RISCARIO INSIDER: March 2014

March 30, 2014

WHEN CAN INSURERS CHARGE MORE FOR THE INSURANCE YOU ALREADY OWN?

Insurance companies make mistakes which cut into their profits. This is called underpricing and happens more often than you might expect. Sometimes assumptions prove wrong and other times matching the competition causes the trouble.

Can the insurer charge you more for the insurance you already bought?

When Prices Can Increase

Some products have premiums which adjust annually (usually upward). You’ve probably noticed that with your car insurance and home insurance. The premiums for employee benefits (e.g., hospitalization, prescriptions, dental care, disability) also change but you may not know. Since that’s one of the two types of insurance you can’t own, your employer can cut back on benefits to save money.

If you’re not happy with your insurer, you’re free to switch companies with no penalties and little effort. When prices go up, you can also reduce or cancel your coverage, which exposes you to more risk.

Where You Have More Protection

You face problems when you buy insurance with premiums based on your health. If your health deteriorates, switching to a new company will cost more — if you can even get coverage. Put differently, you’re stuck with your insurer. You have no recourse against their premium increases.

Guarantees reduce the insurer’s flexibility to make changes. Since you’re protected from surprises, you pay more. You also get much more. The level of guarantees depends on competition and regulation.

Example: Long-Term Care Insurance

Imagine buying a Lexus for $5,000 down plus $500 a month under a contract that allows the dealer to raise the monthly payment if he wants to. Six months in, it goes to $800, and you have a free choice between paying up or handing in the car and losing your down payment. That would be a ridiculous contract to sign. LTC [Long-Term Care insurance] buyers sign contracts like that.
— Forbes (Aug 2013)

Here’s a sad example from the world of Long-Term Care Insurance in the United States. By 2012, half the top 20 insurers stopped selling new policies (though you can likely keep coverage you already have). Premiums keep going up.

John Hancock is boosting premiums by an average of 40%. Some clients are paying much, much more. Would you believe 90%? That’s what a couple in their 60s faces as their annual premiums jump by $3,958.74 from $4,398.61 to $8,357.35.

"We bought these policies because this [long-term care] is the only insurance you really need. Long-term care will eat up all your assets. We were told when we first bought the policies that the rates could go up, but 90% seems outrageous." — John Holtzman, age 67

To offset the increases, this couple is planning to reduce their protection. That puts them at greater financial risk. Cancelling coverage would be worse.

What Went Wrong?

“… the industry over all made incorrect assumptions when it set premiums for older policies — particularly, those issued before 2002 — and didn’t set rates high enough. For instance, far fewer people than anticipated let their policies lapse. And interest rates in recent years have been much lower than expected, making it difficult for companies to earn adequate returns on invested premiums.” — Thomas J McIrney, Genworth CEO

Long-Term Care insurance usually pays a daily benefit if you’re unable to perform two or more activities of daily living such as bathing or eating. The money can go towards help at home or a nursing facility.

The Problems

Problems arises when

you think you have guarantees but don’t
you don’t explore the guarantees you have
you know premiums can increase but don’t examine the “worst case scenarios”

The best time to find out is when you have the most options: before you buy.

March 23, 2014

WHY BILLIONAIRES BUY LIFE INSURANCE

If I had a million dollars, well, I’d buy you an exotic pet. Yep, like a llama or an emu. — Barenaked Ladies

If you had a billion dollars, you could buy a whole zoo. Or $201 million of life insurance. That record-breaking purchase happened in California. The premium is about $2 million a year but cost-effective — perhaps even a bargain.

Self-insure?

Billionaires have the money to insure themselves to

pay medical expenses: no need for medical expense insurance
offset the costs of life-changing diseases: no need for critical illness insurance
replace income if unable to work: no need for disability insurance
provide lifelong income: no need for life annuities

Some afflictions have no cure at any price (and hence no insurance). RIP Steve Jobs (pancreatic cancer) and Warren Buffett’s wife Susie (oral cancer).

Life insurance is different. Large amounts are available and there is no substitute. Even so, why would a billionaire buy coverage?

Maintain Privacy

Life insurance protects the privacy of the buyer. Despite the media scrutiny, the owner of the $201 million of coverage remains anonymous. We know the gender (male) but not the age. The seller is ‘not legally permitted to disclose the name of the billionaire buyer but said it was a well-known Californian tech investor’ (Forbes). The insurers can’t say either. We wouldn’t have known about the purchase if the buyer hadn’t given permission for limited disclosure.

