What hurts more Health risks or Insurance?

In an earlier post, we had touched upon health insurance and how it has created a doubt in the minds of consumers. Here, we re-visit this topic for a better understanding.

Let me quote verbatim from a few websites, a couple of relevant but contradictory perspectives. 1^st, from the point of view of a consumer in the US -

“… My ideal world. Insurance companies are judged by honest third party intermediaries. Insurance companies compete like heck to make customers satisfied. Insurance companies monitor doctors…. and require evidence-based medicine… companies which fail at these pursuits go bankrupt or exile their CEOs to Greenland. Every year prices would fall in real terms, quality would improve, and coverage would be expanded.”

Another consumer responds. “The insurance industry may be the only private-sector institution that I trust less than government. In auto insurance, I find that unless I change providers every few years, my premiums just get ratcheted up for no reason. I think that life insurance is a huge rip-off, particularly considering that it starts out with a tremendous tax advantage.

I do not trust my fellow consumers to understand the concept of insurance well enough to make (force) insurance companies offer products that make sense. Too many consumers think that good insurance is something that provides payouts for small problems rather than protection against rare catastrophes.

In fact, as I have pointed out before, most people do not want insurance of any sort. They get homeowners' insurance to satisfy the mortgage lender. They get car insurance to satisfy the state. They get health insurance only when they think their employers are "giving" it to them. The insurance industry is heavily regulated, and it has gotten quite cozy with that arrangement.

My wife recently sought information on long-term care insurance. What I concluded is that we would be trading one risk for another. Now, we face the risk that long-term care would eat up our savings. If we had insurance, we would face the risk that the insurance company would not pay a claim, because of how it reads the fine print in the contract. I'd rather take the risk I understand …….than the risk I do not understand…….

I think that meaningful innovation in health care is more likely to come from Wal-Mart than from Aetna. …Wal-Mart is likely to be thwarted by the credentials lobbies. If practice regulations and licensing were not a factor, Wal-Mart could rely less on formal schooling and more on internal training for its medical workers. Then you would see real improvements in quality and reductions in cost.”

Counter perspective from a CEO of a new Indian Health Insurance company

“1. What are the major hurdles in the Industry in India in terms of customer perceptions and attitudes? Consumers are increasingly concerned about their health and rising healthcare costs…. this is an opportunity…. Awareness and knowledge levels of health insurance or products remain low…..Customers may not understand the benefits and the value proposition of the policy they are purchasing….not sold or serviced responsibly…..companies need to be more simple and transparent in their processes.

2. How can companies overcome these hurdles? Health insurance requires detailed explanation compared to other financial products….. Hence, need a personalized approach to help consumers make an informed decision…..by presenting information and product options in a simplistic manner…..products in turn need to be more comprehensive, transparent with minimal fine-print……Companies need to address issues related to servicing and low product innovation to successfully tackle these hurdles.

3. What kind of innovative approaches should Insurance companies adopt for a competitive edge? Approach built around service experience.…Companies have to take cognizance of the habits and needs of the consumer and build in better service delivery for both selling & servicing.

4. What role can employees in the health insurance industry play in educating the customers about health insurance? Customer service excellence holds the key….delivered by trained and motivated people, backed by technology…….

5. What are the challenges that you foresee in the Indian Health Insurance sector? …..many challenges... lack of data availability on disease and usage patterns of different socio-economic segments….most important challenge for India is the current low levels of awareness about the category among Indian consumers.”

Our take – Nobody talks about involving the various stake-holders in the process – our experience suggests that whenever you go to a hospital for treatment, response to a harmless question “Do you have insurance?” reveals two sets of charges for the same treatment! Also, should there be a stricter screening of the insured at the outset for a better assessment of the risk, which should lead to better pricing of risk? Also, given the criticality of the exercise to all concerned, is there a case for more appropriately qualified agents, instead of the prevailing “all are welcome” policy? This last measure can be furthered by structuring incentives on the basis of evidence of better disclosures measured by the claims track evidenced over long periods of time.

The key to innovation is in creating win-win solutions for all stakeholders. BTW, have you come across an agent who specializes in health insurance or a doctor who is dedicated to health insurance services? Let us know.

