Incentives Matter!

In last week’s Wall Street Journal, one of my favorite writers, Jason Zweig, wrote an article entitled “Mutual Fund Fees: A Bad Incentive Fades Away” which highlights a known conflict of interest that exists in the financial services industry where advisors are paid by mutual fund companies to sell their proprietary products over other funds.

This payment could soon disappear with the Department of Labor’s expected move to the “fiduciary” standard and away from a “suitability” standard.

Many large brokerage firms and insurance companies are held to a suitability standard, which means they can recommend a product for you that only has to be deemed suitable, but not the best for your needs.  Registered Investment Advisors, or RIA’s, are held to a fiduciary standard which means they must recommend the best product and or strategy for you. (This video take a humorous approach but does a good job in explaining the differences)

I was recently reminded how important incentives are in all aspects of life.

On a late night trip to a walk in medical clinic, my daughter was diagnosed with an ear infection.  Pretty standard for a 6 year old. The doctor prescribed an antibiotic and she would be feeling better in no time.  The prescription was called in and we proceeded to our local pharmacy to pick it up.  While checking out I was stunned to see the antibiotics rang up to a price of $225? 

I asked the pharmacist if this particular antibiotic was specifically prescribed for ear infections?  Nope.  For children?  Nope.  He couldn’t understand why this would be prescribed over a whole host of other drugs that would be 2% of the cost.

I decided to call the doctor and ask that very question.  I didn’t get through to the doctor but did get the physician’s assistant who said she would check.  Needless to say, when the PA returned to the phone she had already called in a new prescription for another antibiotic that was the same but cost $4.  When I informed the pharmacist about this he snickered and mentioned that the doctor must have been incentivized to prescribe this particular medicine.

What if I hadn’t know any better?  How often does this happen?

This doesn’t mean all doctors do this but like financial advisors, incentives do matter. In this case, the prescribed medicine was perfectly suitable for my daughter but I would have paid an extra 5525%! 

This is an extreme example, however, as Zweig points out in his article, “Until advisers are paid solely by their clients, no one will be able to tell whether the advice is tainted”.