October 31, 2009

Why Insurers Won't Insure You (H1N1 anyone?)

You can't always get what you want.
--- The Rolling Stones

You've got the money. What you want is legal and widely available, but you can't buy it. Who would turn you away? An insurer.

This isn't because of supply and demand. After all, an insurance policy is just a printed promise. The quality of the promises varies, but there's plenty of paper to print them.

Why Refuse Motivated Customers?
Conventional wisdom says that insurance is sold, not bought. If you're interested in getting coverage, you're viewed with suspicion. Who wants to buy insurance? Maybe you know something you think the insurer won't find out.

We're self-motivated to buy insurance when we think we're likely to get a higher-than-normal payoff. If we win, the insurer loses.

Underwriters classify risks. Bad risks pay more if they can even get protection. You undergo a similar process when you apply for a mortgage. The higher your creditworthiness, the more you can borrow and lower the interest rate you pay. Similarly, insurers look at your health rating and your finances.

Asymmetry Of Information
What if you know something the insurer doesn't? You stack the odds in your favour. Insurance spreads risks among large groups with similar characteristics. Smokers die younger and have more health problems. Suppose a smoker pays the same price as a nonsmoker. By overpaying, the nonsmoker is subsidizing the smoker. That's unfair. Insurers try to assess each risk fairly and charge accordingly.

Fear Motivates
Since we're attentive to bad news, the media gives us plenty (unless you live a low noise life). Take the current "swine flu" (2009 H1N1 Flu). In previous years, we've warned about West Nile virus, SARS pneumonia, mad cow disease and avian flu (H5N1).

If you've had a bout with a disease, you may want to buy insurance and find you can't --- especially if you were hospitalized. The insurer may require that you wait months to show that you've recovered. By then, you may forget or lose interest. The insurer would rather turn away business than take on an unexpected risk.

Podcast Episode 41 (3:04)

direct link | Internet Archive page

October 24, 2009


If you don't know where you're going, any road will take you there. --- Lewis Carroll

Do you plan before you start or start before you plan?

When discussing finances, some advisors feel you must have a comprehensive financial plan but most recommend piecemeal solutions. You'll find background on Million Dollar Journey where a financial planner laments that Most Financial Planners Don't Plan Finances. Read the comments too.

Some financial planners get overzealous. They feel their way is the "right" way and look down on other advisors. You see similar divides in the Mac vs PC camps and the Microsoft vs Google groups. How unproductive.

Can you save for retirement without knowing how much retirement income you need? Certainly. You might not save the "right" amount but you're moving in the right direction.

Planning To Fail
Here are the problems with financial plans
  • they are expensive
  • they are boring
  • they are wrong
But they are better than nothing. You'll guess wrong on critical assumptions like investment returns, inflation and how long you're likely to live.

No Customers
You'll find financial planners who would eagerly prepare financial plans for a fee. They have trouble finding paying customers. A financial plan typically costs $750 to $5,000 plus ongoing maintenance plus tax . Do you get your money's worth?

You wouldn't pick a laser eye surgeon solely on price, but what about a financial planner? Are you paying for the expertise of the planner, as you would for a surgeon or are you paying for the hours they spend developing the plan? How can you judge the quality and relevance of the plan?

Slow and Painful
Financial planning is much like visiting your doctor for a physical. You answer questions, submit to tests and then get told to eat better, sleep more and exercise more. You already knew that. Will your behaviour change even if you're heading for trouble?

To get a financial plan, you sit down with a financial planner and perhaps an assistant who takes notes. You answer questions for what feels like hours ... and is. You leave your financial records (e.g., tax returns, bank statements, insurance policies, investment statements, etc). The assistant inputs the data into financial planning software (generally an Excel spreadsheet) which the planner reviews. Weeks later, you come back to review the plan, which may induce drowsiness. You'll find out what's wrong with your financial life and get recommendations in a thick, nicely bound report. By coincidence, your financial planner can often sell you the suggested products (their main source of revenue). You'll likely buy because you've already spent so much time and perhaps money too.

Because the process is painful, you probably won't get a plan from another advisor for comparison. You're less likely to switch advisors later. So financial plans are an effective business tactic.

Financial plans can be tough to grasp and we're in a world where financial literacy is a concern. Basics like how compound interest works aren't well understood. We're not known for making rational decisions either.

Ways to Pay
You can pay for financial plan in several ways
  1. money: which may be refunded if you buy the recommended products (like a refundable deposit)
  2. no fee: the advisor gets paid for selling the recommended products (which creates a potential conflict of interest)
  3. free: as a reward for being a large customer (you're already paying for other services and this is a way to coax you to buy even more)
How Plans are Developed
Like tax returns, financial plans are developed using software. You'll find three categories
  • sophisticated commercial grade: e.g., FP Solutions, Naviplan (can be difficult or cumbersome to use)
  • simplified: generally point out deficiencies with your insurance or investments (which the planner can help you rectify); might be unique to the firm
  • proprietary: developed by the planner but not as well tested as commercial grade software
I've had FP Solutions Business Edition for years. This is extremely sophisticated tool costs $1,335 a year (plus tax). Since I didn't know how to develop financial plans, I got training (live, webcast and prerecorded). I rarely use it, though. I offered to develop free financial plans with advisors but got no takers. Zero.

