NEW YORK - A secondary market for annuities similar to life insurance viatical contracts is becoming an increasingly viable option for advisers with clients who no longer want their annuities.
"We estimate that 5% to 10% of annuities are in the hands of consumers who would sell if they could," said Michael Vaughan, managing director of J.G. Wentworth in Bryn Mawr, Pa., which specializes in buying fixed annuities, most of them equity index products.
The program is available in 47 states, and the firm seeks to sell it through broker-dealers and banks, in addition to independent agents.
Firms that buy annuities provide the client with a discounted lump-sum payment based on the present value of the annuity contract. Wentworth, for example, usually uses a discount rate of 7% to 8%. But some advisers have seen much steeper rates - as high as 17% - meaning that the client would have fared better by simply taking out a personal loan for about 8% and using the annuity stream to pay it off.
"Emergency cash flow is the main reason people may choose to sell their annuity," said Heidi Modugno, director of operations for Sell-
YourAnnuity.com, a Parsippany, N.J., firm that buys variable annuities.
"Due to the negative press variable annuities have received, some people question whether it's the right investment for them," she added. "If they're inside their surrender period, there could be substantial penalties if they terminate the contract with the insurer."
Another company in the business of purchasing variable annuities is Coventry First LLC in Fort Washington, Pa.
According to Mr. Vaughan, clients sell annuities when they have life situations - such as medical emergencies - requiring an immediate lump sum of cash instead of the periodic payments the annuity provides. But there are other uses as well, such as when people "unretire" and when their regular salary makes the annuity payments unnecessary.
Also potential sellers, Mr. Vaughan noted, are young clients who inherited their annuities from an older relative and who would prefer other types of investments for tax reasons or to obtain better returns.
Advisers are cautious about telling clients to sell their annuities, but note that there are scenarios in which selling is a viable option.
"It depends on how fast the client needs liquidity," said Adam Paglione, vice president of BCG Securities Inc. in Delran, N.J., which has $400 million under management. "For instance, there could be a serious health problem that's not sufficiently covered by insurance."
Insurers acknowledge that a secondary market for annuities could be useful in certain limited circumstances, but they are wary.
"Are there enough people who really need this product, or are the firms that are selling it manufacturing the need?" asked Linda Lanam, vice president of annuities and marketing for the American Council of Life Insurers in Washington. She added that clients should not think of insurance and annuities as "fungible assets" that can be bought and sold like commodities.
"For many, a lump sum looks more attractive than small periodic amounts, but that might not be the case - it depends on whether the lump sum is used wisely," Ms. Lanam added. "If the annuity is the client's only asset and there's an emergency need, there may be no other recourse than to sell it."
It is conceivable that the client may use the annuity sale proceeds for non-emergency situations such as to expand a business or to buy a vacation home, Mr. Paglione noted. "The adviser's obligation is to notify the client regarding what's being sold, including all costs and fees and tax ramifications, and make sure it's suitable," he said.
How much an annuity is worth depends on the insurer's financial-
strength rating, current interest rates, the periodic-payment amount, and other terms and conditions, such as whether a death benefit is included. It's possible for clients to sell just the payment stream and retain the death benefit for their beneficiaries, according to Mr. Vaughan.