A quote from a wise man

“It is of the nature of organized investment markets under the influence of purchasers largely ignorant of what they are buying and speculators who are more concerned with forecasting the next shift of the market sentiments than with a reasonable estimate of the future yields of capital asset, that, when disillusion falls upon an overoptimistic and overbought market, it should fall with sudden and even catastrophic force.”

John Maynard Keynes - Chapter 22, The General Theory

This definitely makes you ponder whether the pricking of an asset bubble or a sentiment balloon should be viewed with fear of the unknown or a welcome & refreshing cheer!

Readers, would love to have your views on this.

Wealth creation - Innovation is the key

The health insurance industry is plagued by the problem of non-viability. The claims paid are in excess of the premiums collected annually. This has led to multiple problems.

Insurers are pretty non-committal about the premiums they charge. A minor deviation in the health parameters leads to levying of ‘significant extra’ premiums. Till date many prospective clients look at health insurance with suspicion. Will my claim be settled when the need arises? Will they pay me the full amount of the actual expense incurred on treatment? Etc.

The sheer details or terms & conditions (if you please) associated with the products are nothing short of a minefield of “subject to-s”. Your claim will be paid if the illness is discovered after a period of ‘x days’ from availing the cover and if you survive for at least ‘y days’ from the date of diagnosis. This is after you have undergone a proper underwriting procedure prescribed by the insurer. You won’t be blamed for thinking that this is a business to make you pay the premiums but find reasons to deny claims.

For medical service providers, the practices are ill-defined with very little standardization across the board. This applies to costs and procedures, both. Most private medicos and hospitals charge the patient differentially depending on whether she has a medical insurance cover. If the patient is covered, the charges are usually higher. It’s the law of the jungle at work. If the payment is going to be made by the insurer, then, it is almost as if the patient doesn’t care about the charges. The service provider takes advantage being well aware of the nuances of the insurers’ practices. This is a rip-off not only affecting the insurer, but, eventually all the buyer’s of insurance – present and future.

I’d like to quote from the IRDA Annual report of 2009 (pg 34) – “the incurred claims ratio (net incurred claims to net premium) of the general insurance industry increased marginally to 86.30% in ’08-’09 for 84.88% in ’07-’08. The increase was reflected in both public and private insurers……The health segment …..stood at 105.95% in ’08-’09 as against ….141.02% in ’06-’07. However for the public insurers, this ratio increased to 116.60% in ’08-’09 from 112.36% in ’07-’08…..for private insurers this ratio …76.84% in ’08-’09…”

Public & private insurers have significantly different roles, responsibilities and business practices. This shows in their performance. Availability, affordability and sustainability of health care, a key infrastructure, is critical for an emerging economy.

Health care is a huge business opportunity which can be driven by innovation. Innovation can deliver the objectives and provide win-win solutions for insurers, insurance buyers, health care providers and investors who provide the risk capital. We will discuss some instances of innovation which are at work and those that can make a bigger difference.

Wealth creation - Of gospel truths &half-truths

I recently received a chain mail which went on to extol the virtues of long-term investing. It said - If you had invested Rs. 10,000/- in Wipro in 1980, today your investment would have been worth Rs. 200 Cr.+. Other such examples highlighted were - Cipla - Investment of Rs. 10,000 in 1979 is today worth Rs. 95 cr.+; Infosys - Investment of Rs. 10,000 in 1992 is worth Rs. 1.5 cr.+ and so on.

These are facts, however saying only this much is a half-truth, we will see how, soon.

Another mail I received from a multiple financial services provider. This mail says how the Sensex number has always been near about the price of 10 grams of gold. It adds, whenever there was a substantial disconnect, it became a clear case of over (or under)-valuation of one measure w.r.t. the other. A classic example of non-sense dished out with an objective to confuse and ‘steal’ your money!

In 1980, very few people invested in stocks. More importantly, awareness about the workings of business & industry was restricted to a miniscule set of people. Business media, of any consequence did not exist. The few who invested in stocks were ‘risk takers’ armed with better sources of information about businesses & industry or people who did the hard work to find out information which were not easily available or people who were speculators.

