Monday, September 7, 2009

The Next Bubble?

Several years ago you may recall that following the last bust (the dotcom variety) there was a period of very low interest rates (thanks to Mr Greenspan) and as a result it was somewhat difficult to find investments that would generate a reasonable return.

Fortunately I had money to invest at the time, and thus myself and my partner went hunting assets classes that might provide such a return, and if possible in a non-correlated manner.

One of the areas we looked at was Viaticals. This is the general term for buying second hand life policies, typically from old people. The main reason why this business exists is to allow people to enjoy the benefits of the policy before they die, typically using it for health or residential care.

Due to the nature of the discount offered on the purchase, if managed correctly they can potentially offer above average returns over time, as the people pass on thus releasing the full value of the policy.

Of course the general rules apply:
  • their are no free lunches (risk/reward)
  • if it is too good to be true, then it probably is (this seems easy!)
  • read the small print (and then the REALLY small print)
In the end we passed on the idea, partly as we felt uncomfortable with the seedier end of this business which has a poor reputation, and also because the actual mechanism for making money is not as easy as it first appears. Risks include (but are not limited to):
  • the original policy holders living too long, during which time you have to keep paying the premium, hence eating away at your potential return, and of course an increased holding time also reduces the IRR;
  • ultimate beneficiaries suing the secondary purchaser when the original holder dies.
I read with interest an article in the NY Times about bankers sitting around figuring out the next way they can make money from securitizations (as if we have not had enough) and lo and behold they are talking about the securitization of life insurance policies, to be packaged and sold off to the unsuspecting investing community.

When they come knocking on the door to offer this, remember that you read my blog in September 2009. I am not suggesting that you should not buy, just make sure that you do not fall again into the trap that caught us out last time with CDO's CLO's etc.

They will undoubtedly tell you that the product:
  • is backed by a major financial institution
  • has a AAA credit rating, perhaps backed by a different equally solid financial institution (like AIG or Lehman Bros)
  • Historic defaults show that there is little or no real risk to the equity
And I could probably go on!

Happy hunting!

No comments:

Post a Comment