The split subscription right: The insurers’ solution for SMEs
Mr. C., an insurance broker, appears and presents the entrepreneur with the following model: You won’t get any more money from the bank – from me you will get an infinite amount of liquidity, and this without any credit security whatsoever. Your bank will also be thrilled, because gone is the state of high costs due to overdrafts. The solution is quite simple, says the broker: According to § 1 b of the German Company Pension Act (BetrAVG), you can buy a direct insurance policy with, for example, a one-off contribution of 10,000 euros. In the case of the (split) subscription right, you provide 20% employer-financed for your employee (this is the insurance company’s guarantee) – and 80% for yourself (this is financed from “surpluses”). This broker solution also confuses experts: Obviously a smokescreen, because in reality, in such a case, the subscription right to the insurance guarantee benefit, which can be revoked from the beginning, must be provided 100% for the employee – with regard to the uncertain future insurance surpluses and the death risk, the subscription right will lie with the employer. Thus you get – so the further sales consideration of the broker – by the deduction of the costs 40% from the tax office again, because you set off the 10,000 euro from the tax – thus approximately 4,000 euro tax refund for the entrepreneur. In addition, you immediately receive 8,000 euros from the insurer as a policy loan at a favourable interest rate of 6% p.a.. (after taxes, this means an interest rate of around 3.6%). In the end, you as an entrepreneur have received 2,000 euros without loan collateral and that too tax-free on balance. I can solve all your financial problems with it, says the insurance broker from the Bavarian foothills of the Alps. He, the broker, has been working only like this for more than 10 years – and with it he makes every entrepreneur “happy”, he says. At this 3.6%, insurance financing is cheaper than any overdraft facility at a local bank. Insurers are simply better financiers – and insurance companies would have been successful with this model for about 25 years. But what are the catches?
The tax saving trick: The fat end does not come only at the end
The milkmaid calculation begins with the fact that the alleged 3.6% net (the entrepreneur must pay a total of 6% first) refers to the entire 8,000 euro policy loan. For 2,000 euros of liquidity, the entrepreneur first pays 24% interest (because this is 6% related to 8,000 euros of policy loan, so 24% related to the liquidity gained). Even “after taxes”, almost every bank loan is thus cheaper in the end than this “bargain” of the insurance industry. The second deception lies in the fact that the broker refers to the tax exemption of the maturity benefit of the life insurance in the bAV But here the company is the insurance customer, and thus all recoveries (on maturity or early termination) are also taxable as part of the company profit. Strictly speaking, the AG must constantly pay tax on the annual surpluses and capitalise the asset value of the accumulated surpluses in the balance sheet. Due to the interest payments and the balance of the tax effect, so much liquidity flows out again each year that the liquidity advantage has already turned into an equally increasing disadvantage after six years. From the 2.000 EUR liquidity advantage in the first year become accumulated up to far more than 10.000 EUR liquidity disadvantage in the last third of the contract term. The broker points to a “favourable” 90% surrender value from the start of the insurance, and therefore the employer could easily dissolve this insurance contract at any time – for example after 5 years – or repay the policy loan. The only catch to this consideration is that the employee is entitled to 100% of the guaranteed benefits – unless he leaves the employer’s company before vesting. A repayment of the policy loan from the surpluses alone after a few years of contract term will hardly succeed – the entrepreneur will be left with residual debts, not to mention the liquidity disadvantage accumulated until then…. If, after e.g. 20 years, he is able to repay the policy loan in full from the surpluses, his loss from the accumulated liquidity disadvantage has already increased to over EUR 6,000. In any case, the employer will have to fully tax the payment of the insurance – in particular already annually the current surpluses and at the end still the final surpluses and participation in the valuation reserves – as operating income. This is the other side of the coin, since the employer had also deducted the insurance premium. If one balances the estimated 40% tax burden, which accrue for the entrepreneur with the – allegedly at any time possible – repayment, then the “flexible exit” from this construct becomes economically even after more than 10 years contract duration a loss business, above all in the comparison to the usual bank financing with good collateral. With the usual overall interest rate on the insurance, it usually remains a loss-making business in the end – only with above-average interest rates does a small profit remain. Measured against the interim annual outflow of liquidity and initial liquidity advantage, however, this most favourable case also only corresponds to a return of around 1% per annum. Entrepreneurs can hardly refinance themselves more expensively. This model should make a real contribution to boosting confidence in the industry.
Sales lies of the broker
The flexibility of this model has limits, because the medium-sized company loses a lot of money in any case – either because the surrender value minus the commitment to the employee is not enough to repay the policy loan plus taxes, or because the annual interest is enormously expensive, or because after a few years liquidity increasingly flows out because of the taxation of the annual surpluses. The winner is the insurer, because it cannot easily get a 6% interest rate on the market – unless it invests in “toxic assets” that have not yet found a “bad bank”: Of course, that would be a financial bet and not a security with the financial house. Of course, the broker hopes the bombshell won’t burst until his broker liability is time-barred. Meanwhile – i.e. for the next 10 years – the intermediary wishes that the entrepreneur and his tax advisor “don’t smell a rat”, because at first glance this model seems to be a bargain “in this financial crisis”. It takes tax and actuarial expertise to really look through such a model.
Dr. Johannes Fiala Peter A. Schramm
(Municipal Economy 07-08/2009, 466-468)
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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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