Liquidity is one of those funny words. Not long ago, the only people who used the word were financial professionals, and only then when they were talking among themselves.
Suddenly, however, “liquidity” has become an everyman term, what with the world suffering from a liquidity crisis and the feds injecting liquidity into the financial system so that banks can lend to corporations and other banks.
And now consumers, many scrambling for cash, are looking for liquidity, too. Thanks to the emergence of new secondary markets, some of this can be found in assets that have been historically thought of as illiquid. Counted among these are formerly illiquid items such as life insurance policies, annuities, and legal settlements.
While conceptually, the notion of illiquid financial assets may sound obscure, in fact, as Chart 1 indicates, it’s a huge market.
Interestingly, the smallest of these markets — structured legal settlements with $100 billion outstanding — gave impetus to the much larger investment annuity market, and to some degree, the massive $18 trillion life insurance market, which can now be accessed through life settlement transactions.
Structured legal settlements are payments made over time to accident victims or relatives in wrongful death cases. Many times, the thinking behind a structured settlement, rather than a lump sum payment, is to provide for the future financial needs of a plaintiff that might arise as a result of their injuries. In the case of the wrongful death of a child’s parent, payments might be timed to important life milestones such as entering college or getting married. In other cases, accident victims might receive payments into the future that contemplate further medical expenses from therapy or treatment of complications.
Despite the best intentions to anticipate future needs, plaintiffs often need cash immediately, and an entire industry of service providers came into existence to serve these needs.
Most owners of structured settlements are reasonably well-informed about their options. In a September 2008 survey of structured settlement owners, J.G. Wentworth found that approximately 45 percent claimed to be well-informed or very well-informed about their options. However, fully 25 percent reported they were not very well-informed. For these people, understanding their liquidity options might enable them to solve difficult financial circumstances now confronting them. While providing liquidity for structured legal settlements is a court-ordered process, it may nonetheless offer a good option, especially if it allows other assets to remain undisturbed.
From settlements to annuities
The financial instruments backing the periodic payments to plaintiffs are, in fact, annuities. Thus, the industry that was developed to meet the liquidity needs of structured settlement owners — underwriting standards, lines of credit, capital markets support — provided the infrastructure to make the large-scale purchase of investment annuities possible for individuals.
However, one of the most important advances in the structured settlement market that had an impact on the development of a secondary market for annuities was more legal than financial. Specifically, the anti-assignment language that is part of most annuity contracts provided a potent barrier to gaining liquidity for these assets. In the structured settlement market, however, this was overcome by assigning the right to receive payments rather than the annuity contract itself. Applying this principal to investment annuities helped open up the floodgates.