On Vanilla Products

Though Congress may not mandate the sale of vanilla financial products to consumers, it is worth thinking about the concept in general. I have written two articles that argued that consumers should only simple products from insurers:

Life Insurance: A Bet You Don’t Want to Win
The Pros and Cons of Buying Annuities

Men (this includes women) are good at analyzing questions of more and less with one variable.  Stick to that, and most men do well.  When there are two or more variables, the rationality breaks down, because the average man does not know how to analyze the pricing tradeoffs.

Term insurance and deferred annuities are relatively simple; the markets are competitive because men can make simple price comparisons across similar products.  That’s why insurers try to sell unique combination products.  The more unique a product is, the harder it is to compare against products that might be cousins.

The same applies to banks.  I don’t believe that any bank should be forced to sell a product, but it would be smart for some banks to market themselves as “basic banks.”  No products are marketed as bundles, every product is sold separately.  Products are sold at cost plus risk-adjusted profit margin.

Some banks could bring in a lot of business if they did this.  I had a similar idea regarding variable annuities, where a life insurance company would charge a mere 40 basis points per year to wrap a variable annuity, with no guarantees.  It would create the generic tax-deferred mutual fund.

In the same way, some backs could win a lot of business offering generic credit cards, simple mortgages, etc.  The only difficulty is getting through gatekeepers, because the average American does not search for the best deal.  Gatekeepers often offer what compensates themselves best.

Aside from complex tax planning reasons, simple products are usually the best.  I encourage my readers to look over the financial services that they use, and aim for simplicity.

3 Comments

  • Varada says:

    David,

    Regarding your comment about wrapping a variable annuity for 40bp,it is impractical simply because most of the current charges on a VA wrapper(say 100bp out of 140 bp) goes to the salesman who sold the VA to a customer.That is why VA wrappers are expensive.Selling it for 40bp will require a totally new approach to distribution.

    • Varada, you are right — this is a product to be marketed by the mutual funds themselves. “Sir, would you like the T-class shares? Higher expense charge, but they are tax-deferred. Otherwise the same as the class of shares you would ordinarily buy.” The mutual funds make their money off of their ordinary fee structure, and gain stickier business as a reward.

      Also could be used by no fee financial planners.

  • Harper Capital says:

    David, doesn’t Vanguard and Fidelity offer a low fee VA product using in house funds? At some point I another low fee insurace offering was out there (under 50bps+fund fees) for no fee planners, but cannot remember the name for the life of me. I think they worked with Rydex to grab traders assets.

    I agree it’s a great way to retain sticky assets.