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Your Guide to Investing in the Secondary Marketplace
© 2010 by Thomas Hamlin. All rights reserved.
No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical. Any unauthorized use, sharing, reproduction,
or distribution of parts herein is strictly prohibited
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is
accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Thomas B. Hamlin and not necessarily those of RJFS or Raymond James.
Investments mentioned may not be suitable for all investors. Past performance may not be indicative of future results.
The S&P 500 is an unmanaged index of 500 widely held stocks that’s generally considered representative of the U.S. stock market. Inclusion of this index is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not
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Securities offered through: Raymond James Financial Services, Inc., Member FINRA/SIPC.
Somerset Wealth Strategies, Inc. is an independent firm.
4600 S.W. Kelly Ave. Portland, OR 97239 • 800.813.4000 • www.SomersetWealthStrategies.com • [email protected]
2Your Guide to Investing in the Secondary Marketplace
About the AuthorThomas Hamlin is a Registered Principal and Branch Manager with Raymond James Financial
Services, Inc., Member FINRA/SIPC and the founder of Somerset Wealth Strategies. He is ranked as
one of the Top 100 Financial Advisors in the country by Registered Rep magazine (for 2008 and
2009, based on assets under management). For 7 years he has been a member of Raymond James
Financial Services Chairman’s Council of the top investment professionals in the country out of about
3,300 advisors nationwide. (Membership is based mainly on assets under management, education,
credentials, and fiscal year production. Re-qualification is required annually.)
A 20-year veteran in the financial services industry, Thomas has helped more than 3,600 clients in
more than 45 states and is responsible for placing assets worth over half a billion dollars. He and his
team currently manage a portfolio of more than $450 million. He frequently contributes to and is
quoted by financial media such as the Wall Street Journal, Barron’s, The Chicago Sun Times, VARDS, Ignites.com, Tribune Media,
Registered Rep magazine, Financial Planning magazine, National Underwriter, Echos Times, Investment News, Research Magazine,
Senior Market Advisor and numerous newsletters and radio shows.
Thomas is the founder of Annuity FYI and is widely considered to have considerable expertise in the annuity industry.
Despite this exposure, more than 90 percent of Thomas’s production still comes from repeat business and client referrals.
Thomas and his wife Julie live with their three children Brian, Lindsey, and Sydney, in Lake Oswego, Oregon. They are very involved in
charitable giving through their family foundation.
Connect With Thomas:
3Your Guide to Investing in the Secondary Marketplace
Table of Contents
.........................................................................................Introduction 5......................................................................................Where Can Investors Turn? 6
...............................................................................................................................................S&P 500 6.....................................................................................................................Residential Real Estate 6
...................................................................................................................................Unemployment 7
......................................................................................Where Does This Leave Us? 8
.....................................The Secondary Marketplace for Investing 9...................................................................................................What is Factoring? 10
............................................................................................Due Diligence is Critical 11
.........................The 5 Most Common Types of Secondary Market Investments 13................................................................................1. Factored Structured Settlements (FSS): 13
.........................................................................................................................2. Lottery Winnings 16............................................................................................................3. Annuity Income Streams 17
...........................................................................................................................4. Life Settlements 17...................................................................................................................5. Viatical Settlements 20
.................................................................Time For an Alternative? 22
4Your Guide to Investing in the Secondary Marketplace
IntroductionHE LITTLE-UNDERSTOOD AND LESSER-KNOWN SECONDARY MARKETPLACE for investments is one of
the most exciting investing options in decades. The stock market has become so overused that
milliseconds count when it comes to placing trades. Competing with large institutions, individual investors are
finding it increasingly difficult to profit from the market.
There are always opportunities to be found, and one key to
success is to get involved early and to recognize a good
investment when you find one. Savvy investors don’t follow the
herd—they find much better investments by doing their research.
The secondary marketplace can be an option for such investors.
Assuming proper due diligence, these investments may be
suitable for your portfolio.
T
5Your Guide to Investing in the Secondary Marketplace
Where Can Investors Turn?
HE INVESTMENT WORLD IS LITTERED WITH PITFALLS. Investors are sick and tired of losing money.
