#2 Why the insurance industry is broken?

Show notes

  • Million Dollar Round Table Website
  • MoneySmart Blogpost on MDRT in Singapore
  • Further to note that Kevin is not involved in the financial advisory industry nor affiliated to any firm adopting fee-based approach to financial advisory

Not-so-accurate transcript

Insurance can mean two things:

(1) It can be a thing that provides protection against a possible eventuality -> for example, a jacket, it provides protection against an enounter with cold weather, or perhaps the AC

(2) It can also be an arrangement with a company, or state institution that provides a guarantee of compensation for a specific occurrence. Usually this is an event of a loss, damage, illness, or death. This arrangement of compensation will come at a cost. And this cost in the form of a payment of specified premium. Either one-off, or through a series of payment.

In the first case, the insurance protects you against some event. So that eventuality may not be experienced the same way.

In the second case, the insurance protects you against the financial downside of the event.

Actually no, it does not even protect you against the financial downside; it merely compensates you up to some point. There will be some of the financial downside that is not covered, and then there’s a cap on the aspects it does cover.

In fact, to me, it doesn’t sound like it protects at all.

It is basically a type of financial instrument or transaction. You can structure it to protect you from the downside, but you need to think about how to do so. It will not automatically help you do it.

More importantly, there are alternatives to consider. You can self-insure, which means, to take the risk of the financial downside. For most risks in life, we self-insure. We think about the risks we are taking and we accept the potential downside.

Most of the time, the reason we self-insure is because the cost associated with insuring those risks are too high. And it might not be worth the effort to actually find someone to insure us for those risks.

In order for insurance to work, they need to enlarge the pool of people whose risks they are insuring so that they can diversify and pool these risks and hence reduce them. This is the reason for standardised products and offerings. It is also the reason you get a lot of exclusions when the insurance company identifies you somehow as being more risky.

But I think the problem is that the industry is broken. I think that even the person with purest of intentions can have those warped by incentives. When the financial planner you are speaking to is paid not by you but through commissions on what they are selling to you, it is really difficult for them to serve your interest. That’s something they can keep saying they will do. Companies can even fool themselves into that.

The better solution is for the customers to be the one paying the independent advisor, who does not collect commissions but is entirely paid by their customers. The challenge is that people are still not exactly willing to pay for good financial advice. As a culture, we need to change that. We could start financial literacy education at younger age, and we need people to be better educated about incentives.

Consider this. The industry’s premier association is called the Million Dollar Round Table. And the annual qualification requirements for joining include demonstrating a set annual production requirement plus agreeing to adhere to a strict code of ethics. Ethical violations will result in dismissal.

To be eligible for a basic membership in 2022, for example, an applicant must meet sell insurance meeting premiums of $237,000. MDRT also has established two additional tiers of qualification: Court of the Table and Top of the Table. To qualify for these higher tiers of membership, the applicant must demonstrate annual commission of first year income three to six times the base requirement.

If an industry is celebrating sales more than customers’ success, it is hard to say how much they can care for their customers. Ultimately, the conflict of interest is hard to bear.