The History of Annuities:
Annuities seem to be quite modern financial products, and to a large extent, they are. However, the lineage of annuities can be traced back to Roman Empire. The contracts were known as “annua” in Rome and they were quite similar to the ones we have today. These were the contracts between sellers and buyers which guaranteed steady flow of payments for an already set period of time in return for an amount delivered upfront. This sounds quite similar. Such an arrangement provided security for the seller and as well as the buyer, just like today. It enabled the buyers to make sure that financial support was available for them for a period they deemed necessary. On the other hand it enabled the seller to earn profits with chance of paying less than what was taken in by them during the entire term of contract.
There was a level of ambiguity in this. The sellers of annua could not predict how long the clients would live; this often meant that the annua sellers ended paying more than what they took in case the buyer lived for a longer period. As they say “Necessity is the mother of invention”, the annua sellers started to look for a way in order to get around this ambiguity.
The first actuarial table in history was created by the Ulpianis (a Roman Scholar), in 222 Ad. The table showed the potential lifespans of the potential buyers of annua. This was the point at which the Roman annua started to resemble the modern annuities quite closely. A number of different things were dictated by the actuarial tables, including:
- Contract’s interest rate
- Contract’s Terms
- Contract’s payout
All this was dependent on the expected death date of the buyer which was set by actuarial table. The actuarial tables allowed the sellers to build more profits in the operations by making sure that they earned more on the buyers who die before full payment of the annua. The hit which the sellers used to take on the buyers who outlived their terms of the contract was also minimized.
Evolution Process of Annuities
As mentioned earlier ancient Romans were the first ones who used annuities. The annuities have been in use since they were invented and they have changed over time to meet the requirements of the sellers and buyers in a better way. For example:
- In order to help the spread of investment wealth, annuities were widely used by municipalities and communities.
- Annuities were used by the Catholic Church for raising funds.
- A number of rulers used annuities in order to fund wars. They were also used by rulers for financing public works in their regions.
A great example of “annuity pools” is the France’s tontines of 1600s. These provided buyers with a lifetime income in return for upfront payment. France’s tontines and the death benefits of today even have a correlation. The money of the buyers who died was spread out to survivors. In 1700s the annuities became more popular, when different European Nations started to authorize the sale of the annuities in order to raise some funds for national coffers. These were considered great investments, particularly by the buyers or upper class. They were also regarded as excellent ways in order to offset the investments with the higher risks.
We now have the modern day annuities and they are a great solution for the financial security on a long-term basis for many people.
Birth of Annuities in the United States:
As annuities were used widely in Europe in the 1700s, it is quite easy to predict that they came to the United States about the same time. In fact, first annuity which is recorded in the United States was in 1759. A Corporation was behind this annuity in order to provide relief for the distressed widows of the ministers, distressed Presbyterian ministers and the children of the ministers. It was in the Pennsylvania just before it was declared a state. The annuity gave continuous payments to the retired ministers and the survivors of the ministers in return for premiums which were paid by them when they were involved actively in the church service.
Following are some other important dates with regards to development of the annuities in the US:
- 1776 – In this year the National Pension Program for Soldiers was created. It was actually an annuity which was designed for the soldiers and the families of solders in the pre-Revolutionary US.
- 1812 – In this year a company was founded, which was specially designed in order to sell the annuities to public in America, the Pennsylvania Company for Insurance on Lives and Granting Annuities.
- 1905 – The teachers’ Pension Fund was founded in this year by Andre Carnegie. The fund was aimed at distributing annuities among American educators. It transformed to Teachers Insurance and Annuity Association in 1918.
- The Period of Great Depression – During the period of great depression, which was the most hazardous economic period ever in the United States, the life insurance policies and annuities helped the investors to protect some level of the wealth.
- 1935 – In 1935, the Social Security was founded and it was signed to become a law by the then President Franklin D. Roosevelt. It was and still remains a lifetime income annuity.
- 1952 – The members of the TIAA-CREF, the educators’ retirement fund were offered the first group variable deferred annuity.
- 1986 – The year witnessed significant reforms in tax law and the annuities were made the only tax-free or tax deferred financial products available for the American citizens. It was allowed to deposit an unlimited sum of money in this financial vehicle.
