Secondary Market Annuities (SMAs)

A popular and competitive market since the 1980s, the secondary annuity market is an industry allowing customers who have already bought annuities to sell their policies to another provider. In exchange, they receive a lump sum for secondhand annuities and structured settlements.

In the primary annuity market, insurance companies sell annuities to those seeking long-term financial security. In the secondary market, annuity owners may choose to sell their annuities for an immediate, cash-now option, rather than waiting for a disbursement. Owners can sell annuity payments worth $25,000 to $200,000 or more.

Within only a few decades of its creation, the secondary annuity market developed into a large, competitive and regulated industry. The market developed when laws were enacted permitting annuity owners the option to receive a portion or all of their earnings immediately rather than waiting months or years for a full disbursement.

The market consists of lottery winners, lawsuit winners, wrongful death claimants, some workers’ compensation claimants, and owners of other structured settlements collecting monthly or yearly financial payments. This industry connects annuitants to investors willing to pay cash now in exchange for the rights to long-term payment streams.

These single premium immediate annuities (SPIAs) – or annuities paid for by one up-front premium payment – and structured settlements happen from a variety of circumstances. A majority of them come from court. That is, people who win large court judgments or settlements from wrongful death lawsuits and personal injury claims. These financial windfalls, which sometimes represent hundreds of thousands of dollars, don’t get paid out in one lump sum. Instead – especially in the case of court settlements – the awards are doled out in a structured manner, over a period of months or years.

As with any investment, secondary market annuities carry a number of risks and benefits. SPIAs typically stem from people pre-funding their retirement years ahead of time. These types of annuities can also be sold on the secondary market as future retirees trade long-term money for up-front money. When annuity or structured settlement rights holders resell their payments to a third party, the periodic income transfers to a new assignee and usually provides a higher rate of return to the purchaser.

In addition to benefits, secondary market annuities carry a few drawbacks for annuitants.

The secondary market started in the 1980s with financial companies acting as the “lender of last resort” for annuity owners. Clients ranged from lottery winners to physical injury structured settlement recipients — all looking for a more immediate way to access their cash, rather than waiting for monthly or yearly payments.

It wasn’t until the primary market grew that investors began using this alternative solution. After the 1982 Periodic Payment Settlement Act began offering tax advantages to help promote the use of structured settlements, new annuity owners began providing a consumer base for companies capable of providing immediate capital.

The practice of buying the payments established in the primary market became known as “factoring”. By 1997, at least five major companies competed to buy periodic payment rights.

Since then, the industry has quickly developed into a profitable market, functioning amid minimal regulation. Companies in the primary annuity market objected to the second-, third- and fourth-hand sale of their products, believing the sales undermined the rationale behind them. If the point of a structured settlement is to prevent the misuse or dissipation of a lump-sum payment, which historically had been awarded to personal injury victims, how could converting it back to a lump-sum payment be in the best interest of the payee?

Government regulators were not swayed, and the secondary market persisted. However, the lack of uniformity and regulations for factoring company practices left annuitants vulnerable. Unsophisticated annuitants sold their payment rights at steep discounts, and some unscrupulous factoring companies purchased payment rights with little regard for the future financial needs of their sellers.

Despite its controversial start, state governments recognized that the secondary market fulfilled a demand in the annuity industry. People wanted their money and wanted the ability to swap their long-term payment rights for money now. Governments also realized the secondary market needed regulation.

Legislators instituted state and federal regulations to protect consumers, with Illinois acting as the first state to institute a Structured Settlement Protection Act (SSPA) in 1997.

Other protections introduced include the National Structured Settlements Trade Association in 1985 and the National Association of Settlement Purchasers in 1996. These associations monitor legislative activity and work to protect annuity owners and the companies purchasing payments.

In 2002, the federal government amended the tax code to ensure companies comply with SSPAs. Federal law also mandates that structured settlement transfers be approved by a state court judge, who determines if selling the rights to structured settlement payments is not only “legitimate” but also in the best interest of a payee and any dependents.

Though secondary market annuities carry some level of risk as with other investments, they are seen as a safer alternative to market-based investments. These annuities come with a payout guarantee and a fixed rate that won’t fluctuate based on the market performance. However, annuitants cannot easily liquidate their contracts. As a result, all investments are tied into the contract until the terms have ended.

Industry experts expect the secondary market to grow, propelled by the constant flux of consumers’ changing financial priorities and the rise of seniors looking to invest in their retirement. Additional retirement income over the years has become more of a need than a luxury. A secondary market annuity can help provide a greater financial return on income for seniors looking to build upon their nest egg. However, investing in a secondary market annuity can be a complicated decision.

In addition, participation in the primary market ensures a stream of potential participants in the secondary market. An adage that continually seems to be true is that people always need money now.