Secondary market annuities are a little-known corner of the financial landscape. However, a recent LIMRA study found that 61 percent of annuity consumers conduct online research. This means buyers nationwide are finding out about secondary market annuities online, and it’s time that more advisors become familiar with the market before their clients come asking.
What is a secondary market annuity?
The term “secondary market annuity” (SMA) refers to existing, in force period certain payment streams. We use the term “secondary market” to differentiate these existing payment streams from “primary market” newly issued period certain annuities.
While there are payments in the SMA market that originate in lottery prizes and individually owned annuities, it’s important to clarify that most SMA transactions stem from structured settlement compensation for legal claims like personal injury or medical malpractice. It’s also important to note that these secondary market transactions have nothing to do with viaticals or life settlements. Life settlements make bets on actuarial tables, but the secondary market annuities discussed here are period certain guaranteed receivables.
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So, what are structured settlement annuities?
The majority of secondary market annuities are guaranteed payment streams backed by period certain annuities from major carriers that currently pay compensation for damages, injuries, or legal claims.
When an injured party elects to take their award as a “structured settlement” over time, U.S. tax code IRC 130 allows the plaintiff to receive their compensation tax free. By opting for a structured settlement over time rather than a lump sum, the plaintiff can receive both the award and the earnings of that award tax free.
Defendants typically use a qualified settlement fund or other vehicle to shift compensation for the injured party to a major carrier in a tax qualified manner, and generally purchase a life with period certain annuity to fund the specific payments due under the settlement. The qualified fund or an affiliated entity of the defendant is the annuity owner, and the plaintiff is the payee.
Structured settlements are a useful tool in the legal system that help provide for minors, help injured people support themselves if they are not able to work, and help reduce reliance on public support systems.
However, times change and often, payees under a settlement have a need for cash. As the payees are not the owners of the annuity, their payments are not commutable directly with the carriers into cash. Sellers of payments turn to factoring companies to purchase some or all of their future payments for cash today, and must accept a discount rate for those future payments.
Why the high yield?
When sellers sell at a discount, a secondary market annuity is created that offers the new recipient a higher-than-market rate of return. Buyers of SMAs can receive yields 1 percent to 4 percent higher than comparable primary market, period certain annuities of similar credit quality.