There are 5,000 structured settlement transfers every day where individuals trade long-term security for immediate liquidity. This massive ecosystem represents the secondary income market, a space where future promises become today’s capital.
When an original holder decides they no longer want to wait for an annuity or royalty check, they sell that right to an investor. The buyer provides a lump sum upfront and assumes the role of the payee for the remainder of the contract.
Asset Types Commonly Traded
The secondary market consists of many different financially productive assets. The assets may have different structures and risk profiles; however, they are all alike in that they provide predictable revenue over time.
Annuities
Annuities are insurance contracts that allow an individual to receive regular cash flow payments, typically after they retire. Some owners of annuities later sell their right to receive future cash flows for a lump sum as well.
When evaluating a potential sale of an annuity, buyers often consider the credit rating of the annuity issuer and the way in which annual cash flows will be received.
When looking to purchase an annuity payment sale, customers tend to conduct their own due diligence on companies that purchase annuity payments with regard to reputation, transparency, discount rates and overall customer service prior to executing a transaction.
Structured Settlements
In structured settlements, periodic payment amounts are made from resolved legal claims (usually for personal injury) instead of a single payment. Backed by highly rated insurance companies, structured settlements offer low-risk payments, which are often sold by the original payee (recipient) to generate immediate cash flow.
Royalty Payments
Royalty payments refer to various forms of revenue made available to creative professionals or companies as compensation for their intellectual property or the extraction of natural resources. Some common examples of royalties are: music publishing income, book (authorship) royalties, patent licensing fees, and oil and gas royalties.
An artist/creator may choose to sell the future stream of royalties associated with their catalog for quick monetary gain, while an investor may wish to invest for a long-term return in previously created works.
ARR and Subscription Securitization
Securitization is another way in which subscription businesses can raise capital. In particular, companies that have an annual recurring revenue (ARR) (i.e. a predictable revenue stream) will often bundle their ARR and sell it in the form of securities. It allows companies, such as SaaS companies, to issue securities that are backed by a predictable cash flow (i.e. future subscriptions) without having to issue new equity.
Participants In the Income Ecosystem
Various groups of people are involved in the secondary market, which facilitates the buying/selling of income-producing assets through different types of participants performing different functions for the transfer, pricing, regulation, and servicing of these assets.
Depending on the type of income stream being sold (for example, annuities, structured settlements, royalties, or subscription revenues), there will be a different combination of participants, but the following types of participants will typically exist in this ecosystem:
Individual Sellers
Individuals who want to receive cash payments now will usually sell their structured settlement, lottery winnings, or annuity receipt to someone else for immediate payment. There are many life events that can prompt an individual to make the decision to sell future income. These events may include medical bills, repaying debts, taking advantage of a business opportunity, or purchasing a home.
Institutional Sellers
Businesses may also sell their future receivables in the form of predictably expected subscription income, franchise royalties, or long-term service contracts. It is often done within the software, health care, entertainment and energy industries, and is generally referred to as “securitisation” of the receivable.
Buyers and Investors
Hedge funds, private equity firms, insurance companies, specialty finance companies, and accredited investors invest in the receivables by purchasing the future income from an individual seller after evaluating the reliability of the stream of future registrations between the parties involved. The income purchased is then evaluated and priced according to the level of risk, length of time until paid, and current market conditions.
Intermediaries and Platforms
Brokers, market-makers, and advisors support these transactions by providing underwriting and by helping buyers and sellers complete their transactions in compliance with applicable regulations. Specialty finance companies dominate the transaction volume in the consumer market.
Regulatory Framework
In addressing the fact that transactions often require individuals to sell their long-term financial security, regulation also plays a significant role in protecting the interests of those involved in consumer-facing segments.
Structured settlement transfer transactions will generally require that each state obtains court approval to transfer ownership to the new owner. The judge will ensure that the transaction is in the best interest of the seller. This is done by ensuring appropriate disclosure of both the discount rate, any fees involved with the transaction, and the net proceeds to be received as a result of the transaction.
Institutional vs Consumer Transactions
Despite sharing an underlying basis of the transfer of future income rights, the institutional and consumer transaction markets operate in fundamentally different ways. In the institutional market, buyers participate in significantly larger transactions, generally set up in a private negotiation environment and generally consist of a large amount of due diligence.
The buyer or the buyer’s adviser will evaluate the transaction from a variety of perspectives, including financial statements, enforceability of the contract, historical performance data, and macroeconomic risk.
In contrast to the institutional market, most consumer-to-consumer transactions will be based on standardised terms and conditions and will have a significantly greater level of government regulation.
Sellers often use ads, online marketplace sites, and brokers to reach potential buyers. The seller's level of transparency, honest marketing, and quality of customer service, may vary considerably amongst sellers.
Secondary Markets Are Key When Reallocating Risk
The secondary market plays an important role in the economy by reallocating risk, providing liquidity, and allowing individuals to convert the rights to receive a long-term stream of payments into immediate capital to meet immediate needs or seize opportunities. It allows individuals to access diversified income-generating assets with predictable cash flows.
For individual sellers, there are important considerations before they decide to sell their rights to receive payment in the future. Such sales could result in a potential decrease in their long-term financial stability and could undermine their long-term objectives. However, in the right circumstances, an individual may be able to use the potential sale as a means of becoming more flexible in their financial situation and/or achieving strategic advantages.