- Today – The annuities today have become very popular as vehicles for investment as well as preferred options for the payment of court settlements in the cases of workers compensation, product liability, personal injury and more. In the year 2011 about $240 billion of annuity sales took place and the number is still growing. According to current estimates, the total value of the owned annuities is places somewhere around $1 trillion.
The Secondary Annuity Market and Its Rise:
Generally the annuities have been contracts between the buyers and the sellers. The main use of annuities is still the same, but there is another market which has grown a lot, it is a complimentary market known as the secondary annuity market. Rise of secondary market can be attributed to several different reasons.
The first thing is that although annuities are great investment vehicles, they are not quite beneficial because of the payout structure being time determined. For instance, if structured payment (an annuity) is received by a person for the damages awarded as a result of a car accident, the amount will be split and will be paid over time. The problem is that the victim gets the money but not at one time. This doesn’t look bad on surface, but it can be quite frustrating in some situations. The recipient might be facing loss of the income along with rising medical bills as a result of accident and they cannot get the funds which they own in order to pay the bills and other expenses, because of time delayed structure of payment of annuity.
Another big problem which arises is that in case a structured settlement is awarded to the annuitant, because of accident or some other decision of court, the annuitant is forbidden to change the terms of the agreement even in case they are unable to pay the bills. They own the money, but cannot get it and the agreement cannot be restructured by them in order to access that money.
Periodic Payment Settlement Act:
In 1982 the Congress passed the PPSA (Periodic Payment Settlement Act). The act was designed specially in order to encourage use of the structures settlement in cases of personal injury. In order to make sure that all structured settlements were entirely exempt from all forms of income tax, the PPSA amended the tax law. This includes local, state as well as federation income taxes. It was a huge change and had a huge impact on secondary annuity market. According to some people the real development of mature market was spurred by this law.
The main reason why the PPSA has such a huge impact on this marketplace is: – PPSA made sure that those owners who are selling the structured settlements in exchange for lump sum amount don’t need to pay the income tax the lump sum amount. This provided them most of the money upfront without giving about 30 to 40% to the government. This was the underlying need resulting in birth of secondary market.
This term “secondary market” might sound a little ambiguous, so let us break down thing a little more. In the first annuity marketplace there were just two players – They were the buyers and sellers of the annuities. However, with a rising requirement to sell the existing annuities in return for lump sum amount, there was a need for third player – factoring companies. These factoring companies played the role of a bridge, by connecting the sellers of annuities to the buyers.
Of course, it faced some problems. The idea that the customer could sell the products of insurance companies with any say from them did not go well with the insurance companies. There was a thinking that it will result in undermining of the rational which resulted in the issuance of these structured settlement in first place. It made sense.
The whole idea of issuing structured settlements was protection of consumers from themselves – Many people used to spend the lump sum amount carelessly, which left them with nothing for the future. So it didn’t make much sense to insurance companies.
On top of this, the industry had little regulation, which could result in some unscrupulous companies taking advantage of the consumers needing cash. Exorbitant fees, steep discounts and a number of other problems also existed.
Again, it did not seem like a good idea to have secondary market, if one looks on surface. However, if one digs deeper, having secondary market begins to look like a very good idea. It was realized by the government that the demand for the secondary market was there. It was also recognized by the government that there is a need for the regulation in market so that the consumer could be safeguarded and the factoring companies could be policed effectively. This resulted in the Structured Settlement Protection Act (SSPA). Most states have adopted it (a version of SSPA is in place in 43 out of 50 States).
In 2002, SSPA was rolled out in the form of federal law which governs secondary annuity market. As a result of the law the consumers can sell the structured settlements with confidence that they are not being taken advantage of. Out of 50, 43 states have adopted SSPA either in part or in whole.
The SSPA contained a number of hard requirements. One of the requirements was that if any sale of settlement did not comply with any qualified state statute, a 40% federal excise tax was imposed on it. There was the second requirement of approval of sales by a judge. It made sure that the sale of all the structured settlements was in the consumer’s best interest. It also helped cutting down risk of steep discounts, hidden fees and any other pitfalls which threatened consumers.
The secondary annuity market place today is a vibrant and important place. It makes sure that people with different annuity products are able to sell part or all of the settlement for lump sum amount without any threat of a disaster. The rights of annuitants are protected and they can access immediate cash in case they need to cover any costs of the situation.