985, when there were 22,600 career agents. For the past decade, the number has been below 10,000.
Meanwhile, the number of independent agents selling life insurance has soared to 76,300. A large but unknown number of those are now working through MGAs.
The role of career agents has dwindled to the point that they represent less than one-third of the industry's sales. The bulk of sales come from independent agents, and much of that is done through MGAs.
Only a handful of life insurers, including London Life Insurance Co. and Industrial Alliance Insurance and Financial Services Inc., are still recruiting and using career agents. Sun Life has the biggest stable, with more than 3,500 people across Canada. Manulife Financial, the largest Canadian-based life insurer, conducts more business through MGAs than any other underwriter.
"Over the last several years, we've had a strategy to significantly grow our presence in the MGA channel, and that has been driving most our growth in the life insurance business," Paul Rooney, the head of Manulife's Canadian operations, told analysts in late November.
Manulife and many other major insurers declined to be interviewed on the record about the MGA issue. Some insurance executives said that criticizing the distribution channel would be detrimental to their business.
Insurers benefit by relying more on MGAs. One example: A large proportion of life insurance commissions are paid up front, when the policies are sold. If the consumer later abandons that policy, the insurer will "charge back" the unearned commission. Under the old model, the insurer had to track down agents years after the policy was sold to get its money back. Now, MGAs get hit with the chargebacks.
But perhaps the most fundamental advantage of the MGA route is that it saves insurers the costs of recruiting and training agents. These expenses are harder to justify now that it's easy to effectively "rent" distribution, says a senior executive of one Canadian life insurer, who adds, "We love the MGA channel."
Why this became a problem
No one envisioned that an entire segment of the insurance industry would spring up unregulated - it just seemed to happen.
In the old system, before MGAs evolved, it was in the best interest of insurers to keep close relationships with their agents.
This made it easier to drive sales higher, since it exposed weaknesses in sales performance, but it also helped to spot problems. An agent with excessively high sales might be needlessly selling customers too much coverage in order to boost commissions. In such cases, a company risked losing that customer.
But the disconnect under the MGA system has created several loopholes which have direct implications for consumers should problems arise. When approached by the regulators, the insurance companies who underwrite the policies can argue that they have no knowledge of the agent's actions, and that responsibility rests with the managing general agent. The MGA, on the other hand, can deflect responsibility by suggesting that its role is not to police the sales of policies, since it is merely a middleman stocking products from the large insurers for the independent agents to sell on the street.
The industry is now a patchwork of sales practices without any standard procedures. The way MGAs oversee agents' activities varies from firm to firm. Some insurers write conditions into their contracts with MGAs specifying they must police agents, but many do not. Some insurers' contracts require that MGAs screen the agents that they hire; others don't.
"From one MGA to another, there is a different level [of supervision]and different standard at play," says Terri Di Florio, the chief executive officer of Hub Financial Inc., one of the country's largest MGAs, supplying 3,000 independent agents across the country.
That means the consumer can have no expectation of a safeguard when they buy a life insurance policy that is channelled through an MGA - and the consumer is unlikely to know that an MGA is even involved.
The sales practices of agents working for MGAs are not the only worry. The vast amounts of personal and medical information consumers provide to their agents also sit outside the rules.
"One of the big issues is privacy," said one insurance executive. "They have underwriting files from brokers that sit in their file drawers. There's no regulation and they've got medical information on people and it's just sitting there. … I really don't think the consumer has any idea about what happens to their information once they give it in this channel."
To further cloud the picture, it's not even clear who the agent answers to. Some agents will work with more than one MGA, making it harder to determine who is responsible for any given agent.
One more wrinkle is the appearance of a new category of players, generically known as associate general agents, or AGAs. Those are agencies that don't have enough sales volume to get an MGA contract. "They have this middle ground between a brokerage contract and an MGA, and so you might be an AGA of an MGA," says an executive at a major insurer who spoke only on condition of anonymity. "So that's yet another layer. And that gets even further from the regulatory environment."
