Staying ahead of client demands in the annuity product game is no simple feat for even the most informed of financial advisors, and the latest trend may prove even more crucial to successful advising—it involves not a new product or rider, but an entire market for annuities.
Newly developed uniform transfer standards and increased availability have caused so-called “secondary market annuities” to surge in popularity amongst clients in their quest to find financial products with above-average interest rates to supplement retirement income. What once was a niche market is gaining traction with the ordinary investor, and it is time for all advisors to get up to speed.
A Primer on Secondary Market Annuities
Most secondary market annuities (also known as “factored” structured settlements) are annuities that were originally issued pursuant to structured settlements, meaning that the defendant in a lawsuit (often a personal injury suit) is found liable and, rather than pay damages to the plaintiff up front, reaches an agreement with the court so that the plaintiff receives the right to guaranteed annuity payments over time. In many cases, however, the plaintiff ends up needing the funds immediately and, through a court-approved process, transfers the right to guaranteed payments under the annuity to a third-party buyer for a lump sum.
The court approval process is necessary because, while the plaintiff has received the right to income under the annuity, the defendant technically owns the annuity contract. Through this process, the parties enter into an assignment agreement that is presented to the court, which will approve or deny the transfer based on whether it is in the transferring plaintiff’s best interests.
It is important to note that failure to comply with this court approval process can result in imposition of a tax equal to 40% of the discount at which the product is sold. In recent years, however, nearly all states have developed a standardized process that has made obtaining court approval much more simple.
Why Secondary Market Annuities?
A secondary market annuity is often able to provide the client with a higher-than-average interest rate because the selling plaintiff typically must sell his income rights at a discount. The interest paid out under the contract, however, is governed by the original contract terms, which may provide for a rate that is much higher than today’s market averages.
Because interest rates on guaranteed financial products have remained relatively low despite recent market success, these products, which are typically issued by large and well-known insurance companies, are often attractive to clients who are otherwise wary of locking themselves into a low interest rate.
Further, secondary market annuities have only recently become widely available to individual clients—prior to the latest financial crisis, these products were most commonly purchased by large, institutional investors. Today’s economic conditions, coupled with the newly streamlined court approval process, have opened the door for everyday clients to invest in the secondary market for annuities.
Secondary market annuities are not without risk—interest rates could rise during the annuity’s term and the insurance carrier’s financial health, as always, is critical to the success of the transaction. Because of these risks, and the fact that the market has been an unknown to many until recently, it is important that advisors are fully informed before recommending the strategy to any client.