Consider:
S&P 500On June 30, 2000, the S&P 5001 Index closed at 1,454.60 points. Exactly ten
years later it closed at 1,030.71, representing a massive 423.89 point drop
(29.14 percent) for the decade in the most highly regarded stock market on
the planet. This devastating collapse has set many investors back 5 to 15
years in their retirement plans. This means that someone who was 52 at the
start of the decade, with a goal of retiring at 62, may now need to work until
67 or 77!
Residential Real Estate The past 17 years in real estate reminds me of a WWF wrestler lifting up his
opponent higher and higher (1993 to 2006) until finally slamming him down
on the mat in a big thud (2006 to the present). The big difference here is that
it wasn’t acting, he’s really hurt, the soft mat was concrete, and he’s still in the hospital! This is terrible news
T
1 The S&P is an unmanaged index of 500 widely-held stocks. You cannot invest directly in any index.
6Your Guide to Investing in the Secondary Marketplace
for most Americans—even more so than the stock market crash, because most Americans have had (notice I
used the past tense) a majority of their wealth in home equity. Predictions on foreclosures look like we may hit
4 million by year-end, although the pace has been slowed significantly due to the bank not following the
proper procedures.
Unemployment*The national average for unemployment is 9.6% as of August 2010.2 These are some of the highest
unemployment rates since the recession of 1982, and prior to that you have to go back to the Great
Depression to find unemployment as high as today.3 I believe we should change course soon.
2 Source: http://en.wikipedia.org/wiki/List_of_U.S._states_by_unemployment_rate
3 Source: http://www.miseryindex.us/urbymonth.asp
7Your Guide to Investing in the Secondary Marketplace
Where Does This Leave Us?
T LEAVES MOST AMERICANS IN A VERY SCARY PLACE. Most
of us are not flush with cash—and if we are, it’s not keeping up
with inflation! Those of us who trusted the market lost big over
the past decade, and only those among us in the low single digits
can stay invested for the duration of that type of storm.
Now the big concern is can it happen again? What if the economy
double dips?
With the 10-year Treasury hovering around 2.5 percent, the
national average on a 5-year CD at 1.7 percent, and the top-yielding 10-year fixed annuity at 3.6 percent,
where can you invest your money?
Consider the secondary marketplace.
I
8Your Guide to Investing in the Secondary Marketplace
The Secondary Marketplace for Investing
HE PRIMARY MARKET FEATURES common investments like stocks, bonds, mutual funds, CDs, savings
accounts, fixed and variable annuities, life insurance, and more. Over the past two decades or so
different investments have cropped up: junk bonds (now called high-yield bonds), hedge funds, ETFs
(exchange-traded funds), UITs (unit investment trusts), derivatives, and so on.
In the secondary marketplace, “factoring” is used on structured settlements or previously-sold investments,
which creates new investments that investors can capitalize on.
T
9Your Guide to Investing in the Secondary Marketplace
What is Factoring?
ACTORING IS USED BY BUSINESSES and individuals to sell accounts receivable (invoices) to third parties
(called factors) at a discount in exchange for an immediate lump sum payment with which to finance
continued business. It is not a loan—it is the purchase of a financial asset (the receivable).
Factoring involves three parties: 1) the one who sells the receivables, 2) the debtors, and 3) the factor. The
sale of receivables transfers ownership of the receivables to the factor, which means the factor obtains all the
rights and risks associated with them. Accordingly, the factor obtains the right to receive the payments made
by the debtor for the invoice amount and must bear the loss if the debtor does not pay the invoice amount.
The factor's profit is the difference between the price it paid for the invoice and the money received from the
debtor, less the amount lost due to non-payment.
F
10Your Guide to Investing in the Secondary Marketplace
Due Diligence is Critical
HE SECONDARY MARKETPLACE IS LITTLE KNOWN.
However, the fact that it is little known doesn’t mean it’s all good—or safe for that matter, and I want to make
that clear. Think of these investments as used cars. If you buy your used car from a sleazy salesperson who’s
just looking out for himself and how much he can take you for, then you’re probably going to think twice
before buying your next used car. But if you buy a pre-owned certified car or an original-owner car from a
private party, then you will probably feel differently about used cars.
