Tan Kin Lian's Blog: It is easy to be cheated (7) - Cashing out your financial product

Saturday, June 06, 2009

It is easy to be cheated (7) - Cashing out your financial product

Many investors bought the credit-linked notes without understanding the nature of the risks. When they found out later, and some of the underlying assets had turned bad, they wanted to cash out and take a loss.

The only buyer of the product are the product issuers who quoted a very low price for the product. The investor is not able to assess what is the correct price of the product, as they do not have information about the underlying assets and the extent to which they are likely to default.

The product issuer has the information, but they are acting with a conflict of interest and a monopolistic position. They can quote a price that is much lower than the underlying value and make a big profit.

What can the investor do? It is best to take the risk and ride it out. If the situation become worse, it is bad luck. But, it could turn out to be better. If the investor accept the low price now, it is likely to be much lower than the value of the underlying assets, and the investor is likely to take a much definiate loss now.

Is this fair to the investor, to be placed in a weak position against the financial institution that has the information and is taking advantage of the lack of information and desperation of the investor?

A similar situation applies in the case of the policyholder of a life insurance policy who wish to cash out. The cash value quoted by the insurance company is likely to be much lower than the actual underlying value. This allows the insurance company to make a profit on the terminated policy. The policyholder already suffered the large deductions to pay the commission to the agent, the cost of the life insurance cover and the high expenses. Why should the policyholder have to take another big penalty to give more profit to the insurance company?

The lesson: do not trust any financial institution that creates proprietary products where there is no free market for selling off the product at its fair value. You will be placed under the mercy of the financial institution, which will seek to maximise its profits at your expense.

20 comments:

Anonymous said...: Just buy shares and put money in FDs. Then those FIs have no chance to cheat!

And have a reasonable paying job. This should be the way for most ordinary folks.

Is there any other better way?; June 06, 2009 2:08 PM
Anonymous said...: Mr. Tan,

There is a secondary market for whole life/endowment which the policyholder can get better price than surrendering it. It is called Life Settlement and traded endowment policies respectively. Unfortunately, the market is small in Singapore. The secondary market for traded endowment seem to be limited to just UK policies with a very high risk of currency risk.; June 06, 2009 2:32 PM
Anonymous said...: The last few postings seem to condemn the insurance companies to levels which are too extreme. Let me play devil's advocate.. partially.

Specificially, I speak in defence of "Single Premium Policy insurance" (SPP) sold by insurance companies. NOT other decieving products which are admittedly truly devilish and undefensible....

What's wrong with a SPP. Nothing! U put in money for 5 years, at the end of 5 years you get an equivalent interest around 3.2%. For 10 years you get about 4.5% equivalent. This is not cheating! A bank takes your money, lends out 10 times the amount (as allowed by MAS) makes tons of profits, but pays 0.25% interest. WHY NO ONE COMPLAINS THAT BANK CHEATS YOUR MONEY and use it to earn super profits? Why insurance companies are targetted, i don't know. Put a fixed deposit at a bank and you get interest about 0.5% with no insurance cover. Put a SPP and you get 3.2% plus small insurance cover. Who's cheating? The bottom line is what you get... not what other people make from your premiums.

There are those who complain that the insurance coverage is too small for a SPP. Fine, then just buy term-insurance additionally. The pay-out ratio is typically 1000 times the money put in but of course the premium is gone and not withdrawabale. Here again, the bottom line is .. what you get, not what others get.

It seems perfectly ok for the careful simple minded investers to buy SPP and imagine it is an Fd. And, buy term insurance to get "really" insured.
For those who could afford to lose money they could play with shares which offer higher return.. in the long term.. undoubtedly.
REX; June 06, 2009 3:33 PM
Anonymous said...: It seems poor people are doomed to poverty. To get out of the rut they have to really work very hard, harder than inflation for those so called advisers or insurance agents either lose the money for them or invest in low return investment products that preserve purchasing power only.The poor people are condemned. They cannot die prematurely if they have a big family because they don't have enough insurance to take care of their dependents. The insurance agents only sell them wholelife and endwoment whcih the poor can't afford enough to cover themselves or their family. They can't afford to die or to get sick.
The only people who are happy are the agents and the company.; June 06, 2009 3:37 PM
Anonymous said...: Hi Rex,
I like SPP too.
But now it is impossible to get around 3.2%pa for 5 years and around 4.5%pa for 10 years.
Thanks.

starlight; June 06, 2009 9:35 PM
zhummmeng said...: REX,
I know where you are coming from.
But you are living in the past. You must thank Mr. Tan that you could get 3.2% for 5 years and 4.5% for 10 years with low risk. These rates are history.......and to get these rates you may have to take higher risk and risk means not sure to get, right?
However , somebody in this company is advertising the well kept secret of Mr.TanKL and grafting Mr.TanKL's backside skin on to his face and misrepresented shamelessly that these rates can be achieved in the future.

