Structured settlements and annuities are two financial products that have many similar qualities in common. It is tempting to lump them together in the same category, however there are distinctions between the two that merit further investigation.
Annuities are financial instruments with qualities of both investments and insurance policies. They are a contract between an individual and an organization that provides for the repayment of a premium after a given time period has elapsed. Annuities date back to ancient Rome, where the first concept of this financial tool was introduced. “Annua” actually meant annual stipends in Latin. Individuals would give contributions into a large pool of money run by each province and then receive an annual payment each year until death, or for a specified period of time. This allowed the Roman Empire to mitigate risk while providing money to individuals of priority, such as soldiers and generals who often saw combat.
The first annuity on record comes from the American Colonial period in 1759 when the first organization was formed in order to sell financial protection to aging ministers and their families. Ministers would pay into a policy that grew over time. This money was then partitioned out to family members after a period of a few years. Essentially, it established a “safety net” where money now was sacrificed in terms of more stable, and larger amounts of money later. Annuities protected the ministers’ money from fluctuations in the financial markets and allowed them ways to pass their money over to children that were not yet old enough to know what to do with the inheritance.
The company was known as the Pennsylvania Company for Insurance on Lives and Granting Annuities/ Since 1812 various institutions have provided clients with a secure retirement plan.
One of the largest differences between annuities and structured settlements is that the former is guaranteed against the loss of principal while also deferring taxes. The current era of annuities began in 1952 with the establishment of the TIAA-CREF, the first offered group variable deferred annuity. Today, Americans own over $1.8 trillion in annuity products.
A great example of an annuity is a lottery winning. A lottery winner has a contract formerly drawn up with the party responsible for paying out the winnings. Typically the large winnings are separated over time and not put in as one large lump sum. Coincidentally, a lottery winner may elect to sell future payments to a broker in favor of a large lump sum.
Settlements give out money in small portions, just like an annuity, yet they usually arise from a court settlement or personal injury case. The way structured settlements work out is that they arise from some legal claim, providing the winner of the case with a specific amount of capital for a fixed period of time. They are mostly the result of a lawsuit involving personal injury or liability.
Structured settlements are used for large money claims where it is beneficial to pay our beneficiaries over longer periods of time. During the American Colonial era, governments wanted a secure way to ensure the recipients of a personal injury claim did not frivolously spend their money in a short period of time following their settlement payment and end up destitute, forced to rely on social services.
Settlements allow the government the ability to partition out payments over time, changing a large lump sum payment into a series of steady payments over time. They are useful for people who are temporarily or prematurely disabled, have limited financial expertise, or are minors that are not able to handle their own financial affairs.
The need for individuals to turn these small, steady, often decade-long payments into one large lump sum has created a secondary financial market for settlements. Organizations, such as Rising Capital exist that take deferral payments and convert them into one large cash payment. This way, individuals that are injured can pay large medical bills, or use them for other expenses that demand immediate attention.