May 31, 2008

Flying Without A Full Tank

Four police officers boarded the plane upon landing in Toronto and peacefully removed two passengers without drawing their weapons. Thus ended my previous flight to Calgary.

The Next Flight
What a beautiful morning, bright and sunny. I'm in an airplane heading to Calgary again. The doors have been shut. We have our seatbelts fastened firmly and our trays locked in the upright position. No one is sitting beside me --- about 10% of the seats are empty.

So why are waiting for more fuel?

Glad But Puzzled
Would you rather
A. leave on time but without enough fuel?
B. get enough fuel but leave late?

You'd probably pick B because you aren't given the option C:
C. leave on time with enough fuel

We had no choice and got option D:
D. leave late but with enough fuel

Maybe we didn't top up because fuel is cheaper in Calgary? That shouldn't matter because the flight had a fuel surcharge of about $200 for a round trip.

The plane didn't move for a smidgen for an extra 28 minutes. I figured we'd fly faster to make up for lost time, which would use up more fuel . Wrong! We landed 37 minutes late. Pity the passengers waiting to board in Calgary for the continuation to Vancouver.

Why More Fuel?
Why didn't the plane have enough fuel in the first place? It did until last minute passengers boarded. Once the pilot found out, he ordered more fuel. If you fly over the Grand Canyon in a small plane, you get seated based on weight. That's a tad scary. Luckily, a Boeing 737 isn't as finicky.

How Much Fuel Is Enough?
I talked to the airline afterwards. The plane needed enough fuel to reach the destination and an alternate, plus a margin of 1,000 pounds. The plane refuels at each stop. The tank is not filled up because of the weight of the fuel.

Passengers lose. When a flight is full, we are crowded and wait longer for boarding, a washroom, in-flight service and deplaning. I didn't realize that a comfortably-full plane could be delayed too, thanks to a handful of last minute passengers.

Our flight plan got updated too. Otherwise, we could have ended up in Colorado, a passenger quipped. Unlikely, I thought --- we'd need more fuel.

May 26, 2008

The High Cost of Joint First To Die (JFTD) Life Insurance

A family may need life insurance when either spouse dies. Or a small business may need a lump sum to buyout the shares of a partner upon death. Rather than buy coverage on each life, why not buy one policy to cover all the lives?

You can with Joint First To Die (JFTD) coverage. The death benefit is paid when the first of the lives insured passes away. Intuitively, one death benefit should cost much less than policies on each life. Since the oldest or least healthy life will likely die first, isn't the price close to coverage on that life alone?

That doesn't happen. With JFTD coverage, you also lose flexibility.

Suppose there's coverage for $1 million on two lives. If one dies, then $1 million gets paid tax-free. Suppose both die together or within days of one another? How much gets paid now? You can expect $2 million (may vary by company).

Actuarially Speaking
Using simulated actuarial notation, here is the mortality risk for a JFTD policy on two lives, x and y: Qx + Qy - (Qx * Qy) where
  • Qx = probability that life x dies
  • Qy = probability that life y dies
The death benefit is paid when either life dies but does not pay twice if both die together.

If you were buying two single life policies, the underlying mortality risk is Qx + Qy, which is quite similar. The discount for JFTD (Qx * Qy) is relatively small. Consequently, JFTD has limited appeal.

This is what was available when I designed products years ago:
  • Split Option: prior to the first death, can exchange the policy for individual policies on each life (e.g., upon divorce or separation)
  • Survivor Term Insurance: upon the first death, each survivor receives term insurance for a few weeks at no charge (which means that additional death benefits could be paid)
  • Survivor Option: upon the first death, each survivor can apply for a new policy on his/her life without underwriting with premiums based on the attained age (which means coverage can continue)
Products vary and I haven't seen a comparison in ages. There may be better (or worse) options today.

Loss of Flexibility
A JFTD policy offers the same coverage on each life. If each life needs a different amount of coverage (e.g., if one spouse earns a much higher income), single life coverage can be tailored. Another option is to buy coverage on the primary breadwinner and add a rider for the other spouse.

With Joint First To Die, the savings may be less than you expect but enough to be worthwhile.

Links (no endorsements implied)

May 19, 2008

How To Evaluate A Proposal From An Advisor

A verbal promise isn't worth the paper it's written on. --- Samuel Goldwyn

The wealthy receive unsolicited proposals for insured tax strategies along their Financial TRAIL. If intrigued, they may meet the advisor with the idea but leave confused and skeptical. For answers they often turn to their "regular" advisor. Relationships matter.

Basic Misunderstandings
Only Audi has Quattro but other companies offer 4-wheel drive. Advisors and insurers tweak generic strategies (we looked at the top five earlier) and brand them under different names. What looks unique probably isn't --- which is good. Why be a guinea pig for an unproven idea?

