Every work-place has at least one: the worker who laughs just a little too hard at the boss’ jokes, the employee who is shocked-just shocked- you would say something remotely negative about the company or the big ole’ suck-up. For the silent work-place majority, they are, to say the least, annoying but even more galling they seemed to out-last everyone and get the promotions.

Why?

We tend to think of our jobs and careers as badges we earn like we are in the boy-scouts or girl guides. Obtain a MBA and that’s a badge on the resume. Complete a training course and that’s another badge and so and so on.  It is easy to fall into this trap. You are hired on resume so the more you focus on degrees, designations and hard skills acquired, the better your resume looks.

But this overlooks a fundamental aspect that bosses look for: attitude. I have hired and fired everything from the secretary to sales managers to vice-presidents. At some level, skill set basically mushes into an inconsequential differentiator in my mind. What is the difference between a secretary that can type 65 words per minute and 70 words per minute? They type fast. Period. A manager with a B.Comm, MBA, CSC and CFA does not really have that much value add to say a manager with a B.Comm, MA and MBA. They are both well educated on paper.

Instead, I would argue the separation is attitude. For every suck up at work there’s also the really nice person who is competent but really doesn’t want to work there. Given their smarts and skill, they do just enough to keep their job but their heart is not in it. I know I have had jobs where I did just enough to collect my pay cheque.

Throw enough money at someone and you can acquire skill. But you can’t buy attitude. You either love your job and the people you work with and for or you don’t.

Bosses know people are sucking up to them but, in a round-about way, suck-ups are implicitly showing their boss that they have a positive attitude about the company (even if it is a complete lie, at least they make the effort) and its always good for the boss’ ego to think they have created a positive work atmosphere. Thus, they tend to keep the suck-ups around (yes, they know its wrong but they are the boss).

What drives bosses insane is the talented employee who looks like they are mailing it in. If you are a parent, you understand this if you have a talented child who doesn’t apply themselves in the way you think they should. You are driven batty by this. Why can’t they put more energy into work? Why do they look like they don’t want to be there? If only they try harder, they could make management!

Setting aside problems at home and other personal crisis, this frustration comes down to a boss perceiving that an employee does not have a good attitude to work and they tend to be more vulnerable in down-times.

For example, I have worked in two places that experienced lay-offs. In both instances, there was someone who clearly should not have been laid off given they were more skilled or more well-liked than those who stayed but I ended up thinking “well, its probably for the best. They really didn’t want to be here anymore.” In other words, they displayed an attitude that made the decision to lay them off easier.

One final story: I once worked in an office that shared a common receptionist. We once had a receptionist that was vastly experienced and competent, having worked at large companies and understanding all the computer programs inside out. She only lasted 6 months. Why? She had a bad attitude: she snapped at other staff, left the second the clock hit 5:00 pm and she stuck to herself. The office manager had to let her go for the sole reason of having a bad attitude.

You can’t fake attitude for long (or it catches up to you) but if you sometimes wonder why someone gets ahead of you or who to hire, think about attitude.

Even with a slight short-term correction, the stock market has been on an extended rally this spring. Yesterday’s news that the May consumer confidence numbers leaped unexpectedly has the bulls giddy that we will head into the summer with surprisingly positive news on the stock market front.

But is this all premature?

President Obama admitted in an interview over the weekend that: “Well, we are out of money now…” in discussing his health care reforms (full transcript of the interview can be found here) and governments all over the world are reporting or preparing their citizens for record high deficits (in both absolute and relative terms).

Politics being politics, politicians like to deliver the bad news but do not finish the unpalatable thought. Yes, deficits are sky high and (the unspoken consequence) we have to either RAISE TAXES or cut services to tame the deficits. Thus, has governments solved one problem (a global liquidity crisis) by creating another one?

Specifically, massive government deficits can stifle private enterprise over the long term and result in an unproductive economy. The term “crowding out effect” has not been used for some time but it describes the economic theory that increased government spending reduces private consumption and innovation.

Simply put, if government is borrowing so much money, there is less capital for private enterprise. With less capital, businesses do not grow as much. There are several ways to solve the crowding out effect. The first is to reduce government borrowing by increasing revenue through increased taxation. The second is to simply print more money which results in inflation. Neither is exactly a desirable effect.