It’s kind of like the wild West 150 years ago. The people who got in early and did their homework did very
well, and the people who came late and/or didn’t do their research did not fare so well.
The people who fare the best in life are the ones who do their homework—a.k.a. due diligence and
research. They seek out people who have expertise and experience in what they're striving to learn.
T
11Your Guide to Investing in the Secondary Marketplace
Most people don’t consider an investment a good one until most everyone else is
doing it. But by the time everyone is invested, it may no longer be a good investment.
Why do you think the stock market is frothy and humming at a fevered pitch just
before it crashes?
When everyone and their brother is talking about buying XYZ stock or the stock
market in general it may not be a good time to invest! Conversely, when very few
people are talking about it, you may want to consider the opportunity. All of the
greatest investors in the history of the world have understood this basic principle.
12Your Guide to Investing in the Secondary Marketplace
The 5 Most Common Types of Secondary Market Investments
hese seven include the following:
1. Factored Structured Settlements (FSS)
2. Lottery Winnings
3. Annuity Income Streams
4. Life Settlements
5. Viatical Settlements
1. Factored Structured Settlements (FSS): Factored structured settlements (FSS), a.k.a.
secondary market annuities (SMA), are existing structured settlement payments. They were awarded by
settlement or jury to the injured party(ies) and funded through any number of insurance companies. The
awardee, or “Original Payee,” may have been the person hurt or it may have been a member of his or her
family. The payee (seller desires), for any number of reasons, to sell a portion or all of their payments in
exchange for a lump sum of cash.
T
13Your Guide to Investing in the Secondary Marketplace
In order to find an individual or entity (company, trust, endowment, etc.) to buy their payments they will often
contact their original attorney who will refer them to a reputable factoring company. However, more and more
payees/sellers are contacting factoring companies that they saw through advertising. Such companies include
JG Wentworth and Peachtree, who between them spend millions of dollars every year in an effort to attract
payees wanting to sell their payments. As with anything bigger, doesn’t always mean better, so if you are a
perspective seller we suggest you check with several factoring companies prior to making your final decision.
All factored structured settlements must go through a court approval process under Internal Revenue Code
5891. Currently, 47 states allow for the selling of structured settlement payments, of which all involve the
issuance of a court order following the judge’s approval of the transaction between seller and buyer.
The entire process can take months, but most are completed within 60 to 75 days. The lengthy time period is
because there is much paperwork and many background searches in addition to the application for the
hearing, which can vary greatly by state. Also, there is no title insurance or equivalent for these type
transactions, so it is imperative that the factoring companies do a thorough job of vetting out anything that
could be deemed potentially harmful to the buyer (e.g. an ex-spouse or children with a bona fide interest who
didn’t sign off relinquishing his/her rights to the payments, an undiscovered lien or attachment, etc.).
As a Seller there are also many ways you can structure your offer:
14Your Guide to Investing in the Secondary Marketplace
✴ Cash up front as a bridge loan against your proceeds (lump sum). Usually at 0% interest, but your
payment will be less in most cases than if you could have waited until the process was complete.
✴ Biggest payment: In order to receive the biggest payment you must be able to wait until the entire
process is complete.
✴ A specific amount: If you need a specific amount, the factoring companies can work with you and
your family to determine which payment(s), or portions of payment(s), makes the most sense for you
to sell.
Payment rights to these Secondary Market Annuities (SMA) are purchased by investors pursuant to State
law. The annuity receivables "Structured Settlements" are direct obligations of the regulated insurance
subsidiaries of New York Life, Metropolitan Life, John Hancock, Liberty Life, Pacific Life, Allstate, Prudential,
The Hartford, Aegon, State Farm, Mass Mutual and other A and AA rated carriers. As annuities, the structured
settlement obligations are senior to the issuers’ most senior debt obligations. Many are back-stopped by state
insurance guaranty funds. The purchase and sale of each payment stream is approved by a court, which issues
an order redirecting the payments to the investor/buyer under IRC-5891.
You also need to consider the financial strength of the insurance company(ies) backing the payments. If you’re
contemplating purchasing a factored structured settlement, I advise you to retain legal counsel familiar with
these types of transactions.
