David R. Evanson
National Underwriter, Winter, 2006
An emerging secondary market for annuities is providing investors as well as the brokers and agents who advise them with flexibility and new opportunities to maximize the investor’s financial resources. But, with respect to the secondary market, the question that investors and advisors ask themselves is what kinds of annuities offer the most value in the secondary market, and which do not?
One area which tends to offer investors significant value in the secondary market are Single Premium Immediate Annuities (SPIAs) or deferred annuities in payout, hereafter collectively referred to as payout annuities.
One reason that investors can derive significant value for payout annuities in the secondary market is because once their annuities enter the payout stage there are very few, if any liquidity options for them. Thus, for the investor that needs liquidity fast, and has no other options, the secondary market is a godsend.
Testimony to the value of liquidity is the spate of new annuity products that have liquidity options built into them already. Insurance companies recognize they can appeal to a larger market for annuities if their products offer cash out options. The fact that these annuity products have yet to gain traction however has more to do the high costs and low rates on these products rather than a conceptual miscue.
The high cost of liquidity and low rates in these products are ultimately attributable to the rigidity of insurance company balance sheets. However, buyers in the secondary market have an advantage, because unlike the issuers of annuities, they are not matching the duration of their assets and liabilities. As a result they can offer more value on a resale basis than investors are likely find ‘baked in’ to the product itself.
Another area where investors can realize value in the secondary market is with deferred annuities that have an annuitization requirement or which can be annuitized at a value that is significantly higher than the cash surrender value. This opportunity exists because of a differential in the discount rates. Specifically, buyers in the secondary market can purchase the asset, annuitize, and discount back to a present value that is significantly higher than the surrender value in the original annuity contract.
And once again, this differential is attributable to the structural differences in the balance sheets of insurance companies versus opportunistic buyers of annuity assets. While issuers are funding long term liabilities such as life policies with annuity contracts, buyers are simply pooling assets and securitizing them. This difference results in a discount rate arbitrage that forms the basis of the value that can be drawn from the secondary market by investors.
Generally speaking, the time to the annuitization requirement and the difference between the account value and the surrender value have the greatest impact on the investor’s ultimate outcome. More specifically, shorter annuitization periods, such as five years, and larger differentials between account and cash values, generally a north of 20%, will increase the value consumers can realize in the secondary market.
Annuities where investors are likely to realize relatively little value in the secondary market are those that do not have some form of guaranteed payment. There are several reasons for this, but almost all of them relate to the capital structure or the financial operations of annuity buyers in the secondary market.
Specifically, annuity buyers operating with some degree of scale will likely finance their asset purchases with a warehouse line of credit and these lines may have covenants that preclude the purchase of assets without guarantees or may require higher interest rates for purchases of assets without guarantees These same buyers may also pool and securitize the annuities they purchase, and their bond insurers may extract less efficient pricing for portfolios containing assets without guarantees. Taken together or separately, these two market dynamics conspire to place downward pressure on the price buyers will pay for annuities without a guarantee on its payments.
Also noteworthy regarding where value can and cannot be found in the secondary market is whether or not a particular annuity has a qualified tax status. Those that do have a qualified status offer investors very little resale value since they are non transferable and non assignable.
In addition to optimum product profiles there are also optimum investor profiles. Those most likely to seek out liquidity for their annuities, and derive the most satisfaction from a sale include investors who: have shifted their financial plan toward wealth transfer those who inherited annuities, or had a significant life change requiring a lump sum or cash, or individual who have found that initial decision to purchase an annuity was a regrettable one.
Michael Vaughan is the managing director of the J.G. Wentworth Annuity Purchase Program™ (www.jgwannuities.com). J.G. Wentworth, which has purchased more than $1 billion in annuities and other deferred payment obligations over the past 14+ years, is making a secondary market for annuities available to agents and brokers with the Annuity Purchase Program. Contact Mr. Vaughan toll-free at 800-535-0195 x2387, direct at 484-434-2387, or by e-mail at firstname.lastname@example.org.
Shorter annuitization periods and larger differentials between account and cash values, will increase the value consumers can realize in the secondary market.
The question that investors and advisors ask themselves is what kinds of annuities offer the most value in the secondary market, and which do not?
Investors can find more value on a resale basis than they are likely find ‘baked in’ to the product itself.