“Synonym: A synonym is a word or phrase that means exactly or nearly the same as another word or phrase in the same language”
When it comes to Secondary Market Annuities, the marketplace suffers from a plethora of terms. This page should clear up any misunderstandings.
Unfortunately, in the “Wrong” column are several misleading ‘derivative’ words propagated by questionable industry participants who add only confusion and misinformation to the marketplace.
Understanding the Term “Secondary Market Annuity”
A ‘secondary market annuity’ is a term used to describe the court ordered right to receive payments backed by annuities issued in conjunction with structured settlements.
The term ‘secondary market annuity’ may also be substituted with other commonly used terms such as factored structured settlement, structured settlement payment right, or assigned payments.
The term is not at all synonymous with or a relative of a derivative. “In finance, a derivative is a contract that derives its value from the performance of an underlying entity”. Practically speaking, derivatives are usually securities contracts, and the underlying assets take a wide range of forms, from pork bellies to pesos. Prices and values of derivatives can swing widely and are dependent on a number of market forces and factors.
By contrast, secondary market annuities are relatively simple transactions in which a court ordered procedure changes the payee of an in force and existing annuity contract. The price of an SMA is a simple discounted cash flow calculation- it’s the present value of the future payments, at the stated discount rate. It’s math that anyone can do with a little familiarity with basic financial concepts, and the price, payments, and values don’t fluctuate one penny.
Furthermore, most transactions are handled pursuant to IRC§5891(c)(2) and relevant state-specific structured settlement transfer protection act guidelines that give regulatory certainty and consumer protection. In these assignment proceedings, the right to receive payments due under a structured settlement annuity is transferred, but the ownership of the actual insurance contract does not change hands.
Origin of the Secondary Market for Structured Settlement Payments
Initially, the transfer of structured settlement payment rights was the domain of larger institutions. Transactions were packaged up by large buyers such as JG Wentworth, securitized, and sold to institutional investors.
During financial crisis of 2007–2008 a number of intermediaries began marketing structured settlement payment rights to financial advisors and individual investors. Various labels included the term “annuity”, such as in force annuities, secondary market annuity, secondary market income annuity and/or the acronym SMA or SMIA.
The industry has largely coalesced around the term ‘Secondary Market Annuity’ however none of the other terms using the word ‘annuity’ are incorrect or misleading, as “An annuity is a series of payments made at equal intervals.”
Given that what transacts is a series of payments (which by definition is itself an ‘annuity’ ), and those payments are backed by an annuity issued by a major life and annuity insurance company, and that the annuity company is a party to the transfer proceedings, the term ‘annuity’ is wholly appropriate.
And as the transfer occurs in a secondary market transaction among private parties, the term ‘Secondary Market Annuity’ becomes a totally accurate term for the asset.
How Do Regular Annuities Compare With a Secondary Market Annuity?
Primary annuities come in a wide range of configurations, from life only immediate income annuities, to growth oriented fixed and fixed index contracts. Typically, structured settlements utilize period certain guaranteed and life contingent lifetime income annuities issued by highly rated carriers to make the payments due under the terms of the settlement.
In most cases, annuities are shielded from creditors in accordance with their statutory protections. Even in bankruptcy proceedings, they are usually considered an exempt asset and cannot be accessed by creditors.
However, once the right to receive payments due under a structured settlement annuity goes through the assignments and court proceedings to change the payee, it would lose this creditor protection and, like any other asset, be open to the claims of creditors.
In addition the tax treatment of what we call a secondary market annuity may vary from regular annuities, in that regular annuities are taxed using LIFO or ‘Last In, First Out’ accounting, and an SMA is handled by the purchaser and their tax preparer typically as an amortizing receivable, or on an exclusion ratio basis.
Regulation of Sales Practices
Originators of structured settlement payments are typically factoring companies and attorneys. Most factored structured settlement payment rights are acquired by special purpose vehicles and securitized in institutional asset-backed transactions.
However, a small percentage of the transactional flow on an annual basis may be offered for sale to individual investors, some of which may be labeled as a ‘secondary market annuity.’ DCFAnnuities.com is a major retailer of Secondary Market Annuities from the nations premier source of payments, DCF Exchange.
Sales agents are currently not subject to state based licensing requirements as the transaction does not change the ownership of the underlying annuity, which is an insurance licensed activity, nor does the assignment and sale of a payment stream backed by a structured settlement annuity constitute a securities transaction per the Howey Test.
Practically speaking, however, consumers typically encounter secondary market annuities from licensed insurance agents and financial advisors who may be subject to various licensing requirements for their other lines of business. Consumers should inquire as to the professional qualifications of the agent they are working with.
However, be wary of agents who market the product using the State Insurance Guarantee Funds as a selling point. Most states have, as part of their insurance laws, an advertising prohibition which specifies that insurance companies and insurance agents may not use the existence of the guaranty association for the purpose of sales, solicitation, or inducement to purchase insurance, including annuity contracts.
Even though it should not be a lead-in marketing point, it’s important to understand that state guarantee funds are a frequent question among those considering Secondary Market Annuities. The case the case of Executive Life of New York provides some guidance where all payees- both original annuitant and assigned payees- to this day receive restructured benefits under their structured settlement contracts. Insurance company failures are generally very rare, however, and by design the carriers involved in the structured settlement market are among the strongest financial institutions in the world.