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
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.

Links
Podcast Episode 41 (3:04)

direct link | Internet Archive page
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October 24, 2009

WHY IS FINANCIAL PLANNING IGNORED?

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.

Secrecy
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?
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