A reader writes in, asking:
From reading your blog, I know you’re a big fan of lifetime fixed annuities. But I wanted to get your thoughts on secondary market annuities. For example, here are some that I found by googling.
These are backed by some pretty big insurance companies, so why don’t more people invest in these? The returns look better than bond returns. Is the risk that bad?
What’s a Secondary Market Annuity?
Secondary market annuities are fixed annuities that you purchase from somebody other than the insurance company that’s actually behind the annuity.
Example: Don wins a state lottery. His prize is an annuity, backed by MetLife, which will pay $10,000 every month for 10 years (for a total of $1,200,000). Don, however, decides that he wants his money immediately. So he sells his annuity to a receivables factoring company for a lump sum of $400,000. This company then turns around and sells the annuity (at a markup) to other buyers.
Because they are fixed-period annuities, secondary market annuities are quite different from the inflation-adjusted lifetime annuities that I often talk about, because the whole point of lifetime annuities is to provide a guaranteed income for the rest of one’s life, while secondary market annuities provide income over a fixed period.
In other words, secondary market annuities are more comparable to regular bonds or CDs.
How Do They Compare to Bonds?
As I write this, the first item from the page linked to in the reader’s email is a secondary market annuity from MetLife with a 4.25% yield and a 19-year duration. (It appears that they turn over pretty quickly, so this particular annuity might not actually be there by the time you read this.)
So that’s a premium of 1.68% (that is, 4.25% minus 2.57%). In exchange, you take on various risks.
First, there’s a slightly higher amount of credit risk with the annuity than with a Treasury bond. But for an annuity from an insurer like MetLife, the credit risk is still quite low.
Second, there’s a degree of legal risk, because these are complex transactions (at least, far more complex than buying a simple Treasury bond). You will want to hire a knowledgeable attorney (one representing you rather than the seller) to look over the documents to be sure that there are no “gotchas.”
Thirdly, there’s liquidity risk due to the fact that it’s nearly impossible to sell what was already a re-sold annuity. (In some cases you might even be legally forbidden from selling it.) So you can expect your money to be tied up for the duration of the annuity. (This is in contrast to a Treasury bond, which is arguably the most liquid investment on earth.)
So is that 1.68% risk premium worth it? For some people it might be — if, for example, a few such annuity purchases would only make up a small portion of the fixed-income side of your portfolio, and you don’t mind spending the time and money to hire an attorney to do the appropriate due diligence regarding the transactions.
For me personally, I don’t want anything to do with them.