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Learning the History of AnnuitiesHow old would you say annuities were? They seem like pretty modern financial tools, and to a great extent, they are. However, the humble annuity also has a pedigree that would make any purebred dog blush with jealousy – they can trace their lineage back to the Roman Empire. In Rome, contracts were called “annua” and were pretty similar to what we know today. They were agreements between buyers and sellers that guaranteed a steady stream of specified payments for a set number of years in exchange for a sum delivered up front. Sound familiar? It should. The arrangement offered security for both buyers and sellers, much as it does today. Buyers were able to ensure that they had financial support for as long as they deemed necessary, while sellers were able to earn a profit with the potential of paying out less than they took in throughout the term of the contract.
Of course, there was some ambiguity here. Annua sellers weren’t able to predict exactly how long their clients might actually live, which could mean that they ended up paying out more than they took in if the buyer lived a long time. “Necessity is the mother of invention,” as the saying goes, and annua sellers took it on themselves to come up with a way to get around that ambiguity.
In 222 AD, the Roman scholar Ulpianis created the first actuarial table in history, which showed the overall potential lifespans for all potential annum buyers. From that point, the ancient Roman annua began to resemble our modern annuities even more closely. Actuarial tables dictated many different things, including:
- The terms of the contract
- The interest rate of the contract
- The payouts of the contract
The Evolution of AnnuitiesWhile the ancient Romans might have been the first people to use annuities as we recognize them, it didn’t stop there. Annuities have been used ever since their invention, and they have evolved over time to better meet the needs of both buyers and sellers. For instance:
- Communities and municipalities used annuities to help spread investment wealth
- The Catholic Church used annuities to help raise funds
- Many rulers utilized annuities to fund their wars or to finance public works throughout their region
From that point, annuities have come down to us, and they remain an excellent solution for long-term financial security for most people.
The Birth of Annuities in the USGiven the widespread use of annuities in Europe during the 1700s, it makes sense that they would cross The Pond to our shores about that time as well. In fact, the first recorded annuity here in the US took place in 1759. It was at the behest of the Corporation for the Relief of Poor and Distressed Presbyterian Ministers and Distressed Widows and Children of Ministers, and took place in the soon-to-be state of Pennsylvania. In essence, the annuity provided ongoing payments to retired ministers and their survivors in exchange for premiums paid while they were actively in church service.
There are numerous other key dates in the development of annuities within the United States. These include the following:
- 1776 – This year saw the creation of the National Pension Program for Soldiers, which was an annuity designed for soldiers and their families in pre-Revolutionary America.
- 1812 – This year saw the founding of a company specifically designed to sell annuities to the American public, the Pennsylvania Company for Insurance on Lives and Granting Annuities.
- 1905 – This year saw Andre Carnegie found the Teachers’ Pension Fund, which was intended to distribute annuities to American educators. In 1918, it transformed into the Teachers’ Insurance and Annuity Association.
- The Great Depression – The Great Depression was the bleakest, most disastrous economic event ever to hit America, and during this time, annuities and life insurance policies helped investors protect some measure of their wealth.
- 1935 – It might come as a shock, but Social Security, founded and signed into law in 1935 by President Franklin D. Roosevelt, was and remains a lifetime income annuity.
- 1952 – TIAA-CREF, the educators’ retirement fund, began offering members the first group-variable deferred annuity available.
- 1986 – This year saw significant tax law reform that made annuities the only tax-deferred or tax-free financial product available to American citizens, while allowing unlimited amounts of money to be deposited into the financial vehicle.
- Today – Annuities have become immensely popular not only as investment vehicles, but as the preferred option for paying out court settlements in personal injury cases, workers’ compensation cases, product liability cases and more. 2011 alone saw annuity sales of $240 billion and that number continues to grow. Current estimates place the total amount of annuities owned at somewhere north of $1 trillion.
