In-Force Annuities – Buying Someone Else’s Foolishness

Millions of people, in search of yields over 2%, have moved money from their banks accounts to financial markets. Buying up

Photo Courtesy of 401(k) 2012

REITs, MLPs, Preferred stocks, High Dividend-Paying Stocks and Junk Bonds has been the solution for some. And even though yields on those investments are still much higher than bank account yields, many a scared investor still has their money in the bank.

The fear of the markets from 2008 still permeates the brain cells of the masses. And this fear is not unfounded – Federal reserve interest rate manipulation has forced returns on their bank accounts down while encouraging speculation in risky assets. Many of these investors know that the market is not honest but manipulated and they fear that at any time  the market could correct again making their efforts at finding good rates futile.

One option that may not be obvious to folks (though advertisements for it hit TV all day) is buying (not selling) structured settlements or in-force annuities. In a recent email, for example, I received a list of available in-force annuities for sale. Here is a Anonymous selection:

  1. A State Lottery Commission: $574,555 @6%
  2. A Life Insurance Company: $55,564 @4%
  3. A State Lottery Commission: $197,339 @5.8%
  4. A Life Insurance Company: $31,032 @5.5%
  5. A Life Insurance Company: $630,846 @5.5%
Where Do These rates Come From?

How can they offer such high rates? First of let’s get a few disclosures out of the way. First, you are buying someone else’s existing lottery payments or annuity payments. Second, that means you will get payments over a period of time – you will not get to earn that rate of return and cash out at any time with earned interest. You are buying a discounted stream of income.

Of course some of you might say that is a bad idea – and some of you might say it’s a good idea, especially if you need income and you are comparing income sources. Others might also want to diversify, treat this like a laddered bond portfolio that matures a little bit each year, earn the interest and reinvest the regular checks into something else.

Furthermore, the backing of the offering is the issuer as you are taking over the stream of payments so your asset is backed by the insurance company or lottery commission that originally began the contract. And where did these contracts come from?

Many of you are likely familiar with a certain commercial on TV that offers to buy your settlement payments or annuity from you. I won’t mention names but they use opera singing and one of the repeating lines is “I need cash now!” Typically, someone is receiving recurring checks. Whether it’s from:

  • annual loterry payments
  • legal settlement over a period of years
  • a commercial annuity with monthly or annual payouts
  • other regular structured settlements

How Do They Come Up With the Right Value?

And they want to sell that payment stream for a lump sum. How do you calculate a proper lump sum? You would use a financial

Photo from 401(k) 2012

calculation to determine “Present Value of an Annuity.” Basically, it’s a calculation that says, assuming a certain interest rate (likely based off market rates +/-), what is the value of a stream of payments over time, if valued right now? In other words, if we were to trade regular payments for a lump sum now, what is financially speaking, a fair price for that? PV helps us with that.

Because people often have need for “liquidity,” (i.e. to cash out), these products will proliferate and could offer an astute buyer a decent investment – possibly taking advantage of someone else’s foolishness. I have been in this business long enough to say that for many people, a guaranteed monthly check is better for them than control over a lump sum of money – BELIEVE ME. With that said however, to sell, if you original annuity assumed a much higher interest rate, today’s low rates could increase the value of the lump sum. If you are involved in a situation like this on either side, it would certainly warrant further research and analysis before making a hasty decision.

If you have questions about this, if you are weighing an offer to buy or sell in this situation, give us a call. We can help. You can call our office at 781.393.0021 or send us a quick contact form with your questions/situation. Thanks for reading!

FYI: we are based just outside Boston in Medford MA but our advisors also visit and service throughout New England, Florida and the San Francisco Bay Area.