Increased government spending is not necessarily a bad thing since many the public sector does buy from private enterprise but, in a competitive world economy, if the pendulum swings too far the other way to an overly active public sector, are we served any better than when i-bankers ruled the world? It is not that i-bankers are better than government policy wonks; they just both bring a separate set of problems.

While America’s deficit continued to climb during the bubble, it has begun to rocket under dual pressures of falling tax revenue and increased spending and President Obama, who is really America’s Pierre Trudeau (I’ll explain in another post) rather than the next JFK, can do little to halt it (or anyone who would be President). The American work force has aged significantly since the 1991 recession. Demographically speaking, it is in a different and less consumptive life stage to spend again for such sustained periods of time.

Thus, I have a tough time reconciling a stock market rally when the government ledger in the short term looks so bad which sets off a corresponding adverse impact on the economy as a whole.

For the bewildered retail investor, rather than focus on products or short-term trends, focus on a long term strategy that can survive all economic cycles.

Bad times bring scams. Lately, I have heard of the return of the prime bank instrument fraud now draped under the banner of the bad bank paper being sold in the United State. The lawyers’ insurance company has also circulated warnings of a scam occurring where someone hires a lawyer to paper over an equipment loan transaction and uses the lawyer’s trust accounts to clear fraudulent certified cheques from fictitious lenders to fictitious borrowers.

Our collective sense of desperation, greed and our innate longing to find the silver bullet solution to all our woes, financial or otherwise, makes us easy marks. But most scams share common characteristics. While taken alone they may not amount to much, together, they could be a sign you are being sold a scam.

1. What’s being sold is shrouded in secrecy. The prime bank instrument fraud is premised on some secret trading platform the Federal Reserve or the Treasury Department approves of and now you can be a part of this elite group. Madoff was infamous for selling his ponzi scheme as a secret club. In an age of the internet and tabloid journalism, there are few, if any,  secrets left. If a magazine can obtain Secretary of Defense briefing notes to the President  from 2003, nothing is a secret.
2. You have to buy now. Scams are like the Hong Kong tailors that visit North American- buy now or its gone! The faster they push you to buy for no real reason, the more suspicious one should get.
3. Disclosure is murky or relies upon “government agencies” you never heard of. Authentication is based on government agencies you have never heard of or sound similar to existing agencies. The Securities and Exchange Commission is turned into the Commission of International Securities and Settlement.
4. Lots of name dropping. No, you are not being picked up by a leisure suit Larry at a bar. Excessive name dropping while selling you an investment is a bad sign. There are still many professionals who keep a tight lip on their clients’ affairs. Someone who tells you who is buy what is either a professional you don’t want to hire or could be running a scam and cloaking it in name dropping.
5. Way too much jargon and double-talk, inability to speak to the precise details or they make you feel stupid that you don’t know about it. If the product is vastly complicated to explain and they make you feel stupid when you ask for detail (“everyone knows that the Commission of International Securities and Settlement endorses double-shorting of zero coupon l/c’s), its either a bad legitimate investment (see ABCP) or a scam.

Be aware. Ask lots of questions and take your time.  Rules to adhere to in any investment. Good luck.

Canada’s Department of Finance issued proposed new regulations on credit card rules which are aimed towards: (i) targeting certain abuses of the credit card industry; and (ii) providing better transparency for all credit card users. Since the regulations are subject to consultation, they are not final but here are a few proposed changes to be aware of:

1. There must be a 21 day grace period on new credit purchases. Currently, some credit card issuers accrue interest on new purchases if the customer has an outstanding balance carried forward in the previous statement. In other words, interest is charged on both the outstanding balance and the new purchase. The new regulations require credit card issuers not to charge interest for 21 days on the new purchase.
2. Allocation of payment will be beneficial to the customer. Some credit card charge different interest rates for purchases, balance transfer credit cards and cash advances with the credit card company being allowed to apply payments to the balance with the lowest interest rate. The new regulations would require credit card companies to allocate payment to the balance charging the highest interest rate or proportionally to different balances, with both methods resulting in lower interest being paid by the customer.
3. No credit limit increases without consent.
4. No penalties if credit limit is exceeded due to merchant holds. Some merchants place holds on credit cards until the transaction is completed (for example, if you book a hotel room, the hotel will hold place a hold on your credit card to ensure they are paid). If a customer’s credit limit is exceeded due solely to a merchant hold, the new regulations prohibit the credit card companies from penalizing the customer for exceeding its credit limit.