Since death benefits rarely through an estate, the beneficiaries need not be identified.

Have Flexibility

The beneficiaries are not notified until the time of a claim. This allows the buyer to change the beneficiaries and how much each receives.

The buyer can cancel or adjust the amount of coverage. In the case of the $201 million of coverage, the owner says that "he wants his next of kin to keep working hard" rather than waiting for a payoff.

The owner can reduce flexibility by making the beneficiaries irrevocable. This may be required upon divorce.

Save Or Grow A Business

A growing business may need outside money from lenders or investors. Those supporters want some assurances. The business might collapse upon the death of a key person like the owner, especially in the early years.

Ted Rogers is an excellent example. His dad died when Ted was only five: "He didn't have a lot of life insurance at that age, so the businesses were sold or shut or stolen."

In building Rogers, Ted borrowed from banks many times. They required he
have life insurance payable to them as protection. Term life insurance is ideal here --- the most coverage for the lowest price. Later, the temporary coverage can be made permanent for tax planning and estate planning.

DiversifY

You can put all your eggs in one basket and have that basket watched 24 hours a day. That doesn't mean problems won't arise. That basket may not be diversified. Billionaires have lost their fortunes (e.g., Allen Stanford, Sean Quinn, Patricia Kluge). Celebrities have gone broke too (e.g., Abraham Lincoln, Mike Tyson, Michael Jackson).

A solution is to invest in different classes of assets. Permanent life insurance allows, tax sheltered growth, tax-free access via leveraging and a tax-free death benefit. The payout is a predetermined amount at an unpredictable time (death). No other asset offers these characteristics.

Investments inside insurance may fluctuate and lack guarantees. That's true of investments outside life insurance too. However, permanent life insurance keeps growing in value because the date of death keeps getting closer. Can other investments make that claim?

What if an insurer goes bankrupt? There may be protection in those cases (e.g., by Assuris in Canada or a state government in the US). The risks are reduced by spreading coverage over multiple companies. The $201 million of coverage is spread over 19 insurers, each at risk for less than $20 million.

Pay Estate Liabilities

At death, large sums may be required to pay taxes and other obligations such as loans. Permanent life insurance is often the cheapest, fastest way to get cash for those liabilities. Also, there’s no need to have a rush sale on assets at an inopportune time. As a result, more of the estate gets preserved.

Caveats

Life insurance is only available to the healthy. The unhealthy pay more (e.g., smokers). Sometimes the risks are so high that no coverage is available at any price.

There are limits to how much coverage is available on one life. Maybe $201 million is less than the buyer wanted. Insurers want to prevent incentives for

murder (example the ‘professional hit’ on Claude Dray)
suicide (George Bailey in It's A Wonderful Life?)

If the coverage gets cancelled before death, there won't be a payout. It helps to earmark money to pay future premiums.
If affording the life insurance becomes a problem, some jurisdictions allow the sale of the policy to an investor. These life settlements get icky because the buyer gets a higher return the sooner the death.

Surprises

Apparently, the advisor behind the $201 million of insurance (Dovi Frances) didn’t get paid a commission. The firm (SG LLC) “charges clients a flat (and one can assume, steep) annual fee for advisory services ranging from asset management to alternative investments.”

The advisor got the client 4-5 years ago through a direct mail campaign.

Smart

Billionaires have access to excellent advice from top advisors. They do buy life insurance. How about you?

Links

PS There may be larger life insurance coverage on billionaires who value their privacy more than a Guinness World Record.

March 15, 2014

CAN YOU TRUST YOUR DOCTOR’S PRESCRIPTION?

When I was a child, I trusted my doctor. He made home visits, which is what you want when you’re sick.. He even gave me used syringes with the needles attached so I could refill the cartridges for my fountain pen from a big bottle of ink. I felt that he had my best interests at heart. Is the same true today?

Good People. Bad Results.

“… small branded promotional items should increase favorable attitudes for the brand being promoted … but many physicians, because they are medical experts, believe they are not susceptible to these influences. In one survey, just 8% of physicians believed they were susceptible to influence by marketing items such as branded pens, whereas 31% of patients felt these items could influence physicians.” — The Journal of the American Medical Association (May 2009)

Doctors may not think they’re influenced by vendors but they’re people too. Studies show that “even small drug company payments as low as $10 influence doctors’ prescribing patterns” (Australian Doctor).