Evidently, life goes on without financial plans.

Financial planners boast about their financial plans, but they're reluctant to show them. They certainly don't want competitors to see. Why this fear? A finished plan doesn't look distinct. I've seen dozens. They're generally
  • printed in colour on nice paper (though internal drafts may be in black & white on cheap paper)
  • include graphs and tables
  • in nice binders or bound with Cerlox or wire spines
  • have an executive summary because of the length
  • dozens of pages (though most of the content is generic)
You can't see the wisdom that went into developing the plan. You just see the printed result and wonder about the value.

The Real Reason
In the classic book Selling The Invisible, Harry Beckwith points out that our "financial" matters are private and sensitive. Also "planning" sounds tedious and difficult. Acting on the plans shackles our freedom. Now combine "financial" and "planning". Is it any wonder that financial planning and financial planners get ignored. What do you think?

October 17, 2009

Why You Can't Know What You Want

Don't it always seem to go,
That you don't know what you’ve got
‘Til it’s gone.
--- Joni Mitchell,
Big Yellow Taxi

You can't get what you want
Till you know what you want.

Joni and Joe are both correct but there's another aspect: You can't tell what you want until you know what's available.

Some people try but they're cheating themselves. This is often when they're looking for the cheapest price today. In the prior post, we looked at why you can't (and don't) buy on price.

You can't decide without knowing your options.

An Example
Let's look at a concrete example: buying a computer. Here's a page from a old Best Buy flyer. Click on it to enlarge and take a look. Using only this ad, which computer would you pick?

You might buy based on
  • price: low, medium or high
  • brand
  • features or benefits
  • screen: size and resolution
  • performance: CPU speed and memory
  • portability: weight and size
  • intended usage: might pay more for business-grade
  • product life: more expensive might reduce the need to replace the computer
As you look at the ads, notice what's generally missing: weight, battery life, thickness and screen resolution.

What you think you want, may not be what you buy or what satisfies you. That's what happened when I bought one of those new-fangled all-the-rage netbooks.

Case Study
I thought netbooks were interchangeable and bought primarily on price (not from Best Buy).

I got an HP Mini 110 for $50 off. The price was fair, but I quickly found that what I got wasn't what I wanted. I got annoyed by the bilingual keyboard (a pet peeve), trackpad buttons on the sides instead of the bottom, the lack of Bluetooth, the weak wireless antenna, and the poor resolution anti-glare screen (1024x576).

Next, I spent a bit more for a Dell Mini 10v. This eliminated the problems with the HP but added three new ones
  1. wrong screen resolution: 1024x600 glossy instead of the advertised 1366x768
  2. a three hour battery instead of the previous six hours (assuming one hour per cell)
  3. heat: runs too hot, which can't be good for the components or your lap
Finally, I got the Dell Mini 10, costs the most but eliminates the issues above:
  • screen resolution: 1366x768 (a real joy)
  • battery: 6 hours (estimated)
  • metal case: more rugged
  • low heat: uses a more expensive Atom Z chip in place of the usual N processor
  • no moving parts: more durable
The Surprise
Here's the big surprise with the Dell Mini 10: complete silence. Portable computers are generally quiet but the spinning hard disk and cooling fan make some noise. I paid an extra $130 for a 32 GB solid state hard disk (SSD) made from memory chips instead of the usual spinning 160 GB magnetic hard disks. Frigid winters, humid summers and foreign travel are tough on delicate mechanical devices. Even if nothing goes wrong, there's the worry that something could. What do you do then?

The multi-touch trackpad is a "free prize" that did not affect my purchasing decision but is very satisfying to use.

Lesson Learned
The point here is not to keep spending more because your needs are probably different. The lesson is that I didn't realize how much I valued silence before. There's no way I would have bought the Mini 10 at the outset because I didn't know what I wanted or how much I'd pay for it.

You've probably had similar experiences. We don't know what we want until we know what is available. We can't know.

Podcast Episode 39 (5:42)

direct link | Internet Archive page

October 10, 2009

Why You Can't (and Don't) Buy On Price

Today we're looking at prices from free to crazy.

The High Price of Free
We're getting the Toronto Star newspaper free for six weeks. This isn't a gimmick where you pay for Saturday and get Monday-Friday for free. We're getting the paper Monday through Saturday with no obligation. What a hassle. We glanced through a few issues but now the paper piles up in the recycling bin unread. Free has a price: time.

You probably get lots of free email that you don't read but which doesn't annoy you enough to unsubscribe. You probably gave away personal information to get the freebies. The Internet is basically free, but your behaviour gets tracked anonymously through cookies.