For most card card holders who do not use most of the credit provided or pay their balance in full every month, these proposed measures will have little to no impact on their everyday lives.

However, as part of a separate set of regulations, new disclosure rules are also coming into force:

1. Key information must now be in a summary box. The current regulations do not require interest rate information, grace period terms and other fees to be consolidated in one place. The proposed regulation requires all future credit card statements to consolidate the information in one summary box.
2. Disclosure as to consequences of only making minimum payment must now be provided.
3. Notice must now be provided in advance of interest rate increases.

While these are all positive moves, the cynic in me wonders about the law of unintended consequences. By requiring the credit card companies to add new layers of bureaucracy, its cost of business has just increased which means that one or all of the following may happen:

1. Increased annual fees;
2. Slashed credit card reward benefits (a move which is already occurring in reaction to the American version of new credit card regulations); and
3. Higher interest rates.

In other words, there may be an indirect tax to all customers which only further weakens those who cannot handle credit properly and punishes those who can.

Fundamentally, someone will always find a way to get around a law or regulation if they want to and no law is perfect. The larger question is what are governments doing to encourage education and awareness of personal financial responsibility on the consumer level? The relative silence on this matter is deafening.

Along with quality fixed income instruments, the preference or preferred share are the issuance du jour in the markets. Paying a set dividend of well above the  prime rate (most recently issued bank preferred shares are now paying between 6- 6.25% per annum until their reset date) and not as prone to wide variation in share price, the relative safety of preferred shares over common shares has made the product attractive for institutional and retail investor alike.

But can there be too much of a good thing? Should investors holding dividend paying common shares be worried about a company issuing too many preferred shares?

WHO GETS PAID FIRST?

In the abstract, yes. Preferred shares, as the term implies, have preference to dividends over the common shareholders. In fact, common share holders are last in the priorities of who gets paid. The pecking order is typically (from highest priority to lowest):

1. Government is paid its taxes. It has what is known as a super priority to all other creditors;
2. Senior debt holders (senior because they have the highest secured priority);
3. Subordinated debt holders;
4. Preferred shares. Depending on how a company organizes its financing either the entire pool of preferred shareholders, regardless of series, share equally in priority (known as ranking pari-passu) or certain series of preferred shares have priority over others; and
5. Common shareholders.

Thus, the stickiness of dividends is not derived by a function of the law but from the downside risk of a company cutting or suspending its dividend to its share price and market confidence.

SHOULD COMMON SHAREHOLDERS BE WORRIED?

However, in practicality, the threat of preferred shares crowding out potential dividend increases for common shareholders SHOULD BE small. When a company issues preferred shares, it typically states in its propectus its earnings as a multiple of dividend and interest expenses. The higher the multiple, the more desirable the company since it still has sufficient cushion to pay both interest payments to debt holders and dividends to preferred and common shareholders.

Companies with small multiple should tend to scare off a prudent potential investor of either preferred or common shares. After all, if a company can barely meet its on-going cost of capital obligations, why would you invest in it? It has little margin of error and a default on debt obligations is often the first sign of a company’s end.

Larger preference share obligations will also push up the dividend payout ratio. Most shrewd dividend investors would know that a higher than industry average dividend payout ratio would likely result in lower proability of future dividend increases (once again, look at payout ratio and not just yield).

Instead, the larger threat to common shareholders may be conversion of preferred shares into common shares. As part of the bailout package, the American government has the right to convert all the preferred shares it had invested in banks into common shares if banks did not meet the bank stress test (the justification being that it would increase the asset to common equity ratio; a key ratio of a bank’s health).

The potential conversion was criticized for a myriad of reasons (converting shares to prop up financial ratios does not fix the situation, the government would be nationalizing banks etc.) which seems to have died down somewhat given the results of the bank stress test and the market’s desire to recapitalize the banks.

But it does highlight a potential issue for having too many preferred shares. If a company which has issued many preferred shares hits a bump in the road, resulting in the multiple of earnings to interest and dividend obligations decreasing, it could, if it gave itself this option in the prospectus, convert the preferred shares into common shares.

The result would be that the company moves from a contractual obligation to pay preference shares dividends to a discretionary obligation to declare dividends to common shareholders. With many more common shareholder mouths to feed, the company could slash or suspend the dividend to hoard cash. In essence, conversion allows a company to move junior debt-holders (which preferred shares are often described as) to an equity position and then cramp down on the equity holders by slashing the dividend.

