British liability traps

The past regularly catches up with many intermediaries: Leverage transactions with British life insurance policies are still frequently litigated in the courts. portfolio international spoke about this with lawyer Johannes Fiala.
The issue of credit-funded UK life insurance has been a highly charged one over the past year. Are intermediaries off the hook three years after the end of the bear market or three good years in equities? No, there are still plenty of lawsuits for reversal. In a memorable decision in 1997, the Federal Court of Justice established that there was a very considerable potential for losses and a correspondingly large need for information on the part of customers. The customer’s steps are triggered by two circumstances. On the one hand, the high interest rates they have to pay for the credit-financed investments hurt, and on the other, investors see on every account statement they receive that the original, optimistic forecast calculations have simply turned into the opposite. Such combination deals drive many consumers into over-indebtedness. In this respect, it is obvious that the investor is looking for a culprit to pay damages. Often, however, the impetus comes from outside, i.e. from the bank, which demands additional repayments or additional collateral.
From when do most lawsuits for reversal originate, and how long are the statutes of limitations? It is certainly the case that the mountain of credit-financed leverage deals have been made in the past decade. But such deals have also been offered in the last three to five years. The limitation of liability has been regulated in the new law of obligations since the beginning of 2002 in such a way that claims for damages are in principle subject to a limitation period of ten years, with the restriction, however, that the limitation period runs for three years as soon as the consumer becomes aware of the damage and the damaging party. So he’s only got three years.
How do courts define the term “notice”? Of course, this is always judged by the judge in each individual case, but one can basically say that grossly negligent ignorance has an equally high rank as knowledge. So if you don’t read your bank statements, it’s your own fault.
How much have reverse mortgage lawsuits increased in the last few years? From our observation, it is a continuous development. However, one sees an increasing reluctance on the part of banks to lend in the wake of the introduction of Basell II, and this has led to banks becoming more cautious overall. I think many banks will seek the conversation to rehabilitate the client and save the intermediary the loss.
The stock markets have been on the road to recovery for three years. Some of the portfolios concerned must have been restructured. This is certainly true, as the good equity performance is reflected in unit-linked policies. However, there is no certainty as to how high the maturity or final bonus will be. It is possible to speculate about this, but it is not valuable loan collateral for the financing bank. Forecasting and an uncertain maturity bonus at a fixed date are not loanable for the bank, as it cannot know how the stock market will perform and how much money the customer will actually get.
Has sales learned from the investor debacle, or is the market still operating with overly optimistic forecast calculations? The crux of such products is that, at worst, only one in two contracts will last until maturity. First of all, the question arises whether the right product was always conveyed to the right customer. A prudent financial planner would class a UK policy more like an equity fund and will then also look not to put all their eggs in one basket. However, commission interest is high. I advise intermediaries to be careful that the client does not put all his money into such a product, certainly not with ten times the leverage. In principle, the quality of unit-linked policies is good; what matters is that they are marketed in the best possible way, in terms of customer education and risk diversification.
But sales has to work with forecasts because customers demand a return estimate. What kind of return can he offer the customer at all? A forecast calculation must assume a correspondingly long investment horizon. After all, it is not necessarily the case that a product that has generated seven or eight percent per year in the past will continue to do so in the short term in the future. Some insurers must have noticed that some of their sales partners are advertising yields of ten, eleven or twelve percent. Insurers have become more cautious in setting their advisory software accordingly. For the intermediary it is a tightrope walk: The insurers try to withdraw from the responsibility with the reference to the non-binding nature of the forecast calculation. The intermediary must ensure that the customer really understands that the example calculation is only a non-binding forecast. As such, the yield projections do not trigger a liability case. Under no circumstances should such policies be presented as a safe investment, and the nature of the guarantees given must also be explained. But what is given far too little attention is that insurers are also responsible for what the sales force does.
How realistic are investors’ chances of getting out of such contracts? In the case of leverage transactions, which often go by such names as “savings annuity”, “Euro plan” or “immediate annuity”, the duty of disclosure can hardly be fulfilled by the intermediary. In any event, I am not aware of any case in which the requirements of the case law have been implemented. This is also a training fault of sales organisations, which often do not provide intermediaries with sufficient documentation and questionnaires so that proper and complete advice could be provided largely free of liability. The second gateway is negative press coverage of which the intermediary must be aware. There were already highly critical reports in the trade press in the 1990s on the risks of equity pool products. This is the most effective gateway for most investors today to take action against the distributor and obtain the rescission of the policies.
Does the agent face these lawsuits alone, or can the insurer also be held liable? To make the dimensions clear first of all: 20,000 to 30,000 intermediaries are sued in Germany every year. There are also a far greater number of out-of-court settlements. Annually, I estimate that there are probably around 100,000 liability cases involving intermediaries. The intermediary has a relatively good chance of bringing the insurer into the liability boat. On the one hand, intermediaries are usually vicarious agents, in a sense the extended arm of the insurer. In this respect, the insurer is also a contact partner in the event of claims for damages by investors. Second, the smart agent saves all of his training materials and transcripts that he gets from the insurer. It is easy for an intermediary to pass on the liability for leverage to the insurer under the aspect of fault for instruction or training. If there was an event where the insurer glossed over such a concept, then the agent can sue for indemnification.
What does the practice look like? Insurers are generally smarter than banks and will very often seek an out-of-court settlement if the intermediary can provide credible documentation of training negligence on the part of the insurer’s sales management. There is then usually no interest on the part of the insurer in having a judge cast fault into a judgment that is carried by the entire industry.
What advice do you give to intermediaries who are threatened by the liability trap and who are poorly insured? The intermediary could turn to colleagues for ammunition with documents. There are also corresponding service portals on the Internet. There is the so-called claim-made insurance, a reverse insurance, with the property damage liability insurance (VSH) at favourable conditions. But for that, you need a good insurance broker who specializes in VSH. However, such measures have their limits when criminal behaviour is involved. A property crime such as investment or advisory fraud is a major impediment to residual debt discharge. The intermediary should generally ensure that the insurer provides him with advisory protocols that stand up to legal scrutiny. The biggest disaster to assume in the courtroom is when the client says, “Yes, we talked about it, but I didn’t understand it.”
Wouldn’t the intermediary generally have to talk much more about risk with the customer when it comes to investment topics? The parameters of risk and return are elementary components of portfolio theory as formulated by Harry Markowitz to optimize risk and return opportunities. By optimizing the asset allocation, the question of too much risk and too little return can be finely tuned for the client. A look at the past can be very revealing with regard to the volatility of an investment. Broad diversification can bring the optimal mix for client portfolios.
Most advisor tools would have to take Markowitz into account, the problem is often that the client doesn’t understand it and asks at the end of the advice, “What percentage comes out … I still advise the agent to take an approach that educates the client. Especially since acquiring new customers costs ten times more than continuing to maintain an existing customer. If the existing customer realizes that he has been swindled, then the business relationship is significantly impaired.
The interview was conducted by Ali Masarwah
(portfolio international 1/2006, 12)
Courtesy ofwww.portfolio-international.de.

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala
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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