In some city archives historians find records of an annuity purchase – like these. What is behind it and what does it mean for us?
Since then In the 13th century, the purchase of annuities was the predominant credit business of the Middle Ages. The future pensioner bought the right to receive a life annuity for a sum of money from private individuals, church institutions, monasteries, foundations or cities. When in the 14th century. the financial requirements of the cities for construction measures increased, the city treasurers obtained credit by selling life annuities.
This form of life annuity purchase was a common way of hedging the longevity risk well into the 19th century. The life annuity then also found its way into the German Civil Code and its predecessor – §§ 759 ff BGB. This is still valid today as a legal alternative to coverage through a private pension insurance. Anyone can buy a BGB life annuity from private individuals, municipalities, foundations, investors or tradespeople and thus secure their retirement income for life.
From the point of view of the treasurer, this means complying with the municipal ban on speculation and avoiding unnecessary economic risks, for example by financing via cross-border leasing or SWAP interest rate bets. Life annuities can be used to pay off such inherited burdens and eliminate acute municipal investment backlogs. In addition, this offer can save future social welfare expenses.
Life annuity possible without life insurance licence
Nobody needs a licence as a life insurer for this offer as long as he does not conduct the business as a life insurer according to the principle of large numbers with risk equalisation in a collective with actuarial calculation, § 5 of the Insurance Supervision Act (VAG). Anyone who acts as an intermediary in this field in an advisory capacity does not initially require a licence from BaFin or the Chamber of Industry and Commerce and does not have to comply with any corresponding information obligations. It is neither an insurance nor a financial instrument within the meaning of the German Banking Act (KWG).
Since the 19th century, the BGB life annuity has lost its importance – it has become almost meaningless. Since then, more and more life insurance policies have come into being that were able to pay high pensions because they could invest their capital with high returns and were considered to be financially sound and secure. The life insurers grew and BGB-Leibrente withdrew into niches. However, it was not extinct in Germany either.
Real estate against life annuity
This is because the sale of real estate against the promise of an annuity secured in the land register with a value adjustment clause in accordance with the cost of living index is still not a very rare form. Similarly, life annuity commitments play a role today as consideration in the transfer of company assets, investments in legal partnerships, transfers of assets by way of early succession or gifts.
However, they are by no means legally limited to this, because nothing has changed in the legal basis, which once gave great importance to the commercial BGB-Leibrentenkauf. Rather, the private pension through a life insurance policy was seen as the better alternative. But those times are over.
Only low pensions from life insurance guaranteed
Today, life insurers are so low in equity that they can only invest their customers’ money relatively securely, i.e. mostly in low-interest securities such as government bonds. As a result, they can only guarantee low pensions – and the non-binding promises of surpluses hardly improve this situation.
Their security is no longer beyond doubt – BaFin has already threatened the worst with a winding-up order. Others discontinue the classic guarantee offer altogether or even sell their holdings to Chinese investors.
Life insurers are threatened with starvation, just like the dinosaurs once did, which helped the mammals, who were their prey, who until then had been underground during the day, to develop brilliantly into modern actuaries and lawyers. Surely the life insurers – even if it does not help to slim down and put on the ears and leave them in the rain – will continue to live in another form: whoever owns a budgie has illustrative material that this was also successful for the dinosaurs.
Few brokers of life insurance policies are aware that there are up to more than a dozen possibilities to reduce the benefits or surrender values initially promised as “guaranteed”. This is foreseeable practice, as risk capital has not been increased in recent years to such an extent to compensate for risks taken, despite the EU proposal (Solvency II). BaFin has identified a double-digit billion amount as a capital gap. Until some time ago, government bonds bought by insurers were considered risk-free – from practice it is known that there are also debt cuts in the EU, potentially also for German government bonds, for example, through the CAC clause in the bond terms and conditions introduced a few years ago. Austria has already demonstrated this – a parliamentary decision and the state guarantee for billions of euros in bonds is cancelled retroactively (!). Nevertheless, even banks (Basel II/III) do not have to provide equity capital for state casino securities to absorb any risks that arise.
Life annuities from charitable foundations
For many years, some charitable foundations have offered to take over real estate from older people in return for a promise of a lifelong right of residence and an additional life annuity. In principle, however, assets of all kinds can also be transferred in this way – even cash as a pure life annuity purchase. The donation of money or material assets to a charitable foundation, which promises an annuity in return, results in a one-time tax benefit or a tax benefit that can be freely distributed over 10 years, because part of the foundation’s donation is recognized as a deductible gift. This is due to the fact that the non-tax-deductible equivalent value of the life annuity is valued very low in accordance with the valuation law, often only about 50% of the total foundation endowment.