How realistic is this possibility? I would hazard to guess remote but if we enter into a “W” shaped recovery (a double recession) who knows?

WHAT SHOULD I LOOK FOR?

The larger moral of the story is if you are looking to purchase preferred shares or are a nervous common shareholder, read the prospectus of a preferred share issue to determine the following:

1. What cushion does an investor have that dividends and debt obligations can be paid (usually look at the “Earnings Coverage” section)?
2. What priority does this series of preferred shares have over other series of preference shares and classes of common shares?
3. What are the conversion rights of the company or the shareholder?

Most preferred shares prospectus are issued as short form prospectus so they run in 10-20 pages rather than 80-100 plus pages. Here is an example of what a preferred share prospectus looks like. Good luck.

You know you have made it as an investment product when people starting demanding that you provide greater disclosure. As Jonathan Chevreau reported, a lobby group has demanded greater disclosure on the risks involved in purchasing leveraged exchange traded funds (ETFs), of which several ETFs now consist some of the most traded stocks daily on the NYSE and the TSX.

The calls for greater disclosure in leveraged ETFs appear to be a reaction to the fact that retail investors are now purchasing these products and investor rights groups are concerned that investors are purchasing something they understand.

LEVERAGED ETFs: THE QUICK AND DIRTY

The “what” is easier to explain than the “how”. A leveraged ETF is an ETF that aims to return some multiple of an index or benchmark’s performance either positively or negatively. For example, a bull EFT may aim to perform 2 times the return of a particular index whereas a bear ETF may aim to perform 2 times the loss of a particular index. Thus, if the market goes up 1%, a bull ETF with “double exposure” would theoretically return you 2% for that day.

Each ETF states an exposure which is the level of leverage required. Thus, a 2x short exposure means it aims to perform double the daily performance opposite of an index or benchmark.

The “how” is the complicated part. An ETF bull or bear ETF achieves its return through purchasing financial derivatives such as future contracts or equity swaps. The key, however, is that everyday the ETF needs to re-balance itself to its appropriate fixed exposure/leverage level. In other words, at the end of each day, the ETF has to buy or sell positions to re-establish its leverage position. Remember this part, this is key.

LEVERAGED ETFs: WHY WOULD YOU BUY IT?

Why you buy a leveraged ETF depends on your context. If you sit on the trading floor of a major financial institution, leveraged ETFs are a relatively easy method to be a momentum trader. Buying and selling derivative contracts (which is one way of creating an ETF yourself) may simply take too long or you do not have clearance to do it (there are rules on who can buy what; a retail trader does not have the same access or volume of product as an institutional trader). If you believe the market is going one way or another, a bear or bull ETF may be a simple way for even the lowest of institutional traders to play the trend (as the saying goes, “the trend is your friend”). This explains the enormous volume in leveraged ETFs.

If you are a retail investor, you most likely buying on speculation or as a hedge. I am going to quote Preet in his excellent post about leveraged ETF’s describingthe difference between the two concepts.

“Hedging is the complete opposite of Speculation. Another way to put it is that speculation is the taking on of risk in the hopes of a higher reward, and hedging is the elimination of risk and the elimination of higher potential rewards. The two are diametrically opposed.”

I have no issues with speculation as long as one can handle the downside risk of losing your own money (institutional investors speculate too- just mostly with other people’s money) and if one is absolutely positive that the market is going one way or another in the short term. If this applies then this may be a convenient product to achieve one’s goal of speculating on the market. As a hedging tool, it tends to be, as Preet noted, a good tool in small doses and for short peroids of time (as explained below). As long as one understands this, a leveraged ETF can be an effective tool.

LEVERAGED ETF’s WHAT IS THE DOWNSIDE RISK?

There are many disadvantages to leveraged ETF’s but I wanted to concentrate on one known as the Constant Leverage Trap: Over time, constant leveraging in volatile markets diminishes returns. I am going to let some professors explain this concept on their research on leveraged ETFs quoting their example of the constant leverage trap:

Assume you invest $100 in both a market index and a 2x leveraged ETF. The index falls 10 percent, and thus the leveraged ETF falls 20 percent. The next day the index increases by 20 percent and the leveraged ETF increases by 40 percent. Your portfolio value in the index falls to $90, and then increases to $108, for a gain of 8 percent. Note the average return is 5 percent each day, yet your portfolio only averages 4 percent each day. This is the compounding problem. In the leveraged ETF, your portfolio value falls to $80, but only increases back to $112, for a gain of 12 percent. Instead of averaging 10 percent each day, your portfolio only averages 6 percent each day. The leverage ratio for each day is two, but over the two days is only 1.5 (12 percent divided by 8 percent). Thus, the compounding problem is magnified by the use of constant leverage.