You can get library books free but popular titles have a waiting list and a seven day nonrenewable loan period (at least in Toronto). You pay in time, again. Television is free with commercials or ad-free with paid subscriptions.

There's nothing wrong with free, but you pay in some way. If lunch is free, count on listening to a sales pitch.

Different Prices For Nearly The Same
Have you noticed netbooks, the cute, light, inexpensive portable computers? Most models have nearly identical specifications thanks to pressure from Microsoft and Intel to cap the capabilities. For instance, Microsoft is chopping the maximum screen size from the current 12.1" to 10.2" for Windows 7.

Despite the similarities, you'll find surprisingly large differences in usability, design and quality. Unless you buy solely on price.

Think about macaroni & cheese. Prices differ when the ingredients differ. Real cheese costs more than simulated, powdered stuff. You'll also pay more in a restaurant than at home.

The Same Price For Very Different
Houses of the same price differ too. One place may have plenty of washrooms but use cheap carpet instead of hardwood. Or the kitchen may wow you but the guest bedroom may be the size of a large walk-in closet. Or the house may be perfect but on a major, noisy street.

Advice differs because the advisors vary in quality. Professional designations and experience are often measures of quality. But not always. Either could be dated or irrelevant.

It's very difficult to identify the best advice since you're dealing with an intangible. Better ingredients usually mean better results, but some people can burn water.

Water Water Everywhere
Tap water is essentially free. That's the source of Coca-Cola Dasani and Pepsi Aquafina, but those brands cost more. Often more than soft drinks, which have the added cost of additional ingredients. If you like spending even more, there's Fiji natural artesian water and glacier water (which we drank free atop the Athabasca Glacier in Alberta).

It's all H2O but if the choices were placed in front of you, which would you pick? Which would you want to pick?

Even if you normally drink tap water, what do you do when you're parched and there aren't any water fountains around? Price matters but so do many other factors. We don't always pick free or the cheapest.

Podcast (4:11)

direct link | Internet Archive page

October 3, 2009


No one wants to get audited. Not even the tax auditors. But they get audited too.

The Auditor General, Sheila Fraser, looked at how the Canada Revenue Agency (CRA) audits Small and Medium Enterprises (SMEs). Despite 5,600 staff focusing on these businesses, earlier problems remain. As taxpayers, we want compliance with the rules to ease our tax burdens, which vary considerably by province, especially for entrepreneurs.

We're talking about big dollars. The CRA estimates there aren't many tax cheaters but those abusers cost us plenty. About $12.7 billion in unpaid tax according to their 2006-07 Annual Report. Of that, about $2.5 billion relates to SMEs.
Overall, the Canada Revenue Agency (the Agency) has made unsatisfactory progress in addressing the recommendations we selected from our previous reports for follow-up.
--- Auditor General, March 2009 Status Report
Sheila found the "taxman" fares poorly in
  • taxing the underground cash economy (targeted by 1,000 CRA staff): "about half of its underground economy audits over the past five years did not detect unreported income"
  • auditing too many low-risk files
Auditing The Wrong Files
The CRA "has difficulty demonstrating that it is selecting and auditing small and medium enterprises of high risk or priority."
--- Auditor General, March 2009 Status Report
The CRA uses computerized risk assessment to classify tax returns by the potential tax recovery into four categories from low to high. That makes sense.

However, the CRA focuses on low-risk files where they expect a $0 tax recovery. This is like targeting drivers going 0-10 above the speed limit but ignoring drivers zooming past at 50+.

In the last two fiscal years, the CRA audited 87,000 SMEs. Of these, 13% were tagged as high-risk and brought in 41% of the total tax recoveries. However, 56% of the audits were on zero or low-risk files and brought in 39% of the total tax recoveries.
"Available auditors may lack the experience necessary to do complex high-risk files and therefore audit lower-risk files."
--- Auditor General, March 2009 Status Report
What's going on? Among other explanations, CRA says their auditors are better suited to doing low risk audits. Also, audits do turn up problems even where tax recoveries are low. This is like a "broken windows" approach: tackle minor crimes like speeding and littering to prevent bigger crimes.

The CRA does not know why high-risk files bypass audits because the human screeners who make the ultimate decisions aren't required to document their reasons. Screeners favour their own judgement over computerized risk assessments. Human judgement leads to inconsistencies.

The Right Staff
During the Tax Roundtable in the 2008 CALU conference, a CRA official reported difficulties filling two senior vacancies in the Ontario audit unit. Why? The pay scale starts at $40,973 and caps out at $110,779. The private sector pays better. Also, tax auditors would rank among the least prestigious professions. Want proof?

At a party, announce that you're an actuary and people will leave you for fear of boredom. Say you're a tax auditor and watch them bolt even faster and go further away.

The study found that most people know little about the implications of tax cheating, and concluded that more communication would encourage better compliance.
--- 2007 public opinion research by the CRA
Honest taxpayers suffer. Cheaters prosper and encourage others to follow. Until they're caught. Let's see what happens.