Insured strategies combine actuarial, tax, accounting, investment and legal concepts. No wonder they can be tough to follow. To help you understand, advisors simplify which means leaving details out. You may get the "big picture" but miss key details unless you ask questions. Here's what often happens
  • you misunderstand the proposal (e.g., E=mc^2 is elegant but try explaining to someone else)
  • you expect better results than are likely (e.g., benefits get emphasized over risks)
  • you aren't given enough detail for a proper evaluation (e.g., by your accountant)
What You Can Do
To help evaluate a proposal
  • get a copy by email
  • think of questions before you meet
  • make notes during the meeting and think of what's been left out
Before Meeting
Ask for a copy of the proposal by email before you meet. Explain that you want to prepare in advance. The advisor may refuse to send the entire proposal in advance for various plausible reasons, but sure to get agreement that you'll get an electronic copy afterwards.

Since you agreed to meet, you're intrigued or at least a bit curious. Why? Jot down the questions you want answered.

While Meeting
Listen and ask questions. The advisor will likely show you a simplified prepared presentation that looks like a PowerPoint followed by numbers in Excel. This aids understanding but is not a full picture.

To explore further, you need an official illustration compliant with the guidelines from The Canadian Life and Health Insurance Association (CLHIA).
"... the CLHIA's Sales Illustration Guideline underscores the importance of communicating to clients the risks involved and the potential variability of the product for those products not fully guaranteed. For Universal Life policies with an equity component, it requires that any illustrations of non-guaranteed elements prominently specify that actual results will vary from those illustration - upward or downward- depending on future experience. A minimum of two scenarios must be provided - the first within the "primary" scenario range established, on an annual basis, by the insurer; and the second that is less favourable than the primary scenario. The general basis for each scenario and its key assumptions must also be outlined." --- Ontario Securities Commission
After Meeting
If you did not get a copy of the proposal electronically, be sure to request one now. This must include a CLHIA-compliant illustration showing
  • the assumptions used
  • projections for all years
If you don't get enough detail, ask for more. You can then review the proposal or --- more likely --- ask someone like your accountant. The advisor who made the proposal will answer questions, but printed documentation helps. You can then make a decision.


May 11, 2008

Getting What We Want By Distorting Our Spending

Buying something on sale is a very special feeling. In fact, the less I pay for something, the more it is worth to me. I have a dress that I paid so little for that I am afraid to wear it. I could spill something on it, and then how would I replace it for that amount of money? --- Rita Rudner

You can't have everything. Where would you put it? --- Stephen Wright

Since most of us can't afford everything, we spend extra on the few items that really matter and save on the rest. This is why you can see a Hyundai at Birks and a Porsche at Costco.

We want bargains for everything. A great value can tempt us to buy what we might not otherwise: a Coach handbag or tickets to the disappointing The Lord of the Rings play. To compensate, we might buy the house-brand of flour or toilet paper. Buying cheap now means buying smart since quality has improved for low-priced goods. Farewell the stigma of being spotted at a factory outlet or lined up early on Boxing Day.

Author Michael Silverstein helps us understand ourselves in Treasure Hunt: Inside the Mind of the New Consumer. Moving from the middle downwards and upwards at the same time is happening around the world (estimated at $500 billion in the US, $500 billion in Europe). The losers are in the middle because we can get superior or cheaper.

The trends even affect intangibles like life insurance where consumers move up to the most flexible (universal life) or down to the cheapest (term).

The Top Categories
Since our values differ, what we buy won't make sense to anyone else. Using our own values won't help us understand others. It's hard for anyone else to tell how much we'll spend on a product, service or experience.
Example: The snow blower we got two winters ago drew puzzled looks from neighbours who counted on global warming as their salvation from shoveling. We bought to save time and our backs after heavy snowfalls (which paid off this winter).
If you look at the top six categories for trading up and trading down, five make both lists
  • travel and entertainment (Trading Up 1, Trading Down 4)
  • homes and home renovations (Trading Up 2, Trading Down 1)
  • cars (Trading Up 3, Trading Down 2)
  • dining out (Trading Up 4, Trading Down 3)
  • food and beverages (Trading Up 6, Trading Down 5)
This common list misses home goods (#5 for Trading Up) and personal services (#6 for Trading Down).

This leads to anomalies such as
  • sending children to a private school and driving an economy car
  • buying a home theatre with a large widescreen tv and cutting back on dining out
  • traveling but staying in budget hotels

Ladder Of Benefits
Three types of benefits encourage us to trade up: technical, functional and emotional. When absent, we trade down. Just like consumers around the world.


May 4, 2008

Live - The Prime Minister and Others

Spotting politicians in Ottawa is like spotting elk in Elk Island National Park. They're there but they're not in plain view. I lived walking distance from Parliament Hill from 1984-1989 but I only saw the Prime Minister on public events like Canada Day.

As a member of the Conference for Advanced Life Underwriting (CALU), I see politicians and senior government officials regularly now. Our annual conference took place in Ottawa this week (the reason I stayed in a suite for the handicapped). We were addressed (in order) by
  • Deputy Opposition Leader Michael Ignatieff
  • Governor of the Bank of Canada Mark Carney
  • Prime Minister Stephen Harper
  • Finance Minister Jim Flaherty
Here are some of their thoughts.