In plain English, this means the ETF can consistently maintain its stated exposure/leverage position BUT CANNOT DELIVER YOU THE SAME RETURNS AS ITS EXPOSURE OVER A PERIOD OF TIME.

In other words, don’t assume you are receiving the same level of return as its exposure.  In fact, over time, returns will be less than the exposure.

The implications of this are manifold:

1. Definitely not for someone with a buy and hold strategy;
2. A product that optimally performs when there are long to medium terms trends and not in a volatile market;
3. Its usefulness as a hedge declines over time;
4. A useful product for short-term hedging rather than profit-seeking.
   

…I would be remiss if I did not point out the following. Good investors are good historians. Recent history shows that sophisticated financial products aimed at the wrong end-user combined in faith in financial wizardry tends to end badly.

If you are a long time reader of this blog, you notice that I tend not to be an early adopter of financial trends. I like to see how the dust settles before writing about something new. Thus, while I do not dispute the utility of this product in the right hands, I fear for some retail investors that this is nothing more than a stroll down memory lane, substituting the names of some recent structured financial products like ABCP or PPN with leveraged ETFs.

With high interest savings accounts paying below 2% and one year GIC rates at below 1.5%, one could be earning nominal or no after-tax return if your high interest savings account or GIC is held outside of a tax-deferred account. For those holding a large part of their retirement portfolios in cash or GIC, they may be opportunity costs to not shifting from cash or cash equivalent positions to higher yield fixed income instruments or equities.  Given these choices, what is one to do in an low interest investing environment?

Central banks across the world are maintaining low interest rates for a reason; to encourage investors to move out of cash and into higher yielding instruments particularly corporate bonds and equities as a means of recapitalizing private enterprise. The one flaw in the assumption is that people will act rationally to undertake the desired behavior modification.

Rationality is not a word I would use to describe the state of personal finance in 2009: “anything to survive” may be more of an adapt phrase. For this reason, some analysts believe that investment products that usually benefit in low interest environments are under-priced. What may some of these products be?

1. Corporate bond market. AAA rated corporate bonds yielding between 4-6%.  A yield higher than that typically implies higher risk of repayment.
2. Utility stocks. Typically quite sensitive to interest rates because of the highly leveraged nature of the business (not because of undue risk but because of the large amount of capital expenditures it must undertake to maintain the assets of the business). The lower the interest rate environment, the cheaper the cost of doing business.
3. Teleco stocks. Same reason as utilities.
4. Real Estate (under normal circumstances)- stocks and as investment properties. Another business which depends on leverage and thus fares better in low interest rate environments. Of course, if this was a “normal” recession, this analysis would hold true. But where a recession is caused, in part, by a large correction in real estate valuations, you have to pick and chose your spots.
5. Bank stocks (under normal circumstances)- banks usually lead recoveries because the typical economic stimulus in downturns (which we are seeing now) is to lower the cost of lending/return on cash in order to encourage lending-the traditional bread and butter of financial institutions- and encourage investors to stop hoarding cash. But no one is quite sure if banks are out of the woods yet;  some believe the other shoe has yet to drop on banks looking at  rising credit card delinquency rates and increased defaults on corporate loans.

One huge caveat though. Many observers expect that the government is solving one problem by creating another. Throw enough money at any issue and you will solve it. Thus, the fact that financial institutions are starting to get back on their feet is not startling news a trillion dollars later. The issue is that rapidly increasing money supply typically leads to inflation, meaning there may be more of a probability of a 1970′s hyper-inflation environment than a 1930′s style depression.

The typical monetary tool to fight inflation is to raise interest rates or choke off the money supply, both moves will have the same negative impact on the above stocks. Therefore, if inflation arrives sooner rather than later, the return on these products may be decreased.

Thus, caution should be exercised in deciding on any investment strategy based on short-term trends. Certainly, there are  better opportunities out there than high-interest savings account or a GIC but it would be imprudent for most retail investors to swing widely from one extreme to another in such uncertain times. A well-balance portfolio should be maintained at all times to weather all economic circumstances.