Independence

The New England Journal of Medicine found that 94% of doctors have a relationship with a drug company. They receive

free meals at work (83%)
free drug samples (78%)
reimbursement for professional meetings or continuing medical education (35%)
payment for consulting, lecturing or enrolling patients in trials (28%)

The diagnosis and prescriptions may not be best for you. The problem lies in conflicts of interest.

Schooling

Are medical schools are addressing the problems caused by conflicts of interest among their faculty? A study of policies found that over 70% of Canadian medical schools failed. The highest score was 79% at Western University.

The big issues were

interactions with sales representatives (70%)
conflicts of interest or drug promotion in the curriculum (70%)

Having policies doesn’t mean they are effective or enforced. For instance, American medical schools tend to have strict policies but tend to ignore ghostwriting (that’s “when researchers take studies or parts of studies that were written by pharma and pass them off as their own independent work without disclosing the industry ties”). How objective do you think the articles will be? Perhaps court challenges will help since “medical journals, academic institutions and professional disciplinary bodies haven't succeeded in enforcing sanctions”.

Protecting Yourself

Spotting conflicts of interest is much tougher if you don’t know about them. An Australian study found that 76% of patients didn’t know about relationships their doctor might have with a drug company. They wanted transparency, which includes knowing about

any benefits in cash or kind from drug companies (71%)
financial incentives for participating in research (69%)
sponsorship to attend conferences (61%)

Patients felt that disclosure would help them make better decisions about their treatment (78%).

If you remember that people are people, you’re better able to protect yourself whether you’re dealing with a doctor or any other advisor.

March 8, 2014

THE CBC’S HIDDEN CAMERA INVESTIGATION OF INVESTMENT ADVISORS

Can you trust your investment advisor? That’s a very important question for your financial success. CBC Marketplace investigated advisors at 10 major firms and found some ‘atrocious’. Watch this short video using hidden cameras for examples. For the full version, watch Show Me The Money.

The examples may be extreme and unrepresentative but they did happen. Buyer beware. Buyer prepare.

Clarity And Competence?

Dollars are easier to understand than percentages, but …

“The financial industry doesn’t have to tell you how much investing can cost you in dollars and cents.” — Erica Johnson, Show Me The Money

Where there’s complexity, you benefit from advisors who simplify without distortion. Let’s look at an example: mutual funds.

Fees on mutual funds are charged on the total amount you have invested (your capital and the growth/loss on that capital). The math gets complicated because you’re shown an annual charge (e.g., 2%) but that’s converted to a daily equivalent and deducted daily. You’d expect an advisor to know the mechanics well.

“If can’t explain the fees on a mutual fund, which is such a popular investment in Canada — almost a trillion dollars is invested in them — you should not call yourself a financial advisor.” — Preet Banerjee

The hidden camera showed examples of poor explanations. For instance

“That fee is … umm … it’s on the percentage of returns of the fund. So … it’s … like … sorry just want to make sure I’m thinking about this properly. Like it’s not on … just seeing if I can find, like, an easy definition.” — bank advisor

The lesson? You can’t assume advisors have solid financial education. Yet they are employed. What does that tell you about the accreditation process and the standards of their employers? An advisor who doesn’t know can ask for help … or do a Google search.

What’s Worse?

Life and health products are much more complex than investments because you’re now dealing with the actuarial elements of risk (e.g., mortality or morbidity) and have the additional worry of how to get your claim paid. That makes them harder to understand, explain and compare. Getting suitable help is even more important and difficult.

Some advisors sell both insurance and investments, but how well?

The Big Surprise

The big surprise is if you’re surprised by the CBC’s findings. There’s enough information online to raise concerns about advisors. Ask around. You’re bound to hear horror stories if you ask others what they think they bought and what they think they pay.

You may not have a hidden camera but can take notes or record the audio with your smartphone (seems legal). Protect yourself. Protect your money.

Links

PS "Financial advisor" is among the five job titles in most demand by employers, according to Workopolis.

March 2, 2014

BUYING A CAR VS BUYING LIFE INSURANCE

You’re probably more familiar (and interested in) getting a car than getting life insurance. Let’s compare key elements of both decisions.