Michael Ignatieff
On Monday morning, Ignatieff spoke without prepared notes and answered questions. He talked about the role of the federal government. By reducing taxes, the Conservatives were making the federal government weaker, which makes the provinces stronger. Cutting GST by 2% reduces tax revenue by $65 billion over 5 years, which means less money for infrastructure and other projects.

The Liberals feel that Canada can't survive without a strong federal government. Inertia makes north/south relations with the Americans easy. West/East connections among the provinces take effort. He called Canada an act of imagination. It's easier for Atlantic provinces to send electricity to the US than west to Ontario. Since children are our future, they want more money spent on childcare and teaching young children.

Ignatieff wants the same level of healthcare regardless of province or urban density (city vs rural). Since healthcare costs spiral (consuming 51% of Ontario's budget already), he wants to focus on prevention. This means better food (e.g., better labeling) and more exercise. He was open to partnerships with the private sector.

Mark Carney
The Governor of the Bank of Canada spoke over lunch from prepared notes and then took questions. He flew in from a morning meeting with bankers in Toronto.

Canada's growth rate of 3.25% for 15 years is the best in the G7. Commodities have helped. Our jobless rate is the lowest in 33 years. In Alberta, 10% of current residents lived in another province five years ago.

Not all is rosy. Our aging population is growing at the second fastest rate in the G7. Our productivity is too low: 1% less than the US for the last 10 years. Globalization will determine our future.

The Bank of Canada focuses on maintaining a low, stable, predictable rate of inflation. This lowers the cost of capital. The target is 2%. We don't always gauge inflation well. Did you know that food prices dropped 10% last year? We can thank our strong dollar and new "big box" stores.

Two Pieces of Advice
Carney received two pieces of advice 20 years ago
  1. In banking, it's never too soon to panic.
  2. If it doesn't make sense, it doesn't make sense. [e.g., stay away if disclosure is poor as it was for Asset-Based Commercial Paper]
When asked about the rising prices for white rice ($230 to $1,000 to ??? per ton), Carney identified three factors
  • speculation
  • low supplies
  • increasing demands, as people in poorer countries start eating more
Stephen Harper
The Prime Minister spoke in the afternoon from notes and did not take questions. He knew what Ignatieff said and joked that those who felt GST was a "good tax" could continue paying a higher rate. His focus is lower tax, controlled spending and debt reduction ($37 billion paid off during his term). He would rather strengthen individuals through tax relief than strengthen the federal government.

Canada is in the best position in the G7 but we are not an island protected against the US subprime problems. Canada is on track to have the lowest corporate income tax rates in the G7 by 2012 (but Ontario has not been supportive). Money is being spent on infrastructure and education.

Tax-Free Savings Account
Harper called the Tax-Free Savings Account the centerpoint of the 2008 budget, the single most important new savings vehicle since the introduction of RRSPs 50 years ago (see The Original and Overlooked Tax-Free Savings Account). Savings are exempt from taxation forever without penalty. The tax savings give a powerful incentive to create a national pool of investment capital. In contrast, the US has been encouraging debt. Here we are aiming far, aiming high.

Jim Flaherty
On Tuesday morning, Jim Flaherty spoke. His three budgets have all passed. A minority government hasn't had this success since the 1960s. When he first addressed the conference in 2006, he spoke of optimism. In 2008, we're being affected by world events and the US slowdown. We are not an island. Here is our situation:
  • strong Canadian dollar
  • high energy prices
  • aging population
  • shortage of skilled workers, especially in Western Canada
Even so, we continue to have the greatest fiscal strength in the G7. The value of our timber reserves has doubled in a decade to $1 trillion.

Even Flaherty's children ask why reducing public debt matters. His reply? Lower pubic debt reduces interest rates, helps us weather economic slowdowns and reduces intergenerational inequity. Our debt has been reduced by $1,570 per Canadian, which means savings in interest payments of $2 billion in 2009-2010.

Charitable giving has increased since the elimination of capital gains tax on donations of shares. Flaherty felt that Canadians should decide for themselves which charities they want to support.

In Canada, the subprime mortgages are less than 3% of the mortgage market. However, Flaherty felt we need one common securities regulator. We have 13 for a population of 33 million.

Tax-Free Savings Account
Like Harper, Flaherty talked about the significance of the TFSA, which is similar to programs in the UK and US. He reminded us that there are no restrictions on the reasons for savings, no federal clawbacks. Young people benefit the most. Over time, 90% of Canadians will pay no tax on their savings. Already, 20,000 Canadians have used an online calculator to see their tax savings.

In wrapping up, Flaherty said, "I have gone on almost as long as it seems".

Each speaker spoke well and radiated confidence. Last year, St├ęphane Dion --- in his only appearance --- did not. I'm looking forward to next year.