Sunday, February 8, 2009

SIAS COMMENT may be detriment to INVESTOR

Dear Mr. Tan Kin Lian

I have the worry that SIAS statement dated 7 February 2009 and MAS affirmation could actually weaken the investor position, un-wittily. As a result, the FI could corner the investor even if they are in the complete wrong.

Let me give you a HYPOTHETICAL illustration below.

1. FI offers 30% compensation

2. If the investor accepts, the investor will only get 30%. Investor will lose the possibility of full claim (the rest of 70%), reimbursement of costs and compensation for distress. The FI saves 70% of compensation and other related compensation. Most importantly, FI escapes being punished under the Financial Advisor Act.

3. If the investor rejects, the investors will have to fight on his own. That means investor forfeits the original 30% compensation. Investor will have to take out money and time to fight the case, and not to mention the stress and anguish of injustice investor has to go through. While the FI fight the case as an institution with full resource and support eg. full-time staff, corporate lawyer, financial advantage etc. Whilst, the investor has to fight as an individual with bare knuckle and with little knowledge and financial resource. This is another situation of “institution vs individual” and “strong vs weak”.

With the above illustration, FI stands on the upper hand.

If my analysis is correct, and if I were the advisor for the FI, I would be well rewarded by advising the FI to compensate all the investors with investment below $100,000 a compensation of 30%. I think more than 90% of the investors will accept it, as the investors are being cornered. The FI will amass their might to fight the remaining disgruntled 10% investors.

This is an effective strategy. Using the military metaphor, you have effectively segregated and castrated your opponents, thereafter using “an army of Goliaths to fight an infant David”.

If the FI chooses to take advantage of SIAS’s statement, I hope not. The investor will lose out greatly both in terms of unfairness and injustice.

It is unfair because the investor will likely be cornered to accept 30% compensation even if the FI is in the complete wrong. This is especially so when the investor invested less then $100,000 and below. The original words of comfort from MAS that “complaint handling should not be based on legality but guided by principle of fairness” will come to nothing. The investor is misled and suffered loss, he could only recover 30% compensation. Investor is unlikely to spend more than 100,000 legal costs (Note: Structured notes is complicated and legal will not be cheap.) to fight the remaining 70% or $70,000 claim.

It is unjust because investor who is being misled, if investor accepts 30% compensation would have to pay for “70% of the FI who misled”, suffer “anxiety and anguish” and see the FI “escapes punish by law under the Finance Advisor Act”. It is unjust because if investor rejects the 30% compensation, he stands alone fighting a disproportionate battle against the FI. Hopefully, the money invested is not the investor’s coffin money or cash reserved for children tertiary education.

I think FI will take maximum legal leverage. This is because admission to mis-selling is self-incriminating that FI contravenes provision of the Financial Advisor Act.

I really hope that my deepest fear of injustice will not occur to ordinary people.

FROM: CASHEW NUT

REPLY
The position stated by SIAS is correct. If the investor goes to FIDREC or take legal action, the offer by the financial institution is automatically withdrawn. 

I believe that a fair offer is 50% of the amount of the loss, i.e. that the loss should be shared equally between the distributor and the investor. I hope that the financial institution will agree to offer 50%, so that most of the investors will accept it as a fair offer.

Buying a life insurance policy

Dear Mr. Tan,
I read from your blog that the minibonds and other structured products, earning 5% yield, can be very risky.  I do not wish to take this kind of risk. Is it all right for me to buy a life insurnce product? Although the return is low, it is at least capital protected and relatively safe.

REPLY
If you save $5,000 a year in a life insurance policy for 20 years, the total savings is $100,000. 
The benefit illustration shows the return that you can get assuming the gross return over the next 20 years to be 3.75% or 5.25%. The average is 4.5%. In my view, this is a reasonable projection for the next 20 years, assuming a balance mix of investments at moderate risk.
If you get an average return of 4.5%. you should get $164,000 at the end of 20 years. However, the actual return is lower, due to the charges taken away by the insurance company to cover marketing and other expenses and profit. In most cases, the charges is about 50% of the gain, i.e. $32,000. This leaves a maturity return of $132,000 or a net yield of 2.6%.
I consider a net yield of 2.6% to be unsatisfactory, as it may not be sufficient to cover the rate of inflation.
A good value policy will take away about 25% of the gain, leaving a return of $146,000 or a net yield of 3.5%. As a rule of thumb, the reduction in yield should not exceed 1%.
If you wish to invest in a life insurance policy, you should ask the following questions.
1. What is the projected return on my policy, based on the assumed yield on the investments?
2. What is the amount deducted in various charges to cover the death benefit and expenses?
3. How much, as a percentage of the assumed gain, is taken away by these charges?
4. What is the effecitve reduction in yield?
If the charges is more than 25% of the projected gain, the life insurance policy is high cost and does not give good value to the customer. It is better to buy term insurance for the life insurance cover and invest the savings in an indexed fund (such as the STI ETF). Alternatively, the reduction in yield should not exceed 1%,