Promises and Their Value

Most financial tools are merely promises.

Many are treated as a certainty.  My bank promises to give my money back some day, possibly with a little interest added.  A pension plan is a promise to pay money at some time in the future.  An insurance policy is a promise to pay some amount in the event of a predefined event. My brokerage account includes a promise to let me trade and own the securities.  My cash includes an implicit promise that it will be worth something in trade.

Other promises are not so reliable.  Political promises come to mind.  But then I give up little to get the promised benefit, so perhaps I should not be surprised when the value returned is of little value.  Cheap is expensive if you will recall.

Promises cover a wide spectrum of reliability.  We have become trusting but perhaps should not.  In 1970 I had a client who had agreed to ship $2,000,000 worth of goods to Bolivia against a letter of credit.  I suggested that he should have his bank check out the issuing institution prior to shipping.  He did that and discovered the bank in Bolivia was owned by the customer and had total assets of $40,000.  Canadians trust banks because ours are large and thoroughly regulated.  Not so much elsewhere.

Some people do not like to buy life insurance because the insurance companies are large and profitable.  They must be taking advantage of their customers.  The reasonable question is, “Would you prefer to trust your business or family’s future security to an insurer that is losing money?”  It is important to assess their predictable future reliability.  Large, historically well managed companies are a better risk from the customer’s standpoint.

I saw a customer once who wanted to buy insurance from a tiny but low priced carrier.  He decided otherwise when he realized that he was worth more than the insurance company.

Insurance must be kept in perspective.  You trade money for a future value.  Be sure the carrier can deliver on their promise.  You do not need to mistrust them as you would with politicians but you do need to use common sense.

Tim O’Brien’s blog, Private Risk Advisor recently included this Warren Buffett quote from the 1984 letter to shareholders.

“The buyer of insurance receives only a promise in exchange for his cash.  The value of that promise should be appraised against the possibility of adversity, not prosperity.  At a minimum, the promise should appear able to withstand a prolonged combination of depressed financial markets and exceptionally unfavorable underwriting results.”

The same idea applies on the client side of insurance.  “The value of that promise should be appraised against the possibility of adversity, not prosperity.”  How valuable would the insurance be in times of adversity?  Try to see it as if something could go wrong.

Cheap insurance is not necessarily good insurance.  Be sure you understand that price is not necessarily a good indicator of value.

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Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

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