Well, if you use cash and NOT interested in real growth and because you have 'eat cannot finish' wealth it is
understandable that preservation is your goal. But for many out there they CAN'T AFFORD to lose and they NEED to grow their real wealth these products are definitely not suitable. Worse insurance agents are unscrupulously
cheating them and pushing them to put their CPF money into these products WHICH NOW OR IN THE FUTURE WILL NOT GIVE THAT KIND OF RETURNS YOU EARNED.
CPFOA gives risk free 3.5% every year, no lock in,ie no need to put for 5 years or 10 years, for first $20K and SA account gives 4+1+1%=5% for first $30K and 4% for the rest or at least 3.5% from next year and maybe higher.
We are talking about these heartless conscienceless cheats insurance agents and their company for cheating the man in the street of their hard earned retirement money. I hope you see the issue here.; June 06, 2009 10:05 PM
Very frustrated said...: Perhaps a better heading for your series of posts should read "it's easy to be a fool..."

'Cheat' = to deceive; influence by fraud

Nobody's out to deceive anyone.

The terms were there, that's why you know how it works. If you only think about it.

If you choose not to think about it, and then claim someone else cheated you, how can that be?; June 06, 2009 10:19 PM
AB said...: I think this blog is doing good by highlighting risks and how easy it is to be cheated. Hence I dont see why people like REX (3:33pm) need to come in defence of insurance companies for one product when they suck your blood with many other products.

In this country all the people of authority and big institutions are already elevated to almost godly status by main stream media while anyone who dares speak out will be snubbed out. There is already enough injustice so there is really no need to come in defence of them.

You also ask why no one complains about the banks who takes your money and lends out ten times that amount to make big profits.

Well firstly not many in this country would know about this fractional reserve banking system. Did the main stream media publicise it? Even if you tell people about it not many would dare to believe you, prefering to believe only what they read in main stream media. And of those few who know it or believe what you say, what can they do against big power, fear sets in and they would rather ignore it.

Such is the mentality of many people in this country, the same mentality that prevents them from being able to vote wisely.; June 06, 2009 10:38 PM
Anonymous said...: Thanks for an excellent set of articles for what is wrong with the financial industry.

The root cause of the financial crisis was because FI's exploted the fact that most investors did not pay close attention to what FI's did with their money after they collected it.

The posting by Anonymous (3.33 pm) on the SPP is a case in point.

In that posting, the SPP of an insurance company is equated to a FD in a local bank. The marginally higher return and the small term cover on the SPP is then highlighted for why it is a better investment than the FD.

The problem with this arguement is that the risk of the two instruments is vastly different.

For an FD with a local bank, you are protected with a Singapore Government guarantue on the deposit. Then there is the protection afforded by the regulatory regimes which specifies what kind of assets deposit accepting banks can hold.

For a SPP, you have none of this protection. The insurance company could take your money and underwrite all sorts of things, many of which are beyond the understannding of most lay investors. A good example is AIG, once the world's largest insurer. They found that it was very lucrative to use money collected in this and other ways to underwrite the default risk of sub prime mortgages.

The "cheating" comes in the form of slick marketing to mislead investors into thinking that the SPP is infact the same as a FD with a small term cover. The bait is the higher return and "free term" cover; the hook is the fact you have just deposited money with a company where there are essentially no rules as to what they can do with your money.; June 06, 2009 10:46 PM
Concerned said...: With so much cheating going on and the relevant authorities just looking on, we are going to have a big problem when the casinoes start operating. Many more people will get cheated, more frequently and on bigger amount. Sad state of affairs.; June 06, 2009 11:36 PM
Anonymous said...: Doesn't matter what happen. Minibond issue, cheating issue, recession issue, more NCMPs issue, income gap issue etc etc.

The most important thing is Singapore is still very stable and peaceful, no matter what.

Not only that, COEs continue to rise, restaurants are still crowded, traffic jams are still there, crowds at Great Singapore sale, queues for 600K HDB flats etc, etc.