Of the 3, the last category is not the object of our understanding. About the other 2, it would be safe to say that they are more evolved and enterprising investors. They find out about investment avenues which are not commonly followed. They are willing to take uncommon risks and also stick to it, once they have made up their mind and invested. They know that they have made a right choice and will not exit their investments based on a panic reaction or short term profits or any emotion. This is the power of conviction in the long-term story of a business.

Sensex and the price of gold: I’ll not get into the debate of whether gold is a dud investment (that will be for some other time). For the moment, let’s assume that gold is a good hedge against inflation and its price moves accordingly. Then it will be safe to say that the price of gold does not offer any ‘real’ return since there is no economic activity linked to the ownership of it (say unlike a productive asset like property or plant & machinery or farmland or a real business).

Now contrast this with the Sensex – if the BSE Sensex stocks was all that was there to the Indian economy (assumption), it would be safe to say that the growth in the GDP (% terms) should be approximately equal to the growth in the Sensex plus the rate of inflation (since the GDP growth figure is calculated net off inflation).

Can the 2 or their growth numbers ever be identical? Oops…sorry! I am introducing arguments which will lead to demolishing a myth….A herd is meant to ‘follow’, not think!

Wealth creation - Life cycle planning

Creating a financial plan is like looking into the future with a telescope that provides at best a blurred image, financially speaking. However, there are certain aspects of this vision which is fairly clear. Let us understand, why?

There are 4 stages of an individual’s career –

1. Green-horn
2. Office junior
3. Middle-level functionary/Managerial category
4. Leadership level / Senior babu

Each stage has its own characteristics - the roles, responsibilities, rewards and growth opportunities. In the green-horn years - one learns the ropes, works his back-off and tries to get recognized as someone who can figure in the organization chart. Roles are barely defined and responsibilities can be described as anything from running errands to doing the work of two people. From an earnings and savings perspective, you are lucky if you don’t get time to socialize - you get to save some money!

The office junior is the gal who has been confirmed in service. She gets a reasonable salary. She can look forward to some planned savings. This may not be much, as the family may be interested in getting her hitched and started off in a family way.

It is only at the middle-level - which if you reach at a relatively early age of mid-thirties, you get a reasonable opportunity to make some serious savings. This is when you can add some bone & muscle to your financial plan.

You are lucky to graduate to a level of senior leadership by the time you are in your forties. Then, you are really able to take off in terms of wealth creation. Only, if you have built a strong foundation, you are in a position to take some risks to push your returns from your investments and get to create some ‘serious’ wealth.

From this one can conclude that –

1. At all stages, your returns on investments are likely to be less than the returns you generate from your intellectual capital as a professional (job or business).
2. At every stage your priorities are likely to be in focusing on your profession, hence, the basic business of wealth management is better left to the pros.

A level-headed gal will realize that not until very late in life, the financial balance sheet will always be smaller in comparison to the intellectual balance sheet or the simple value of the professional, quantified in financial terms (remember, Infosys quantifies the value of its human resource).

You decide, whether you want to fight the battles or win the war!

Wealth creation: Zero-sum games - a killer virus

Continuing from risk vs. returns, we move forward to compare and contrast activities which create or destroy wealth.

An activity or a part of a business that does not create any value cannot exist. If one does, I am sure you would be surprised. It would not exist only if the users or clients realized that it does not create value.

Let us take the example of stock trading. There are professional day traders. Their objective is to make money by spotting trading opportunities, e.g. arbitrage or intra-day price movements. Day traders are an essential part of the market eco-system. They provide the much needed volumes or liquidity that really adds depth to the market and attracts investors.

But, if day trading is not your profession, should you be placing bets or ‘punt’? Let us understand this better before deciding. On a daily basis, the total gains made by people who won (through day trading), will be equal to the total losses made by people who lost.

Investopedia.com says – “What does Zero-Sum Game mean? A situation in which, one participant's gains result (only) from, another participant's equivalent losses. Options and future contracts are examples of zero-sum games (excluding costs). Gambling is also an example of a zero-sum game. The stock market, however, is not a zero-sum game, because wealth can be created in a stock market.”