The Research

You’ll find lots of information when shopping for a vehicle. There are lots of reviews and comparisons online. You’ve seen the vehicles on the road. You can take test drives. You can visit more than one Toyota dealership and also try other brands.

Life insurance is very different. You’ll find very little information online. Where is the Build Your Own option to configure your insurance, estimate costs and compare companies? You won’t see what other people have and the products are complex. These factors nudge you towards advisors but do advisors help with your financial literacy?

Related: How would Mike Holmes fix the financial sector?

The Price

The price you pay for a vehicle depends on factors such as demand and your negotiation skills. There are often specials which expire at the end of the month. Repeat customers might get loyalty bonuses.

With life insurance, your premiums depend on you (age, health) and your advisor (skills, companies represented). You’re usually required to buy at list price, which means you don’t need to worry about negotiating. Choosing a different advisor won’t cut the price.

Depreciation

No matter how shiny or well-maintained, a vehicle drops in value. Resell the day after you buy and you’ll take a loss.

Life insurance becomes more valuable each passing day because the probability of a claim keeps increasing. Permanent insurance will pay a benefit one day. Temporary insurance may not for two reasons. We’ll use Term 10 as an example:

Premium increase sharply every 10 years when you renew coverage.
Coverage ends at an age like 75 before claims are most likely.

Maintenance

Vehicles have maintenance schedules you’re encouraged or forced to follow. You might get a gentle reminder each time you start your engine.

Don’t count on a prompt to update your life insurance, regardless of how long since your last inspection or how your life has changed. Advisors earn more from selling than servicing.

Surprises

The cost of repairing and maintaining a vehicle increases every year. You never know what surprise is lurking. The biggest risks lie outside the warranty period when you’re liable for the full cost and suffer the full inconvenience.

Life insurance requires some maintenance too. As long as you keep paying the premiums, you don’t need to worry about breakdowns. Your coverage may not remain suitable for your evolving needs. You’ll probably need help from a suitable advisor to explore your options.

Related: What happens if my life insurance company goes out of business?

The Nudge To Buy

There are lots of incentives to get another vehicle. The repair bills on the old one might start stacking up. Perhaps you visited an autoshow or saw an intriguing ad. Your lease might be ending. Maybe a friend or neighbor got new wheels.

There isn’t much pressure or motivation to buy insurance. These days, life changing events no longer trigger insurance purchases (e.g., marriage or the birth of a child). We have “tax season” and “RRSP season” but no “insurance season” (though the US has Life Insurance Awareness Month each September with celebrities like Boomer Esiason, the Cake Boss, Lamar Odom and Leslie Bibb). It’s easy to delay buying insurance.

Preowned

You might save money by getting a used vehicle. You save on depreciation but face higher maintenance costs and don’t know how long your ride will last.

You can’t buy used life insurance because the coverage is personalized to you. You can save money by getting coverage that’s temporary rather than permanent — like leasing instead of buying.

Reselling

You can sell your vehicle for cash. The value keeps going down with age and condition.

Permanent life insurance grows in value after purchase. You might be able to cancel your coverage and get some money back. If legal, you could sell your coverage to an investor (a “life settlement”), though it’s creepy to know the buyer gets a higher return the sooner you die.

Finding The Money

A vehicle is expensive. Where do you find the money? We’re good at getting what we want by distorting our spending. Perhaps more money for a car means less dining out or road trips instead of flights.

Life insurance gives you peace of mind but you can’t touch that. We don’t think anything will happen to us, which makes insurance premiums look like a waste.

Changing Your Mind

“Unlike most other contracts, vehicle purchases are binding once signed, and can only be cancelled under certain conditions.”
— Office of Consumer Affairs

Buying a vehicle gets emotional and the advisors have ways to add to the pressure. Once you sign the contract, try changing your mind. It doesn’t look like you can unless you got a lemon (which you won’t know until later).

Life insurance is different. You have a 10-day free look from the time you take delivery of the insurance contract. You can change your mind for any reason without penalty.

The Biggest Difference

For many, getting a new vehicle is exciting and even the search is enjoyable. New wheels might be a necessity. Heated seats, navigation and great sound aren’t but make driving more pleasurable.

Getting life insurance isn’t like that at all. The first challenge is finding an advisor who will help you and nudge you to take action.

Links

PS Do you have better insurance on your tires and rims than on your life?