15Your Guide to Investing in the Secondary Marketplace
2. Lottery WinningsAs you may have guessed, lottery winnings are the payments available for sale
from someone who actually won a state lottery prize. Regardless of whether you
are looking to sell your payments or buy someone else’s prize, the process is
very similar to that of the factored structured settlements (FSS) above. Unlike
FSS, the lottery prize transfers are not subject to IRC-5891. However, they must
still go through a court approval process, which will delay any transfer from
seller to buyer, although not quite as long as an FSS dealing. The lottery transfer
process usually takes 30 to 45 days.
Lottery prizes are all the direct obligations of state lotteries. They are all the direct obligations of state
lotteries and pre-defeased with U.S. Treasury instruments maintained in segregated trust funds. In every case,
the transfer of payment rights from original holder to investor is reviewed and approved, in advance, by a
court.
Lottery payouts do not depend on tax collections or appropriations. When a 25-year prize is awarded, the
Lottery sets aside all the funds necessary to make all scheduled payments by purchasing 24 “Zero Coupon”
U.S. Treasury obligations, each timed to mature on 24 annual payment dates. Those Treasuries are held in a
segregated trust fund for payout to past winners. Thus, annuitized prize payment obligations are pre-defeased
with pools of U.S. Treasury securities purchased when each prize is awarded.
16Your Guide to Investing in the Secondary Marketplace
In practice, this means that even as California’s fiscal crisis has forced that state to furlough workers, delay
medical reimbursements, and post-pone tax refunds, there has not been a single day’s delay in payouts to
lottery winners. Why? State Lottery operators know that a steady supply of willing lottery losers is best assured
by never failing to pay a winner.
3. Annuity Income StreamsThese are existing immediate annuities whereby the original purchaser has decided to sell his/her existing
payment stream in exchange for a lump sum of cash. This asset is typically not liquid and has no commutable
value whereby the investor can “put” it back to the insurance company. So they look to the secondary markets
to supply the liquidity in exchange for the remaining payments.
Unlike FSS, SMA, and Lottery Winnings, transferring from seller to buyer does not require any type of court
approval. A prospective buyer may view this as a positive or a negative, e.g. the transfer will take place more
quickly but it may not be as secure. An annuity professional who specializes in these transactions should also
be consulted.
4. Life SettlementsWith life settlements, the owner of an unnecessary life insurance policy sells it to a third party for more than
its cash value and less than its face value. This is an excellent option for policyowners worried about lapsing
policies. Until recently, if a policyowner opted out of a policy through surrender or by allowing it to lapse, the
17Your Guide to Investing in the Secondary Marketplace
issuing life insurance company received the additional value. In some cases, an insured’s health may have
declined since the policy was issued, and the policy may be worth considerably more than the surrender value.
A life settlement is an alternative to this surrender or lapse of a policy, or when the owner of a life insurance
policy no longer needs or wants the policy, the policy is underperforming or can no longer afford to pay the
premiums.
Life Settlement History
Although the secondary market for life insurance is relatively new, the market was more
than 100 years in the making with a few key events, judicial rulings, and individuals.
The Policy as Transferable Property: In Grigsby v. Russell in 1911, the Supreme Court
established the policyowner’s right to transfer an insurance policy. Justice Oliver
Wendell Holmes wrote that life insurance possessed all the ordinary characteristics of
property, and therefore represented an asset that a policyowner could transfer without
limitation. As he put it, “Life insurance has become in our days one of the best recognized forms of investment
and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same
legal footing as more traditional investment property, such as stocks and bonds. As with these other types of
property, a life insurance policy could be transferred to another person at the discretion of the policyowner.
This decision established a life insurance policy as transferable property that contains specific legal rights,
including the following rights:
18Your Guide to Investing in the Secondary Marketplace
✴ Name the policy beneficiary
✴ Change the beneficiary designation (unless subject to restrictions)
✴ Assign the policy as collateral for a loan
✴ Borrow against the policy
✴ Sell the policy to another party
Viatical Settlements Model Act: A second milestone occurred in 2001 when The National Association of
Insurance Commissioners (NAIC) released the Viatical Settlements Model Act, which defined guidelines for
avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers
that are prominent today began purchasing policies for their investment portfolio using institutional capital.