What more do you want?; June 07, 2009 12:28 PM
Anonymous said...: One point raised by someone here about putting money in SPP with insurance comapnies as no different from placing fixed deposits with banks.

Not so similar in my opinion.

For fixed deposits you put your money knowing exactly that you are going to get a fixed rate of interest at the end of a period. What was the motivation that makes you put your money in FD? None. You know the returns, no hidden factors persuading you to do so, and you put your money in.

When your insurance agent sells you an SPP, he gives a projected return (made up of guaranteed and non guaranteed rates of return), that are, almost always overly optimistic, and that optimistic projection, more often than not, is the only motivating factor that makes you put your money into such policies in the first place. If they had projected a more realistic rate of return, not many people will buy such SPP.

I would say that almost all SPP returns (my definitely did) fell far short of expectations. If I had known the returns would be that dissappointing, I would not have bought such SPP in the first place.

Lost Citizen; June 07, 2009 3:02 PM
AB said...: Anonymous (12:28pm) speaks as if what is happening is a non issue.

Do you want your future generation to be cheated of their entire life savings with no where to turn to? Do you want them to pay $5mil for a hdb flat while earning $5K/mth to service it? Do you want them to work till 90 yrs old collecting cardboards while money in their retirement a/c is untouchable? And all this happening while a few rich elites would care less and gloat over you with "you go in with eyes wide open".

Capitalism and meritocracy has to go hand in hand with democracy. Without democracy what is left behind will be exploitation and abuse.; June 07, 2009 6:00 PM
Anonymous said...: There are agents from one local company peddling annuity using CPF .
They tell you that their annuity will pay for life and CPF will run out. Beware of them. Don't trust them because it is not true when you examine your circumstances and what CPF pays. These agents are conscienceless and unscrupulous . Get a qualified retirement planner to help you.; June 07, 2009 8:25 PM
Anonymous said...: Here is REX again in answer to some of the earlier postings.

I think Single Premium Policies are capital guaranteed products just like FD. It is, for all intents and purposes , as safe as any FD's as far as the capital is concerned. And, just like FD's if the issuing institution goes bust, you also lose the capital. That is life. It has been like that all the time. There are just two difference between SPP and FD. One, the SPP gives you a small amount of insurance cover (not much. It is not meant to be an insurance product per se) not the FD. Two, the SPP does not guarantee interest rate but
instead you are told that a low limit and a high limit.. (over the last 20 years i have bought at least a handful of SPPs and without fail i am paid the high limit usually 3% pa for 5 years and could reach 4% if 10 year term). How can anyone complain it is cheating? Let me give an analogy. We use Windows XP, $135. Everybody knows Bill
Gates co. is earning too much. I can complain like mad that he makes too much profit, but to complain that he is cheating, this is not the right word to use. Cheat means deceive, it's got nothing to do with super-profits. So similarly, since SPPs are just about the only way we can make 3% with very low risk, i feel that it is an acceptable product and should never ever be mixed up with those stupid fanciful manifestations of wall street bankers products. I once scolded a finance adviser from a bank when he tried to sell me a crazy product which, in reality, after some analysis, used part of my capital to finance the "interest payments" to me after some years of steady payments. And they claimed that the interest is very high.. what a joke, they used my capital to finance the "interest payments" back to myself!! THAT was pure cheating, and i don't know why MAS is so blind as to not stop such rubbish!!

Secondly i should mention that in fact, credit creation (banks lending 10 times the cash they receive) is the cornerstone of bank operations since a very very long time ago, there is nothing deceitful about that. Every pre-u student taking economics would know. What is wrong is really the manipulations of wall street bankers which created CDOs and the subprime loans that crashed an otherwise healthy system.

Finally, i am not trying to defend anybody. I just felt it right to moderate the forum postings in a way which is more balanced. Insurance companies are not 100% crooks.

My advise is, to buy term insurance (covers 1000 times what you pay) and buy some SPPs. If one is able to take some risk, go for shares and stocks which offer a higher return. And yes, avoid all those "proprietary products" and fanciful name products which Tan Kin Lian mentioned, yes those are cheats...

REX; June 07, 2009 10:32 PM
Anonymous said...: Not all SPP are capital guaranteed. There was one insurer that offered capital guaranteed and a return of 3.18% p.a. after 5 years, but how it will turn out nobody knows.

In fact, most SPP are just capital protected, which does not even ensure that you will get back your capital.