The last qualifier is very important. This is because over a period of time, a business, which is the underlying activity behind any stock, delivers in terms of sales, profits and creating return-generating assets. These are wealth creating steps. The stock market thereby becomes instrumental in improving the efficiency of price-discovery; and contributes in recognizing and aiding wealth creation.

For creating long-term wealth, actions should aim for minimizing risks for the same level of returns or enhance the returns without increasing the risk. Or, improve the returns per unit of risk. Day trading like zero-sum games is to be avoided at all costs.

2 questions to ponder over –

* Will an investment with a 50% chance of making money qualify for long-term wealth creation?

* Should SEBI mandate stock brokers display a warning “Day trading is injurious….and can also kill you financially”?

Buffet-speak “Only buy something that you’d be happy to hold even if the market shuts down for 10 years”!

Wealth creation - risk vs. return

Investors in capital markets understand the connection between risk and return – higher the risk, higher the return. This is simplistic. To make this complete we need to add the elements of time spent in the investment and the ‘prospect’ or ‘expectation’ in the return.

The point is that all market linked investments are priced dynamically. Hence, there are minute to minute deviations in their price and return expectations. However, the longer the holding period, the dynamic price will eventually regress or settle towards the mean or the intrinsic value of the asset.

Also, let us not forget, for an investment in which the risk-assessed initially, has eventually gone bad, the price will settle towards its intrinsic value which at times may tend to zero.

Coming back to the self-evident truth about higher the risk higher the return, the situations when this may not come true are – when the timing of entry/exit is caught on the wrong-foot due to price volatility and when the investment may turn out to be a dud. Simple!

With this background understanding let us, going forward, try and understand how this impacts short-term trading versus long term investment. We will also add the perspective of off-market investment, private equity and venture capital.

Is your Banker, your best guide for Wealth creation?

This headline is not to mislead you. As the byline to the masthead reveals, the underlying objective of this post is to serve as “The Layman’s guide to Financial Freedom”.

I clarify that, this post is only to provoke the layman to question what lies behind a banker’s actions, goals & objectives, strategies (and advisory?) etc.

In a tête-à-tête with a friend, he said - My young banker friend told me that he had just purchased his 3^rd property (all residential). What is it that is driving smart & intelligent (because he is a banker) professionals to have such high exposure to realty assets?

My friend was also lamenting about the high EMI he is paying for an under-construction property, having booked it during the 2007 peak property season.

Indian banking has evolved significantly over the last 15 years. This is the time (1994) a couple of leading private Indian banks were born. They carved a niche initially and then captured a significant mind and market share through -

1. Advent of anywhere banking and proliferation of ATMs
2. Wider ‘inclusion’ through lower (than foreign banks) min. average quarterly balances
3. Emergence of universal banking - new businesses such as retail loans (personal, cars and homes), credit cards, distribution of 3^rd party products (MFs & insurance) which generated fee income.
4. Growth of trade-finance and project-finance to manufacturers where sales financing tie-ups led to sharp growth in retail loan portfolios (q-o-q).
5. Increase in FII’s investments in listed Indian private banks; Private placements of equity at hefty premiums and ESOP programs for bankers; this led to Business Heads flogging growth in retail loan portfolios and distribution led revenues, which led to further increase in stock valuations.

The greedy consumer of banking services choked himself with personal loans, car loans, home loans MFs and ULIPs. As valuations kept soaring (2003-07), it was a win-win situation for bankers, manufacturer-borrowers, buyer-borrowers, wealth managers and their clients. The financial meltdown of 2008 put the brakes for a while.

2009 brought back the feel good factor, once again based on valuations (rather than earnings) of stocks, property, commodities. All of this was backed by easy liquidity through aggressive currency printing by Central banks across the globe. This was (euphemistically) labeled as govt. induced stimulus for driving growth.

The 2008 financial crisis was a wild fire that was doused by injection of liquidity. This was the mistake that created the mess in the first place. Now, there are signs of the currency printing machines getting weary (metaphorically). This cycle of growing valuations are not driven by real GDP growth but by growth in global money supply.

