Sunday 6th May, 2007

 

Prices equate quality

 
 
 
 
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At a small service plaza on the road between Mecca and Madinah, in Saudi Arabia, I came across a man selling “brand name” watches from a tray-box. He knew what he was selling and buyers knew also, because pricing equates with quality.

I often tell people who are comparison-shopping for financial products that one cannot get a Mercedes, for the price of a 120Y.

There are no bargains! You get what you pay for! The majority of insurance products are priced according to the same rules, using mortality tables as well as morbidity data common for the region, and using claims experiences that are also common for the region.

The expression “claims experience” refers to the amount and type of claims that the insurance company and its re-insurers have received from people who have suffered a loss, and filed a claim for compensation.

The re-insurer is typically a larger international organisation that is called upon by the local insurance company, to help share the risk when the risk is deemed to be large. When there are too many large claims, for example after massive flooding or earthquake, the re-insurers may recalculate benchmarks, and reset the pricing.

Pricing of financial products is standardised by the fact that numbers within the population are ranked by virtue of age, occupation, location, etc. These factors relate to the amount of risk exposure that face all individuals in the grouping.

Draconian measures

For example, all males between age 30 and 35, in general, who work in a clerical position, are exposed on a daily basis to the same degree of risk of accident, and illness. Compare them with males age 30-35, who work with contagious disease patients, or who are policemen or firemen.

Although they may be the same age, and same health status, the job-related risk is different.

But there is another more critical area in pricing of financial products: I call it packaging. Very often the core product is mixed with other “added value” products that are bundled as a bargain when the two are packaged together.

Unlike the buyer from the tray-box vendor on the road, you may find yourself in a situation where you cannot differentiate how the packaging accounts for the difference in pricing.

For example, you can easily buy cheaper insurance if you choose term insurance, as opposed to cash value insurance. In cash value insurance you get back money if there is no claim. In term insurance, you get back nothing if there is no claim.

In addition the hidden fee structure in investments is seldom explained in full. You can be shown a glossy projection that completely ignores the fees that will be charged.

There is even an incredible new ploy where certain institutions are refusing to accept guaranteed cash value instruments as collateral. They urge investors to close off accounts in one institution, to place in theirs.

Hence the need for central banks to be extra vigilant and fair is legislating for financial institutions across the board.

In the end it is the small man who suffers the most from the draconian charges and schemes of large institutions.

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