Lost Citizen; June 08, 2009 2:57 PM
Anonymous said...: Don't invest in these SPP endowment products mentioned by REX with your CPF money. Whether it is with your OA or SA the risk is stacked against you. Why take chances with these useless products when you sure win with CPF return?; June 08, 2009 7:29 PM
Anonymous said...: Hello here is REX again,
If a Single Premium Policy is not listed as capital guaranteed than don't buy it i can agree to that. However to my knowledge, every SPP i bought is capital guaranteed, it carries the same risk on the capital as a Fixed Deposit. It is true that you can't be sure if you get the upper limit interest on maturity. But over the past many years, i have SPP that matured (one just matured last month), everytime i get the upper limit interest. Even if you get the lower limit interest it is still higher than normal bank FD, or hiding money under the bed, so there.

As for the comment that the money would earn more, if placed in CPF, it is correct, numerically for sure. But to be able to use the money you have to wait till age 55 years!! If the intention is to buy a house using such investment in 5 years time, then ok.., since cpf allows such withdrawal. On the other hand if the intention is to roll on the spare money or to use it in 5 years time on items other than what CPF savings are allowed to be used for, then it wouldnt be feasible to keep spare cash to top up OA and SA's.

SPP is still highly recommended extremely safe haven for parking spare cash for those who dislike playing with shares and the volatile exchange markets.. which certainly don;t have capital guarantee nor protection at end of a fixed number of years.

REX; June 09, 2009 9:43 AM
zhummmeng said...: REX, you are wrong... SPP is NOT capital guaranteed for first 3 years. How can you say it is the same as FD? FD is liquid and not SPP.FD is risk 'free' from the start and guaranteed and SPP is not.SPP's return is not guaranteed either, only a fraction is.SPP has lock in risk and reinvestment risk.
As said before this type of products are meant for the rich who have no NEED for growth but preservation of value only. In fact most insurance products are meant for the rich, like whole life and endowment, single or regular premium. SPP is an endowment.
Poor people who buy SPP are condemned to poverty if they are poor at the point purchase. Yes they will not lose but neither can they grow out of the rut. Only hope is to work vely hard so that the rate of increase of their income beats inflation otherwise...
I have a friend who has a net worth of $20 million. He locks the money in 15 year bonds to earn average 3% to preserve his wealth. He is happy because he doesn't more money.He can afford to lose some in FD for the sake of liquidity. It is chicken feed to him.; June 09, 2009 5:18 PM
Anonymous said...: hello Zhummmeng
I checked again and reconfirmed that SPP (Single PRemium Policies) ARE captital guarnateed. Always there is a column "Guaranteed" and "non-guaranteed" return, in the payouts table.

Also i disagree with you that "FD is liquid" and sPP not. Fd is the same. If i close the Fd during the period of the tenure, i earn zero interest. Let us be clear that we have to follow the contract on our part too when we want to benefit from any product. The main difference is that FD usually sold as 1 year product whilst SPP sold as 5 year product or more. During the period of tenure there is NO LIQUIDITY whether SPP or FD, and the buyer incurs penalty if he breaks the contract. That is reasonable if one assumes that whther FD or SPP the capital put in is just contingency spare cash for rainy day.

And yes, i already said before, that SPP's interest is not guaranteed, but from my experience, they always pay the upper limit of the interest to me, even this year.

Even if they pay the lower limit of the interest, you don't lose, compared to FD's interest.

I disagree that SPP is for the rich. Many people have, say, about $2,000 spare cash or more for contingencies. This can go to SPP for 5 years or more. You need not put $20million! SPP offers a viable alternative for those who are KIASU, not for those who are rich.

Yes, SPP can not make you grow rich and "get you out of the poverty rut" as you put it. Be real, How can returns of 3%, or even 5% (aka Lehman bond!!) make you rich anyway?

To grow rich, as you said, you need a good job, run a successful business, or you flip properties, or you inherit wealth, strike a lottery, buy and sell shares at the right time.

SPP is like a parking lot for spare cash for a rainy day. Unless you are very very poor, most people will have some spare cash of a couple thousand dollars for contingency purposes! SPP is for kiasu people, who don't like shares trading (some dont even know how to use internet for trading or have no idea or no interest to interact with stockbrokers). There is nothing to lose with SPP. One does not need to be rich... just kiasu that is all.
REX; June 10, 2009 9:08 AM

Saturday, June 06, 2009

It is easy to be cheated (7) - Cashing out your financial product

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