Finally, I would suggest the best investment of all- yourself. With just about every good or service to be had on the cheap, it may be a good opportunity to devote some resources to improving yourself whether through formal re-education, seminars or resources. Products come and go but there is only one of you in life.

Union rules prohibit me from posting on Fridays (especially on a long weekend). Thus, in case you have not read about it,  Canadian Capitalist, Money Gardener and Triaging My Way To Financial Success are hosting a personal finance clinic. More details can be found here. Good luck.

Even though the market is beginning to pick up again, a lot of investors still have recent negative experiences with their investment advisor. Some members of the investment community counter that any relationship is not a one way street and some degree of personal responsibility needs to be taken by the client themselves.

Who is right?

Depends. I have been a legal advisor (an industry with its fair share of horror stories) and been a client of  investment advisors. Thus, I have sat on both sides of the advisor-client table and I would provide a few brief comments and tips.

HOW DID YOU CHOSE YOUR ADVISORS?

This is where I think the investor more often than not trips up. Like anything else in life, there are good, bad and indifferent advisors. It is your responsibility to find the one that is the best fit and not the most comfortable fit.

More often than not, I hear people pick investment advisors because of proximity, they saw an ad or they got what I call a throw-away referral (a referral given by someone who never used them or knows them casually). In other words, we act out of comfort and not accuracy. For example, my first non-bank account investment was to buy mutual funds through my bank branch because it was down the street- wow, was that a learning lesson!

I would also be remiss not to point out that not all advisors can sell mutual funds and stocks).  Conduct your due diligence of what they can buy and sell for you.

Start right. Even if it means taking longer to find a good advisor, take that time. The good ones often don’t advertise (don’t need to- their word of mouth referral networking is great) and the bad ones sometimes make the most noise. It is like dating- you have to sift through a lot of crap to find a good one.

WHAT IS YOUR INITIAL CONTACT WITH YOUR ADVISOR?

This responsibility is shouldered on both the client and investment advisor. If hiring an investment advisor is a long-term relationship, you just don’t propose to a girl on the first date do you? You enter cautiously and you establish some ground rules.

When I hired my investment advisor, I gave him a part of my portfolio and told him upfront that I was doing this and would transfer the rest if things worked out well. I also said that we needed to meet periodically- in other words, I set some ground rules. I find that clients who gave me reasonable boundaries to work with legally, even if I did not like them, gave a better form to the relationship.

On the flip side, it is really the advisors responsibility to be honest. Investor expectations can be unrealistic. A good advisor does not pour fuel on the fire of those expectations. If the client feels that he should be paid 18% on a guaranteed fixed income instrument, and if the advisor has told them this product may exist only in la-la land, then it is the investor’s responsibility when his result does not meet these unrealistic expectations.

HOW DO YOU DEAL WITH YOUR ADVISOR?

If you manage employees, unless you trust them 100%, you check in with them from time to time right? So why do some people hire an advisor and then never have periodic contact with them to see how things are going? Letting the advisor know you are around and want to talk is the investor’s responsibility. Ask “why?” a lot. Ask “what are all my options?” a lot. Ask “justify your advice” a lot.

The advisors responsibility should ideally: (i) keep in periodic contact (bonus points if you are actually not selling product but doing this to earn trust); (ii) lay out ALL options (not the ones that make the most sense for the advisor only); (iii) educate;  (iv) answer the “what” and “why” questions; and (v) avoid sales pressure tactics.

If you have a salesperson, fire them. If your advisor never calls back, fire them. If you had a terrible boy-friend, you would dump his sorry butt right?

FINALLY…

One final note, I have had very indecisive clients in my time who want me to make the decision. Here is the thing. A good advisor can give you options and tell you what they would do but clients always don’t disclose everything, they are emotionally attached to the issue, they get all sorts of other advice etc. etc. In other words, an advisor does not have perfect information about you.

Thus, at the end of the day, an advisor cannot decide for you. This is your life. You have to take responsibility for the final decision. Use your advisor to give you ALL options and information to arrive at that decision but you have to make it yourself. If you abdicate decision-making powers to your advisor, you are setting yourself up for failure because the decisions that will be made are from someone else’s perspective.

