Evidence of Comprehension - How Do You Know When An Investor Understands? And How Much Does It Matter?

May 1, 2017 12:34:00 PM



In an earlier blog, "The DoL Fiduciary Rule: How does investor comprehension fit in?", I explored both the written and implied requirements in ERISA and the DoL rules related to disclosures and the need to ensure that investors understand.
This blog explores the question of ‘how do you know’ that an investor understands?

Let me start with a personal story. My husband and I don’t claim to be the sharpest tools in the shed. However, I have a degree in chemical engineering, and my husband has a master’s in computer science. So, you would think that between the two of us, we could read and understand the investment agreements for the purchase of an annuity for our retirement planning, right?

Well not exactly.

It’s not that we didn’t try, but somewhere in the mix, the brochure that explained what we thought we were buying didn’t quite match the 60-page contract. It’s not that it had outright conflicting information, it was just that the agreement was loaded with many provisional exclusions to basic terms, or additional terms that didn’t seem to apply (at least not at the time, but might in the future). I knew that it was important that I understood the contract I was signing, but it was very complicated and difficult to see clearly where the agreement aligned with terms that our advisor had explained to us for the product we were buying.  

My advisor/broker at the time did what he could to explain the contract, including getting the insurance company on the line, but much of the explanation involved apologies for a poorly written, overly complicated agreement. We wrote the check and signed the contract, hoping that we made a good investment choice, but felt irritated and uneasy about the fact that, after reading the agreement, we weren’t sure.

Unfortunately, I’ve got to believe that our experience is not unique- but how much and to whom does it matter that we did not fully understand the terms of the investment we made? 

I’ll now fast forward 9 years from the purchase of the annuity and my husband and I are getting more serious about our retirement situation. We are wondering how much we can count on in the form of monthly payments and when we could start receiving them. In our world, and at this stage, it’s important that we understand how the policy works because we don’t want to end up short on cash. We went back to the documentation- and WOW! To our surprise, it didn’t answer the question. Even the annuity statements did not provide an answer to the question. Eventually, we got a ‘liquidation of benefits statement’ which answered the question, however getting a clear answer was hard work.  Nonetheless, it mattered greatly to my husband and me that we understood the annuity payments, terms and timing.

But how much does MY understanding matter to the insurance provider?

I know that most advisor/brokers care sincerely about the well-being of their clients and act in their best interests. However, they appear to be stuck with badly written contracts that don’t make their job any easier.  Is it that the insurance company doesn’t want to make written agreements more understandable?

Some data gathered by behavioral psychologists found that there is a correlation between the amount of competition in the financial industry (number of products), the pressure to be creating new differentiated or unique offerings and the complexity the investment disclosures. The result is that the more complicated the investment product, the more complex the language. Another feature is that the higher the fees, the more complex the language.

You might suppose that the more experienced, savvy investors would be better suited for more complicated investments, right? But it doesn’t work that way either. There appears to be no correlation between the capability of the investor to understand their choices, and the type of investments they are sold.   

The bottom line

The bottom line is that (it appears) the financial industry has benefited from the obfuscation of important information, sometimes at the expense of the investor.

In the increasingly competitive world of financial advisory services and sales- including encroachment from automated ‘robo-advisor’ platforms, I suggest that approaches involving confusing and complicated disclosures do not help build trust that enables wealth managers to build their business.

This is why practices to confirm ‘comprehension’ on the part of investors of key terms and costs associated with their investments is valuable to both parties.

If you’d like to learn more about a solution for capturing "evidence of comprehension" that we’ve developed to support the retirement savings industry, please download the white paper that I co-authored with Marcia S. Wagner of the Wagner Law Group, a prominent ERISA lawyer in Boston, MA.


Annette Quintana

Written by Annette Quintana

Annette Quintana is the CEO of Istonish Holding Company, a privately held, Native American- and Latino-owned information technology services company established in 1990. Headquartered in Denver, Colorado, Istonish helps organizations, individuals and communities to be great through innovative technology solutions. Annette’s unique capacity to inspire her team to deliver successful results stems from her enthusiastic commitment to this vision. Under Annette’s leadership, Istonish has grown and evolved to serve government agencies, private companies large and small, and mission-driven not-for-profit organizations throughout the Mountain West.

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