Imagine a used car lot, presume that there are two types of cars; one that is in good repair, carefully driven by an elderly man, and the other a ‘lemon’. Now assume that used car shoppers are prepared to pay up to $20,000 for a good one and up to $10,000 for a ‘lemon’. For the salesman, he knows that the owner of the ‘lemon’ requires a minimum of $7,000 and the elderly man won’t pivot below $18,000.If shoppers dealt directly with each car owner, they could surely make a fair offer for each, but adding a third party intermediary (the salesperson) can obscure the information leaving shoppers unable to determine a quality difference between the ‘lemon’ and the well-handled car.
When this occurs there is no longer two options for used cars, good and bad, it is now compiled into one market. The result being that shoppers will modify their budget based on the information available causing them to average their budget to $15,000. Since this is below the elderly man’s minimum of $18,000 he will exit the market leaving favorable market circumstances for the ‘lemons’.
When bad quality products push good quality products from the market because of an information gap, this is known as adverse selection. The lemon dilemma is how economists refer to situations where the seller has more information than the buyer. This theory was materialized in the 1970 research paper “The Market for Lemons” by George Akerlof, a professor and economist at University of California, Berkley.
Lemon Dilemma Pertaining to Financial Advisors
This is not to say that the insurance industry is the same as a used car lot, but there are some similarities to be drawn. Consider financial advisors as the car and yourself the buyer, there are good advisors, and not so good advisors. Those that have your best interest at heart, offering productive advice and recommendations tailored to your needs, and those that prioritize a high commission over a happy client in the long run. If you’ve ever arranged for a meeting with a financial advisor, you know it can be a bit daunting, not only because you are planning for your life and the well being of your loved ones but because you may not fully understand what’s best for you. For example, let’s assume your advisor is walking you through all the benefits of whole life insurance (as many of them do), but your friend recommends you explore a buy a term life policy and invest the rest strategy. Juggling the pros and cons of each, it’s natural to trust the paid advice of an advisor, but are they offering what’s best for you? Provided this asymmetric nature of knowledge in the insurance industry between the advisor and client, you’re likely setting foot on an uneven playing ground.
An often scrutinized facet of the financial advisory is the aggressive recruitment techniques of insurance agents and financial advisors. As a recent university graduate, two of my first job offers came from insurance agencies, their main draw being the fresh network of family and friends I could add to their client base. A larger team means a greater reach and ultimately, more sales. The majority of financial advisors in Singapore can be considered self-employed, working on a pure commission basis, simply put; they get paid when they sell products on behalf of the agency they represent.
Naturally, you may be asking yourself; is my advisor a salesperson or an advisor? Well, there’s no easy way to establish this, but it is valuable to understand the difference. An advisor is typically considered an expert in their field, regarded for the service they provide rather than a product they sell. A salesperson would tailor their sales pitch to an individual’s needs in order to propose something that makes sense. I’d like to indicate that whether you believe your agent is a salesperson or advisor does not necessarily make their advice better or worse, an advisor may be considered an expert but still offer really poor advice, whereas a salesperson can offer great advice even though their ultimate goal is to sell.
To put things in perspective; the deputy Prime Minister of Singapore, Tharman Shanmugaratnam, published a 2016 account detailing employment data for the insurance industry; 19,022 insurance agents operating beneath 79 insurance agencies. Singapore, with a 2016 population report of 5.607 million, boils down to about 295 clients per single insurance agent. Chances are you know an agent, either directly or through a friend. While most would agree that having insurance is important, it can be intimidating to navigate. Some of us may even avoid it all together.
When dealing with your financial future, it is perhaps most important that you assemble any and all information you can get your hands on, educate yourself before you listen to someone try to sell you on something. Having this knowledge in your back pocket can give you a first-hand understanding of what’s available and what you need. Insurance becomes increasingly relevant as you age and it is important to understand your options so you are able to ask the right questions.
Insurance can be an intimidating obligation, but arming yourself with the right judgement and know-how is half the battle. At Hive Up we aim to equip you with the means to make your own, educated, decisions through a platform that offers transparency and simplicity to an often convoluted world.
We have tackled the issues of mistrust and complied a team of advisors that have been specially selected by Hive Up. Check out their profiles and set up a meeting today!