There has been a lot of focus lately about insurance. Particularly, there has been  focus on post-claim underwriting (Ellen Roseman addresses the post-claims underwriting and the banks, Canadian Capitalist’s guest writer addressed post-claims underwriting in discussing mortgage vs. life insurance, and Four Pillars wrote  an editorial about post-claims underwriting). This raises a much larger issue of when and why do insurance companies deny coverage and what you, as a smart consumer, can do to attempt to avoid this.

First, let’s take a step back. An insurance company actually does not make money selling insurance. It is a loss leader.  Instead, insurance companies make money by investing your policy money and the more they keep, the more likely an insurance company will keep Wall Street happy. Thus, its business model relies on keeping your money.

To this end, there are two primary ways that an insurance company can deny you coverage on policies that are not in default for non-payment. The first is fraud by the policy-holder. This is pretty self-explanatory.

The other, murky, way to deny insurance coverage, subject to countless lawsuits, is the intersection between pre-existing conditions and post-claims underwriting.

PRE-EXISTING CONDITION

Under the “limitations, exclusions and non-waivers” section of a typical policy, there are paragraphs of exclusions if you suffered from a pre-existing condition which was not disclosed in your insurance application and which you were aware of or should have been aware of before the commencement of the policy.

In plain English, was there some condition that the insurance company you did not disclosure which would have either resulted in them increasing your premiums or denying you coverage altogether?

What happens if you have a pre-existing condition and you make a claim? If you disclosed your pre-existing condition, you may be denied coverage on that particular condition for a period of time. If you did not disclose the pre-existing condition and the insurance company believes you should have reasonably known or disclosed the pre-existing condition then your coverage may be denied.

Of course, pre-existing condition has been abused by certain members of the industry as a blanket means of denying coverage.

How do you attempt to avoid being caught in pre-existing condition trap? Some pre-existing condition denials occur simply because the policy-holder has not seen the doctor for a while and the insurance company is reviewing older documentation. The gap between the last medical visit and the commencement date of the policy could have incumbated a lot of medical conditions not disclosed. For policy holders who are more high risk, insurance companies do require a physical now as part of its due diligence.

But for what appears on paper to be less risky policy-holders, the insurance company may forgo this altogether (this was the case during good times but this may have changed) and by doing this really placed the risk onto you that you have a clean bill of health since your last visit. The moral of the story being get a physical as part of the process of obtaining insurance (if you are not required to already).

The second practical step is be honest and forthcoming and do it in writing. If an insurance company has on file a medical disclosure which may or may not be part of your medical records, it is more difficult to deny coverage.

POST-CLAIM UNDERWRITING

Post-claim underwriting is a denial of coverage based on a pre-existing condition on steroids. In essence, the insurance company does little to no due diligence before offering you coverage and, at the time of a claim, begins to determine whether you are actually eligible to be covered at all according to the risk the policy-holder provides, giving it, with 20/20 hindsight, potential carte blanche to deny coverage.

If you live in the United States, some good news. In 2007 and 2008, 38 States and the District of Columbia passed laws limiting post-claim underwriting. In an important 2008 decision of Hailey v. the California Physicians’ Services, the California Court of Appeal ruled that it is the insurance companies duty: “to make reasonable efforts to ensure the subscriber’s application is accurate and complete as part of the Pre-contract Underwriting Process.” (emphasis is my own).

In other words, unless you make reasonable investigation before the policy is signed, barring fraudulent misrepresentation, it will be more difficult for insurance companies to use post-claim underwriting as a means to deny coverage.

If you live in Canada (land of the lumbering consumer protection laws- see the laughable do not call list as Exhibit A), I understand that only the Province of Alberta has taken some legislative action on this front (anyone care to help?). So, the one thing you can do as a pro-active consumer, is lobby for a change in the laws to prohibit or restrict post-claim underwriting. Insurance is a provincial jurisdiction so write your elected representative provincially.

In the meantime, how do you know if you are part of a post-claim underwriting insurance policy? A few things to watch for:

1. Medical portion of your application is vague to non-existent;
2. No medical exam no matter how much risk you may pose; and
3. Very quick turn-around between application and when policy is issued.

Ask about the process and if all three pop up, you may want to walk away.

The truth is that an  insurance companies, if it wanted to, could employ a phanlax of claims adjusters and lawyers to help deny coverage. However, if you believe in third part insurance, this should not mean you should not take pro-active steps to help ensure you are covered when you need it. Good luck.