The rules are so lax that even when a regulator confronts a problem agent, it's all too easy for the agent to simply find another MGA. Earlier this year, Mr. Matier of the Insurance Council of British Columbia revoked the licence of an agent he was investigating. That didn't put the broker out of action. The agent simply found an MGA in another province - Saskatchewan - that would provide a contract, so that the agent could keep on selling policies in Canada.
"It's these kinds of issues that you're starting to see," Mr. Matier says.
No one is taking responsibility
Despite the major role the agencies are playing in selling billions of dollars of insurance products to consumers, regulators have yet to grasp how unclear the picture is, and what little oversight exists.
The Canadian Council of Insurance Regulators, an umbrella group of provincial watchdogs, became aware of the MGA issue at least two years ago and assigned a group of officials to look into it. However, the group has yet to report or take any action.
The Financial Services Commission of Ontario, the largest provincial regulator, would not comment, other than to say it is now reviewing the matter of MGAs.
Highlighting the degree to which MGAs have eluded scrutiny, even just determining how many have sprung up in Canada is difficult. "Nobody in the country is really sure how many managing general agencies there are," says Mr. Lamarche, the president of the MGA industry group.
Goshka Folda, senior managing director at the consultancy Investor Economics, estimates that there are nearly 400 MGAs operating in Canada, of which about 100 would be sizable agencies, while the remainder have one or two contracts. The largest operations supply more than 1,000 brokers; the smallest have just one contract from an insurer.
In an effort to play catch-up, the life insurance industry's umbrella group, the Canadian Life and Health Insurance Association, has developed a lengthy questionnaire asking MGAs to detail the extent of their activities.
But the association's vice-president of distribution and pensions, Leslie Byrnes, declined to be interviewed on the subject, citing a need to wait for the Canadian Council of Insurance Regulators to publish its long-overdue consultation paper on the issue.
The move by the life insurance association to start gathering information on the agencies points to how little is being done to monitor the sector's activities. Of the nearly 100 life insurance companies active in Canada, only a handful, including Sun Life and Manulife, are actively conducting any sort of auditing work on the MGAs with which they have relationships.
Some MGA players acknowledge the need for better regulation. "There probably should be some oversight. That's probably true in any professional services industry where you're advising the general public," says Ms. Di Florio of Hub Financial.
But many agencies say that they don't want to pay for any more oversight - including ensuring that consumers are not being sold inappropriate products - unless they're compensated for it. The agencies make the case that their profit margins are too thin to support the oversight and paperwork involved.
The Independent Financial Brokers of Canada, which represents about 4,000 independent financial advisers, told regulators in a recent report that significant new rules for MGAs are not necessary - and moreover would prove expensive to implement.
They would much rather just let their own insurance cover any problems.
"In the event of an administrative oversight, most agencies have corporate E&O [errors and omissions insurance] which is the appropriate recourse for consumers," the brokers association argues in documents to the regulator.
That approach means consumers may be subjected to a lengthy claims process.
In the meantime, the problem has become tangible for Mr. Matier and his team in B.C.
"The level of supervision, accountability and training that was inherent in the career insurance company model has diminished and accountability for the actions of new life agents is less clear," the B.C. regulator said in a report on the MGA issue.
"Once licensed, a life agent is not subject to any mandatory industry oversight, which differs significantly from all other sectors of the financial services sector [such as]property and casualty insurance, securities, mutual funds and real estate."
An industry left to police itself
While the state of regulatory limbo persists, MGAs are left to decide for themselves how to appropriately conduct business. Some have taken steps to police themselves and their agents, but they are the exception.
At Qualified Financial Services, Mr. Cott took matters into his own hands. The Toronto-based MGA culled its ranks, cutting its contracts with more than 130 advisers, in part because the company realized it had too many agents to keep proper tabs on.
The move raised eyebrows in the MGA industry because it was so unusual. In an otherwise free-wheeling industry, there have been few clampdowns. Mr. Cott is alone in that regard. "We, like the insurers, don't want to have 10,000 people running around that we don't know who they are, where they are or what they are doing," Mr. Cott says.