The Rise of the Secondary Annuity MarketAnnuities have generally been a contract between a buyer and seller. That’s still the primary use of these financial vehicle, but another market has grown up as well – a complementary one, called the secondary annuity market. There are several reasons for the rise of this market.
Firstly, while annuities are excellent vehicles for investment, they’re not so beneficial because of their time-determined payout structure. For example, if a person received a structured settlement (an annuity) for damages awarded during an auto accident, that amount would be split up and paid out over time. The victim receives the money he or she is due, but they don’t get it at one time. On the surface, that doesn’t seem so bad until you realize the frustration in the situation. They’re facing mounting medical bills and loss of income because of the accident, but they can’t get at the funds they already own to pay those things off, because of the time-delayed payment structure of the annuity.
Another problem here is that if the annuitant has been awarded a structured settlement because of an accident or other court decision, they’re forbidden from changing the terms of that agreement, even if that means they can’t pay bills due directly to the accident that started the entire chain of events. They have the money, but they can’t get at it, and they can’t restructure the agreement so they can access it.
The PPSACongress got involved here back in 1982 when it passed the Periodic Payment Settlement Act, which was designed specifically to encourage the use of structured settlement in the case of physical injury cases. The PPSA amended the tax law to ensure that every structured settlement payment was completely exempt from any form of income tax (including local, state and federal income taxes). That was a big change, and it was one that had a massive impact on the secondary annuity market. Some might say that it actually spurred the true development of the mature market in the first place.
The reason that the PPSA had such a massive impact on the annuity marketplace is this – it ensured that owners selling their structured settlements for a lump sum payout did not have to pay income tax on that amount. That gave them most of their money up front, without them having to shell out 30 or 40% of it to Uncle Sam. That was the underlying need that drove the birth of the secondary market.
The term “secondary market” sounds a bit ambiguous, so let’s break things down a little bit more. There were traditionally only two players in the “first” annuity marketplace – annuity buyers and annuity sellers. However, with the rising need to sell existing annuities in exchange for a lump sum payment, a third player was needed – enter factoring companies. Factoring companies acted as a bridge, connecting those seeking to sell their annuity with those who wanted to buy it.
Of course, this didn’t go off without a hitch. The insurance companies who issued annuities didn’t like the idea of their customers selling their products without any say-so. The thought was that it would undermine the rationale that propped up the issuance of structured settlements in the first place. Again, this made sense, at least on the surface.
The point of issuing a structured settlement in the first place was to protect the consumer from themselves – too many people spent their lump sum settlements frivolously, leaving nothing to brace up their financial situation down the road. To the insurance companies, converting a structured settlement back into a lump sum settlement didn’t make any sense.
On top of that, there was little regulation in the industry, which meant that unscrupulous companies could take advantage of consumers in desperate need of cash. Steep discounts, exorbitant fees and other problems were definitely present.
Again, on the surface, a secondary market didn’t seem like such a great idea, but if you dig deeper, it begins to. The government realized that the secondary market answered a demand. There was a need that this market addressed. Of course, the government also realized that there was an immense need for regulation in the market in order to safeguard consumer while policing factoring companies. Thus was born the Structured Settlement Protection Act (SSPA) which has been adopted by most states now (43 of the 50 have a version of the SSPA in place).
The SSPA was rolled out in 2002 as a federal law governing the secondary annuity market, and making it easier for consumers to sell their structured settlements without fear of being taken advantage of. Of the 50 states, 43 have adopted the SSPA either in whole or in part, and have also modified that law to offer further protection for their residents.
There were several “hard” requirements in the SSPA. One of these was that any settlement sale that did not meet with a qualified state statute had a 40% federal excise tax imposed on it (effectively removing the tax-free protection offered to qualified sales). A second requirement was that all sales had to be approved by a judge. This ensured that all sales of structured settlements would be in the best interests of the consumer, rather than the factoring company, and also helped to cut down on the risk of hidden fees, steep discounts and other pitfalls that threatened consumers.