If a part of the assets is used for charitable purposes, 20% of the total amount of income is tax deductible as donations for private individuals p.a. For sole proprietorships and GbR/OHG, 20% of the profit is used to calculate the maximum amount, § 10 b I 1 of the Income Tax Act (EStG). Contributions to the assets of a charitable foundation are tax deductible up to 1 million euros – which can be distributed over 10 years – as special expenses, § 10 b Ia EStG.
This form of retirement provision is already widespread abroad. Over the past 100 years, the Stanford University Foundation has become one of the financially strongest foundations by combining endowment contributions with life annuities, and has thus opened up new groups of donors who combine tax-privileged foundations with their own retirement provision. This makes more sense than if Harvard University wanted to increase its foundation capital through the Bernard Madoff snowball system. The Carta Mensch Stiftung Deutschland (www.carta-mensch-stiftung-deutschland.de) has developed an innovative project for life annuities in Germany as well.
Life insurance in a low-interest environment
In the low-interest environment, life insurance annuities have fallen to less than half in some cases over the past 15 years. Life insurance companies have considerable problems financing adequate pensions due to the low interest rate phase. Added to this are high costs and very strict investment regulations. In practice, the paid-in capital is devalued, with the consequence that the pension is no longer sufficient and poverty in old age is threatening.
The claimed assets of life insurers actually represent debts, i.e. borrowed capital that still mostly has to bear interest at more than 3%. But unlike life insurers, which advertise the coverage of the biometric longevity risk with an alleged unique selling point, there is a better alternative: the modern life annuity purchase, as it is also offered in Germany.
Life annuity as a new pension model
Alternative providers have addressed this problem and contributed their strengths for a new pension model. Frictional losses are minimized by directly allocating capital against life annuity commitments – thus significantly higher pensions can be guaranteed, even in relation to life insurance pensions including surpluses. These life annuities are promised by foundations, project investors, e.g. in infrastructure, building owners, companies or municipalities – they can also be secured, e.g. through land registry.
Foundations in particular can invest the additional foundation assets thus gained with higher returns than life insurers, and also promise higher pensions than these because of their lower costs. At the same time, their foundation assets are also increased, thus furthering the purpose of the foundation.
However, commitments of life annuities by selected investors of all kinds for whom this is an alternative to borrowing are also promoted. This eliminates all margins for intermediaries such as life insurers as capital collection points and banks, as well as interest rate adjustment risks. Compared with these advantages, the risk of longevity takes a back seat, not least because it can be spread over a larger number of life annuitants.
30 percent higher pensions
The guaranteed pension payments, which are thus solid, are up to more than 30% higher than those that life insurers can offer. In addition, the pensions are designed very flexibly as desired pensions. The future pensioner can determine his or her individual wishes, e.g. with regard to the start of the pension, adjustment to the cost of living, survivor’s pension, as no pre-formulated pension tariffs are offered. Pensions can be negotiated as flexibly as a loan would be individually agreed. This is an ideal form of financing, especially for very long-term project financing and foundations that are set up for eternity.
Each individual offer can – if desired – be evaluated by an actuary. If the founder decides in favour of a charitable founder’s pension, there are also considerable tax advantages already at the time of payment. The pensions themselves only have to be increased in price by the share of income. With slightly lower initial pensions, pensions can even be paid with terms of up to several survivors and up to two further generations.
annuity of capital contributions, real estate and brokerage portfolios
In addition to capital contributions, real estate can of course also be pensioned. In the case of real estate pensions – in addition to the lifelong right of residence – an all-round provision is offered. This concerns the building management but also the later care e.g. in case of nursing. This can be agreed with the pension.
For centuries, the nobility and farmers have used the designs on old people’s homes, personal belongings, securing care and food, as well as housing rights and other easements. Many a rich man bought himself into a monastery, whereby he received a lifetime supply and saved his salvation, including eternal mass for the soul after death. With timely and careful design, such models can secure the supply largely insolvency-proof and seizure-free over several generations.
It is also possible to take over businesses – or e.g. broker portfolios – in return for an annuity commitment. Commercial and private property owners are often offered the purchase of their land – as an alternative to a bank loan – after which they lease it back for 99 years as a leasehold. But then they are no longer landowners. If, on the other hand, they promise life annuities against payment of money, which are secured in the land register, they can collect about the same amount of capital, but the life annuities only have to pay the pensioner for life. If the last pensioner has died, they now continue to own the property completely unencumbered. This can be repeated as often as desired, whereby the subordinated life annuities secured in the land register are somewhat higher than the first-ranking secured annuities. Instead, the life annuities can also be secured by a bank guarantee.
Through these alternative offers, all people can receive a higher, securely guaranteed and stable pension for their saved capital. Investors are shown how they can obtain a reliable and useful alternative to borrowing through life annuity commitments – without the risk of interest rate changes and overall even cheaper than a correspondingly long-term annuity loan – a win-win situation.
And foundations, how they can promote their foundation purpose through the acquired foundation assets and the opening up of new founder circles by also guaranteeing the founder a lifelong pension for the assets donated.