Is the cookie going to crumble? A trillion dollar question for valuation experts to figure! Will the all important ‘growth’ in the valuation equation last till eternity? Or is it a myth, whose time has come?

My reply to my friend was – In the long term, the rate of return from residential property will definitely be less than that of investment in equity*. Your banker friend will eventually realize this but after paying a heavy price. The longer any bubble survives, the bigger it gets. Eventually when it bursts, all bubbles leave behind a trail of damage and bigger the bubble, bigger the damage.

Sometimes a Banker may also become a victim of the chimera that he creates and sustains! For you, dear reader, the time to introspect is NOW – Will you blindly follow your banker’s judgment when it comes to taking decisions relating to your personal finances?

ESOP – employee stock option; MF – mutual fund; ULIP – unit linked insurance plan; GDP – gross domestic product; * Anybody seeking historical evidence of the same can email me.

Wealth creation - much sought after but rarely practiced!

Everybody wants to be wealthy? Right! – What a dumb question to ask? Not really, as you shall see -

What do you expect a wealthy man to have? A strong financial balance sheet; a reasonably good health; and, a rational mind which continuously updates itself for financial (if not all) decision making (among other things).

Now look around you (no need to pry, it is easily apparent) to realize how we practice wealth or value destruction through some choices we make –

1. How many of us have a Balance Sheet? Don’t kid yourself by saying that since you are a salaried person, it is not mandatory for you to prepare a balance sheet. Without a balance sheet, how accurately would you know, what exactly are your assets, liabilities and net worth? What is the rate of growth of your net worth over the last year etc. etc.? Without a clue about this, how will you know how far you are from a financially safe retirement corpus?

2. How many of us go for an annual health check-up? How many of us keep a track of our vital health parameters and file records, so that in case there is an emergency hospitalization, the doctor on duty can quickly access the relevant medical records to know the history and proceed on an appropriate plan of action without losing time? In such an event, the potential damage health-wise and in financial terms can have long term consequence. But, then who cares? This is a typical ploy of an insurance agent to sell more insurance (or so you think)! Ok, this need not be the truth, but then neither is it far from it!

3. Most employers mandate that you have to submit details of your tax saving investments or any other financial detail, latest by some date in December, January or February. This is to help the department responsible for deduction of taxes and payment of salaries, so that it has adequate time on hand to take care of both without mistakes and delays. However, how many us, start planning and executing this activity from April 1^st, the first day of the new financial year? Apart from being way ahead of any deadline, this will also give us more time in deciding which is the best way to go about it, rather than do these in a hurry, when we have no time to evaluate the decisions we take nor evaluate the recommendations we receive.

4. You have some on-going insurance policies for which you pay a significant premium. A new-kid-off-the-block who is a self-styled financial planner says that they are not worth continuing, that you should surrender these policies, collect the surrender value and insure yourself with term insurance policies and invest in mutual funds and other long term investments. Now this guy is a relative on your wife’s side of the family and you are politely avoiding him, citing a busy schedule. Are you inclined towards finding out, whether there is a grain of truth in what he says? Do you have the where withal to evaluate the pros and cons? What will you do?

5. Sorry, to leave you with a teaser rather than a set of New Year Resolutions which would have made for a feel-good read but then you would have done nothing about it and hence it would not have left any impact on your thinking. You read in the papers sometime back that electricity consumers have been allowed to switch their service providers in the suburbs of Mumbai and that Reliance Infrastructure which is your provider has been found to have charges higher than their competitor Tata Power, because they buy power from Tata’s and supply to their customers, the higher bill you pay is simply the mark up which Reliance levies on its customers. Now, what you have to do is simple – i.e. if you are a Reliance customer, find out the potential savings per month and calculate the total value of your savings till retirement, assuming that you will be saving this amount and earning a return of 10% p.a. on the same.

Rounding off with another gem from the Oracle of Oklahoma, Warren Buffet “I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”

What is the fun in having NYRs which are 7-foot bars, if we fail to notice & clear the 1-foot bars?

Mera Bharat Kahan-- Bala's Blog: Aegon Religare- Well Done-

Mera Bharat Kahan-- Bala's Blog: Aegon Religare- Well Done-