The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth
management tool for high-net-worth policyowners who no longer needed a given policy.
Major Study Findings: In 2002, the Wharton School of Business at the University of Pennsylvania conducted a
study that showed the potential of the life settlement market. The research papers, credited to Neil Doherty
and Hal Singer, were released under the title "The Benefits of a Secondary Market For Life Insurance.” This
study found, among other things, that life settlement providers paid approximately $340 million to consumers
for their underperforming life insurance policies, an opportunity that was not available to them just a few
years before.
19Your Guide to Investing in the Secondary Marketplace
“We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life
insurance policyholders who have exercised their option to sell their policies at a competitive rate." - Wharton
Study, pg. 6
Another study by Conning & Co. Research, “Life Settlements: Additional Pressure on Life Profits,” found that
senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was
owned by seniors eligible for life settlements.
5. Viatical SettlementsA viatical settlement is the sale of a life insurance policy by the policy owner before the policy matures. Such
policies are sold at a price discounted from the face amount of the policy but usually more than the premiums
paid or current cash surrender value. This provides the seller an immediate cash settlement. Viatical
settlements typically involve individuals with shorter life expectancies. It’s a practical way to help such
individuals pay extremely high health insurance premiums. Life settlements are similar, but involve insureds
with longer life expectancies.
Viatical settlements grew in popularity in the United States in the late 1980s, when the AIDS epidemic peaked.
AIDS sufferers often had no wives or children (the traditional dependents in a life insurance policy), but they
had life insurance policies through employment or due to other investment activity. The dependents on the
20Your Guide to Investing in the Secondary Marketplace
policies were often their parents who did not need the money. Viatical settlements offered a way to extract
value from the policy while the policyholder was still alive.
At the time, the AIDS mortality rate was very high, and life expectancy after diagnosis was typically short.
Investors were reasonably sure that they would collect in a relatively short time. This combination of events
caused a surge in viatical settlements as both investors and viators saw an opportunity for mutual benefit.
Viatical settlements eventually developed a bad reputation in the investing community. The companies that
purchased them from policyholders typically resold them to individual investors. Salespeople were paid large
commissions to push the settlements, which were not conventional investments and which were
misunderstood by many investors. The government regulatory agencies had little experience and few
regulations dealing with viatical settlements, and the industry attracted some unscrupulous dealers.
Despite the bad experience of some investors, viatical settlements remain an often valuable tool for the
personal financial management of many ill people. A 2002 study showed that among hospice financial
counselors who have had experience with viatical settlements, most report positive experiences.
21Your Guide to Investing in the Secondary Marketplace
Time For an Alternative?t’s funny how people are drawn to traditional, well-worn paths. In some
cases, this is wise and may save us from a lot of pain. But in many cases it
prevents us from finding better routes. In the case of the stock market, it’s
become painfully clear that the ways of the past may not be the most suitable
path for you. Investors must be smarter and must dig deeper to find other
investment opportunities worth considering.
Currently, because it’s largely off the radar still, the secondary marketplace
may present you with such opportunities. It’s not a panacea and not every secondary market investment is
viable, but if you’re smart and patient, there are incredible deals to be had.
If you are going to climb Everest, you don’t hire a guide because he’s half price—especially if he’s never been
up the mountain. You hire the guide who’s been up there 50 times and has surrounded himself with the best
Sherpas that have also been up there 50 times! Price is a distant second when you’re talking about life and
death. If you need a great heart surgeon, do you seek out the cheapest, or the best?
The secondary marketplace is the Mt. Everest of the investment world. When you get to the top, man, what a
view and what a rush. But if you don’t have a guide, the risk isn’t worth it.
I
22Your Guide to Investing in the Secondary Marketplace
Ready to hire your secondary marketplace guide? We invite you to visit us at
www.SomersetWealthStrategies.com, email us at [email protected], or call us toll free at (800) 813-4000.
Every investor's situation is unique and you should consider your investment goals, risk tolerance, and time horizon before making
any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The foregoing is not a
recommendation to buy or sell any individual security or any combination of securities.
23Your Guide to Investing in the Secondary Marketplace
