Friday, June 17, 2005

Coffee

Yes, I admit, I am addicted to coffee. But my addiction means that it's one of the few consumer items that I instantly know the price of.

So my theory is that the price of coffee is quite closely related to the demand. The smaller the overall demand level, the more price inelastic the remaining coffee drinkers are.

So in Cairns, where locals are too sensible to drink a hot drink in a climate where winter mean its only 28 degrees, a not particularly good small cup of coffee costs $3.50 - strictly for the coffee addicts amongst the tourists.

In Melbourne, where there are a huge number of fussy coffee drinkers, I got a large cup of coffee for $2.00. Around Circular Quay, in Sydney where I work, my morning coffee is $2.50.

So it is true, Melbourne is the coffee capital of this great nation of ours.

Wednesday, June 08, 2005

Super choice - winners and losers

The retail investment press is full of articles about super choice these days. Depending on the ideological slant, they are either along the lines of "what a wonderful thing superannuation choice will be - it will give people the chance to choose something that suits them, and Occasionally, an article makes it in about insurance, and how important it is. They make me wonder what the impact of super choice is likely to be on my clients (mainly retail life insurers and fund managers).

Funds management first

First, the change is likely to be quite gradual, and very hard to disaggregate from all the noise that influences sales of investment and insurance products on a monthly basis. For savings products, it seems likely that anyone who relies on the corporate market (either through true wholesale products, or through the corporate mastertrust market) will gradually leak money. A true retail fund manager will likely pick up some (but not all) of that money. And the industry funds will definitely get some of it, but not the huge amounts that some big-end-of-town scaremongerers are suggesting.

The other winner is likely to be DIY funds (as seems to be the trend from pretty much every super change). Inertia, plus an existing corporate fund that they can't leave, is the main thing stopping many high income earners from going down that path. But super choice is likely to shake a few more of them loose.

Life insurance

The scary thing, though, is life insurance. Unlike the funds management side of super choice, it seems likely that super choice is likely to lead to lower levels of insurance over the longer term. Again, the process will be too gradual to disaggregate from the monthly and yearly sales figures.

But if you take your money away from a corporate super fund, wherever you put it is likely to have a lower level of minimum insurance than where you left. Most people find it hard to believe how much insurance they really should have (a rule of thumb is 10 times income - that seems like an awful lot of money to most people). So they'll take the minimum level, because it's cheaper, and they won't have to do any medical tests or go see their doctor.

And the general population will be even more underinsured than they used to be. A recent study from Comminsure showed the extent of underinsurance in disability income; it's there for life insurance too.

That said, the winners will probably be the insurers to retail mastertrusts and industry funds; and to a lesser extent true retail insurers; the losers will be the insurers to corporate funds.

And what about consumers?

This whole process has made me want to read The Politics of Choice; Why More is Less, by Barry Schwartz. I read a really good review of this recently. The point of the book seems to be that choice isn't just a undeniable good thing; it comes with a cost. That cost is the time you take to think about it, and the cost of making a bad choice. It's hard to know without looking at the outcomes where the cost benefits of super choice will end up. But is likely that more risk will be transferred to consumers, and not necessarily more benefits to match.

Saturday, June 04, 2005

Risk transfer

The Economist (subscription only) had an article in its recent survey of banks on the new and increasingly tight regulation of banks world wide.

"Medieval engineers built many daunting castles with thick walls and redoubts that made them seem impregnable to the armies of the day. But sooner or later they were destroyed or simply by-passed by invaders. In the same way, the big banks that dominate the financial landscape at present may turn out to be less secure than they seem."

The major argument of the article was that by regulating banks very carefully to require them to hold more capital if they took greater risk, a natural process of regulatory arbitrage means that the risks get transferred elsewhere. And when the regulators of other parts of the financial system do their job properly, a substantial amount of risk gets transferred to the end consumer.

According to a recent IMF study into insurance, “It is likely that such [credit] risk will continue to be passed to less sophisticated participants, namely to policyholders and hence to the household sector.” (IMF commentary in the Financial Times)

In a small way, this is what has happened to the Australian life insurance industry in the past two decades. The regulator forced the life industry to hold sufficient capital against the long term asset liability mismatches that were implicit in their traditional with profits and less traditional investment account contracts. Once that happened, life insurers were increasingly reluctant to sell such contracts, and now policyholders are effectively taking those risks by being invested in unit linked contracts.

Looking at what happened in the UK (where for whatever reason, life insurers were not sufficiently discouraged from their guarantees, and went through a pretty hairy couple of years in the early noughties) suggests that the Australian life industry got it about right. And ultimately, if the life insurer did go bust, the policyholder is wearing the risk anyway.

But right now, householders are the ones wearing the risk that their long term savings are going to be adequate for them to live on, and it's unlikely that most of them understand the risks that they are exposed to. Those that do understand those risks have decided that they're not worth taking.

Thursday, June 02, 2005

Fee rate illustrations

Superannuation choice is leading to a new round of interest in fee disclosure for superannuation (and other managed fund products). The latest argument is (as usual) between industry funds and the retail funds.

The industry funds have put together a piece of advertising showing the impact of the current difference in annual fee on a superannuation investment over a working lifetime. As expected, given that the average industry fund has a lower fee than the average retail fund, the industry funds came off much better ($85,000, according to the advertising). The retail funds hit back, and argued that the fee differential wouldn't necessarily stay the same when projected into the future. ASIC forced them to make some qualifications to the projections, and the advertising is back on air.The Australian has more.

The retail funds further argue that you're not comparing like with like; you don't get any advice with a retail fund, whereas the retail fund fee includes the cost of advice. The question is, is the advice that you get with a retail fund worth the extra amount you pay for it?

The retail funds seem to have won this round on points, but it's unlikely to be the end.

My view? It is likely that the fee differential between industry funds and retail funds will narrow. It's certainly narrower for new investments than it is for existing investments. But it won't close entirely, because advice is a valuable thing; perhaps not quite as valuable as the amount people are (implicitly) paying for it at the moment.