What is a Secondary Market Annuity?
The term secondary market annuity or SMA, in short, refers to a current payment stream in a given period. The term secondary market is used to differentiate these existing payment streams from certain annuities of the primary market period.
Although there are payments in the market that originate from lottery prizes and individually owned annuities. It is important to clarify that the majority of secondary market annuity transactions come from structured settlement clearing. For example, legal claims for personal injury or medical malpractice. It is also important to note that these transactions have nothing to do with life settlements. Life settlements make bets on the actuarial tables, but the secondary market annuities discussed here are receivables guaranteed for specified periods.
So what are structured settlement annuities?
In short, most SMAs are guaranteed payment streams backed by certain period annuities. These SMAs are from the main operators that currently pay compensation for damages, injuries or legal claims.
When an injured party chooses to take their compensation as a structured settlement over time, US tax code IRC 130 allows the plaintiff to receive their compensation free of income taxes. By opting for a structured settlement over time instead of a lump sum, the plaintiff can receive both the award and the proceeds of that award without tax liability.
Defendants typically use a qualified settlement fund or other vehicle to shift compensation for the injured party to a parent company in a tax-qualified manner. Defendants then typically purchase a term life annuity policy to fund specific payments due under the settlement. The qualified fund or an affiliated entity of the defendant is the owner of the annuity and the plaintiff is the beneficiary.
Structured settlements are a useful tool in the legal system that help support children, help injured people support themselves if they are unable to work, and help reduce reliance on public support systems.
However, times change and often the beneficiaries of a settlement are in need of cash. Since the beneficiaries are not the owners of the annuity, their payments are not directly convertible with the carriers into cash. Payment vendors use 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 performance?
When sellers sell at a discount, a secondary market annuity is created that offers the new beneficiary a higher-than-market rate of return. Buyers of secondary market annuities can receive 1% to 4% higher yields than those in the comparable primary market, not to mention certain annuities of similar credit quality.