The secondary market for structured settlement payments has its share of commentators who have tried to inject confusion into the marketplace, but they are misguided.
A ‘secondary market annuity’ is a term used to describe assigned payment rights backed by annuities issued in conjunction with structured settlements. These payments are transferred in a secondary market transaction following a court ordered and state-specific transfer process. The transactions are handled pursuant to IRC§5891(c)(2) and relevant state-specific structured settlement transfer protection act guidelines.
In addition to ‘secondary market annuity’ you may also hear other terms such as factored structured settlement, assigned annuity, in-force annuity, structured settlement payment right, or assigned payments. All are accurate, but secondary market annuity is the most common.
Secondary Market Annuities Are Not Derivatives
The term secondary market annuity is not at all synonymous with or related to a derivative.
“In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the ‘underlying'”
In a nutshell, derivatives don’t have a principal value that changes hands like the underlying asset. They simply derive their value from their relationship to the principal amount of the underlying asset by reference, which is known as as the *notional principal amount*. The derivative is related to but *entirely separate from* the underlying asset and therefore, the value of derivatives can swing widely and independently based on various market forces. Thus, derivatives – by their very nature – are used almost entirely for speculation and hedging.
Typical derivative instruments include: Futures markets, options on futures, options on any asset class including equities, bonds, foreign exchange and even institutionally traded derivatives like interest rate swap options called swaptions. Institutionally traded derivatives include Interest rate swaps, basis swaps and credit default swaps.
By contrast, secondary market annuities are relatively simple. They are court approved assignments of payments due under in-force annuity contracts. They have clearly defined sets of cash flows which actually change hands. They do not derive their value from any underlying instrument and are therefore clearly not derivatives.
Indeed, the price of an SMA is a simple amortizing cash flow calculation – it’s the present value of the future payments, amortized to zero at the stated discount rate. This is the same mathematics used to calculate a mortgage. Thus a mortgage is also – by definition – an annuity.
In addition, transactions comply with IRC§5891(c)(2) and state-specific structured settlement transfer protection guidelines that offer purchasers certainty and consumer protection. In these assignment proceedings, the right to receive payments due under a structured settlement annuity is transferred, but no derivative or security is created.
Secondary Market Annuities Are An ‘Annuity’
As structured settlement payment rights became known to investors, various labels entered the market, including in force annuities, secondary market annuity, secondary market income annuity and/or the acronym SMA or SMIA.
None of the terms are incorrect or misleading, as “An annuity is a series of payments made at equal intervals.”
Secondary Market Annuities Are Not Securities
Sales agents are not subject to SEC or 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.
The assigned payments are clearly outlined in the underlying annuity contracts, and those assigned payments appear in the court order, stipulation, and other documentation, all the way to the end purchaser.
In the DCF Exchange process, at no time are the payments subject to any co-mingling, common management, price variability, or payment diversion risk.
At the end of the day, a secondary market annuity is a relatively simple transaction. Purchasers acquire the right to receive payments due from in force and existing annuity contracts. The transfer process is state-regulated, court ordered, IRS compliant, and reviewed by legal counsel. The annuity itself does not change hands, just the right to receive the payments, and in the transfer process, no complex securities or derivative instruments are created.