THE RISK OF FINANCIAL INNOVATION

Innovation gets overrated.

In the financial world, innovation may not be in your best interest. What looks “new and improved” may be worse. A bicycle is more stable with square wheels but (a tad) tougher to pedal.

What's wrong with solving underlying problems with proven strategies? Do you want to be among the first to use a new parachute? If your goal is peace of mind, then no.

We have the same six basic fears that Napoleon Hill identified in the 1930s. We have the same basic solutions. Why? Because they work.

Innovation is a sales strategy.

Risks

Governments are getting more aggressive in collecting tax and less lenient in making exceptions (example). Do you want to become a test case? You reduce your risks when strategies are backed by at least two major companies. This may mean waiting. You’ll still need to use your judgment. Mortgage life insurance has major pitfalls no matter how many banks sell it.

Mistakes are most likely when a new strategy is introduced. The unintended consequences can't all be known because … they're unintended.

Introducing rabbits to Australia seemed like a good idea in 1788 (Wikipedia). The subsequent innovations were a rabbit-proof fence (1901) and then the fatal myxomatosis disease (1950). There’s now a vaccine for pet rabbits but usage is illegal in Australia. That’s a lot of unneeded innovation. Rabbits never asked to go to the land of the kangaroo.

The tax rules could be misinterpreted or misapplied. If the innovation goes wrong, the accountant usually gets blamed. That’s the downside of being the most trusted advisor. If they are compensated to approve the strategy, their advice may be biased. Unless they accept incentives, their natural response is to skeptical, even of sound strategies. That can lead to suboptimal results like advice to "buy term and invest the difference" (you lose the opportunity for tax-sheltered growth) or invest only in fixed-interest investments (you save your capital but may fall behind in after-tax after-inflation returns)

Safe Innovation

In the world of life insurance, there hasn't been much innovation in years. In the 1990s, universal life insurance became the dominant product, displacing  whole life. In recent years, whole life has resurged because universal life isn't as universal as the marketing implied. Advisors do more work since you make the investment decisions. This requires more care and more skill. It's easier to sell whole life

The last major new strategy was "10-8" leveraging (now 9-7). That's from the late 1990s. CRA expressed concerns in December 2008 with threats of audits. The insurers continue to stand behind the strategy and no major accounting firm has withdrawn their support. Even so, CRA has created enough uncertainty to frighten some clients and accountants — and collect more tax.

The Real Change

Products don't change much. The major differences are in the packaging. These take the form of "strategies" (which don’t change much either). Internally, they might be called "wrappers" since the same basic products are underneath the shiny new skin.

Then And Now

When I was designing products and strategies, more seemed better. That's because advisors crave the new. Innovation was a way to get their attention. Accountants were also shown the new stuff for the same reasons.

You might watch reruns on TV or go to session after session on a topic of interest, but advisors were reluctant to attend the same presentation again. They craved the new. Many would have invested their time more productively by re-learning strategies they saw before. As the 10,000 hour rule demands, mastery takes time. Mastery takes practice.

Innovation doesn't matter much to you. As a client, you don't know what's “new and improved”. You're buying now. You're unlikely to "trade up" to the new model three years later. Even if the features are better, you'll face higher prices because you're three years older and you'll need to go through underwriting again. Guess if the criteria will be more lax? Don't count on stronger guarantees either.

Links

• The six basic fears from 1930s via Napoleon Hill
• How accountants feel about insured strategies
• Your trusted advisor:  what you like/dislike
• How CRA identifies issues that concern them (and then you)
• CRA refuses to back down on tax demand (Toronto Sun, Nov 2, 2011)
• Tax planning: The top five insured strategies
• The pitfalls of mortgage life insurance
• image courtesy of AppolloNui (US)

Podcast 142 (5:57)

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PS Outside the financial world, new usually means improved. Would you want to buy last year’s gadget?