Stable conditions for investors
While it is a considerable risk for a life insurance company to have to guarantee fixed pension conditions and interest rates in the long term, it is desirable for an investor as an advantage if the conditions for the pensions to be paid cannot change or can only change within the scope of the rate of price increases .
The providers do not have to calculate like a life insurer according to strict mathematical rules and high costs for a large number of pensioners, but provide the life annuities in individual cases on request in return for, for example, strengthening the assets of the foundation or as an alternative to borrowing for investments including private or even basically public construction projects. In the case of deferred life annuities, there are initially no payments at all for the years of the deferment period, which, unlike an annuity loan, can be reconciled very well with the returns from a long-term investment.
Single premiums for foundations
If a lump sum is paid into a foundation, for example, the foundation grants a lifelong annuity at a predetermined fair amount in such a way as the existing foundation assets and the payment allow. The future pensioner determines what requirements the pension should meet. A progressive pension, a deferred pension or, for example, a pension guarantee in the event of death can be agreed. The same applies to dynamic adjustment to price developments and surviving dependants’ pensions. Each annuity is agreed individually, not according to fixed rates and mathematical formulas or a specific guaranteed interest rate – therefore they are very flexible and can also meet special requests.
In the case of endowment to a charitable foundation, pensions may also be paid in accordance with § 58 (6) of the German Tax Code. The pensions are then financed only from the income and have the tax advantage of the full donation receipt – this can be tax deductible.
Foundation with edition
Another solution here is the foundation with conditions, also with tax credit on a large part of the deposit. For the founder, this means that he or she can determine during his or her lifetime for what purpose he or she wishes to use the funds that are no longer paid out for life annuities due to death. Mortality gains do not benefit any insurer or its shareholders, but rather the intended purpose.
The same solution is also suitable for non-profit associations with capital requirements for investments, for example. Whether the animal shelter is to be expanded, the golf course or the sports stadium: the money for this can be raised by club members or third parties by selling life annuities. The entire assets of the association are then liable for their payment and, if necessary, a bank guarantee or a land register security on the association’s property, if required.
Of course this is also suitable for the investment of maturity benefits or lump-sum settlements from life insurance. In the case of severance payments for employees, e.g. also for a company pension, the tax burden of the severance payment can be further minimized by means of the so-called 1/5th regulation and a life annuity can be acquired which is now only taxable with the profit share.
The providers concerned including Foundations invest their assets in secure and profitable investments, where they are not subject to the restrictions of a life insurer. In particular, not their even higher solvency requirements in the future, which will force them to make very safe and low-yield investments.
Since foundations use only a part of their assets for life annuity obligations, but the remaining part for charitable purposes, a larger amount of foundation assets is available to meet life annuity obligations if necessary. This means that they can be guaranteed to a greater extent than a life insurer, who must provide pensions for a group of pensioners with the highest possible security only from the capital paid in for this purpose less costs and only from its secure and therefore currently low returns. Foundations can do this in each individual case without having to rely on a large collective because of the involvement in a larger, high-yield foundation asset. They therefore do not conduct any insurance business subject to supervision.
Occupational pension provision according to this model is also possible
In principle, a company pension scheme (bAV) outside the German Company Pensions Act (BetrAVG) is also possible – while avoiding all the disadvantages of a bAV subject to the BetrAVG: no employer liability, pure contribution commitment possible, freely configurable vesting rules, no surprises from legislation and case law, low complexity and high transparency through manageable solutions that can be individually and flexibly designed within the company and are not restricted by law, no balance sheet exposure for the employer, no social security contributions in the pension phase and only taxation of the share of earnings in the pension phase.
Anyone who, for example, receives a occupational pension scheme from a group of companies or with a shortfall in the assets already saved is dependent on the employer’s obligation to pay contributions. More often, in the case of groups of companies, there is not even an obligation for the Pensionssicherungsverein to pay if a parent company or subsidiary has assumed the payment. In addition, provision through a foundation has the advantage that the occupational pension assets do not disappear into thin air as a result of the squeeze-out of a financial locust. In the “Kaufhalle” case, the money disappeared into nirvana for the time being – the occupational pension payments were suddenly stopped.
If the estate is not to be settled according to the motto “after me the Flood”, it is advisable to arrange the estate during one’s lifetime, even in the case of foreign assets. In this context, the right of the beneficiary of the compulsory portion to information vis-à-vis heirs must be considered, as well as the supplementation of the compulsory portion if assets have been transferred to a foreign foundation (BGH, decision of 03.12.2014, ref. IV ZB 9/14). In the case of spouses, a tax-free compensation for gains can at best be arranged before death.
by Dr. Johannes Fiala and Dipl.-Math. Peter A. Schramm
by courtesy of
www.experten.de (published in Experten Report 11/2015, pages 26 – 31)
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About the author
PhD, MBA, MM
Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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