Equity-Indexed Structured Settlements

In a market desperate for innovation, Pacific Life Insurance Company appears to have answered the call with a new, optional "Indexed-Linked Annuity Adjustment Payment Rider" (ILAAPR) for its structured settlement products.

Although life insurance companies first offered equity-indexed annuities during the mid-1990's to compete with indexed mutual funds, Pacific Life's ILAAPR represents the first U.S. equity-indexed structured settlement option.

Pacific Life's ILAAPR is linked to the Standard & Poor's 500 (S&P 500) index which includes a representative sample of common stocks traded on the New York Stock Exchange, American Stock Exchange, and NASDAQ National Marketing System. One of the U.S. Commerce Department’s leading economic indicators, the S&P 500 represents over 70% of the total domestic U.S. equity market capitalization.

Indexed annuities differ from other fixed annuities based upon the method interest is credited to an annuity's value. Traditional fixed annuities credit interest at the rate set in the annuity contract. Indexed annuities credit interest based upon a formula in the index (either equity-based or bond-based) to which the annuity is linked. The formula determines whether and how much additional interest is calculated and credited.

The increasing popularity of indexed annuities is highlighted in this Investment News article which cites LIMRA data:

• Indexed annuities accounted for 46.3% ($39.3 billion) of all fixed annuities sold and 27% of total annuities sold in the U.S. during 2013.
• Indexed annuity sales increased by $5.4 billion (17%) in 2013, more than any other form of annuity.
• Pacific Life ranked thirteenth among U.S. life insurers selling indexed annuities in 2013 with 2.45% of the U.S. indexed annuity market.

By comparison:

• Estimated structured settlement annuity premium totaled $5.13 billion in 2013 and $139.5 billion from 1975 through 2013.
• Pacific Life's 2013 structured settlement premium totaled $848,725,000.
• S2KM estimates more than $160 billion per year of United States tort costs have represented payments to personal injury victims and their attorneys since 2006 - based upon Tower Watson's annual studies of U.S. Tort Cost Trends.

Pacific Life's online ILAAPR brochure features hypothetical examples and product information including:

• Structured settlement payments with the ILAAPR option can increase annually based on positive S&P 500 index returns [with a five (5%) percent cap] but will not decrease if the S&P 500 declines or remains flat.
• Unlike a variable annuity, the ILAAPR is not an investment security and does not participate directly in the stock market or the S&P 500 index.
• Like its traditional structured settlements, Pacific Life's ILAAPR payments are backed by the company's financial strength and claims-paying ability.
• ILAAPR payment increases take effect on the anniversary of when payments originally started.

Also note, according to industry sources:

• Pacific Life has received a favorable IRS private letter ruling for the ILAAPR confirming tax exclusion of its indexed payments under IRC section 104(a)(2).
• If the initial ILAAPR benefit payment is deferred, the ILAAPR indexing feature only applies after benefit payouts begin.

Whether Pacific Life's ILAAPR will experience market success and help grow the U.S. structured settlement primary market remains uncertain and subject to debate among structured settlement consultants.

To sell the product, these consultants must convince settlement recipients that potentially higher long-term ILAAPR payouts (based upon S&P 500 performance) will offset lower starting payments compared with traditional structured settlement annuities.

ILAAPR advocates will point to historical S&P 500 results. During the past 30 years:

• The S&P 500 index has increased an average 9.8 percent per year.
• In 12 of those 30 years, the S&P 500 index increased less than five (5%) percent (ILAAPR's cap) or decreased.
• Incorporating ILAAPR's five (5%) percent cap, the annual applicable S&P 500 index increase averaged 3.5 percent per year.
• Also relevant for 30 year historical comparisons: the yield on 30 year U.S. Treasury bonds in April 1984 was 12.65 percent. As of April 21, 2014, the yield was 3.52 percent.

Conclusion

The moribund U.S. structured settlement primary market needs a jump-start. Pacific Life's new equity-indexed structured settlement rider represents a welcome innovation and hopefully will become one catalyst for future market growth.