Investors bear risks of poor life insurance returns

Time and again, investors have fallen for “non-binding annuity forecasts” from life insurance companies – the agent and the advertising material of some companies suggest dream returns of, for example, 12.9 percent or even 31.2 percent to the customer, especially in the case of British policies. At times, clear warnings that such returns are not indicative of future performance have simply been brushed aside.


Risks of your life insurance to repay the loan at the end of the term

A very common mistake in construction financing advice lies in the mismatch of maturities: For example, the loan interest rate is fixed for ten years – while the life insurance still runs for another ten years. This can lead to an undesirable increase in the cost of credit.

Often a life insurance policy or a building society contract is also coupled with a fixed loan, although the permanently high loan interest rates for owner-occupied property are not tax-deductible. In such cases, the banks, intermediaries and the credit institution are then liable to the customer for the damage resulting from excessively high financing costs.


Risk of a shortfall in cover – subsequent collateralisation claim by the Bank

If it is agreed with the bank that a loan is to be repaid by the maturity benefit of a life insurance policy, the borrower or loan customer alone bears the risk of a shortfall in cover in the case of standard banking contract models, as the Federal Court of Justice (BGH) has now ruled (ruling of 20 November 2007, ref.: XI ZR 259/06).

The lawyer then says that the maturity benefit of the life insurance was agreed “on account of performance” to repay the loan, which is the rule in banking practice. The customer therefore remains sitting on the remaining debts.


In individual cases it depends on the judicial interpretation of the contracts

By way of exception, a credit agreement clause can also be interpreted in such a way that performance is agreed “in lieu of performance”, as shown by a ruling of the Karlsruhe Higher Regional Court (OLG) of 4 April 2003 (WM 2003, 2412): Only then does the bank bear the risk of poor life insurance returns because it can only claim the maturity benefit of the life insurance, i.e. it has exceptionally assumed the investment risk of the insurance customer.


Financial and bank advisors in liability

Also with the immediate annuities and other alleged tax savings models sample calculations are regularly presented to the customer for the financing of a capital investment. These sample calculations may be seriously flawed, implausible or even clearly or deliberately inflated and serve to keep the customer in the dark about his risks and the costs of financing.

In this case, the insurer may also be liable if the advertising promises were excessive from the outset and the insurer cannot later reduce the profit participation on the grounds of lower returns. In addition, there are those cases in which the partial external financing of a capital investment leads to certain losses for the customer, contrary to the model calculation of the intermediary:

Often, only an analysis of contracts and brochures provides evidence that neither the customer nor the intermediary had seen the complex interrelationships. In such cases, the bank and/or insurance company may nevertheless have to accept liability for incorrect or incomplete investment or financing advice.


Yield concept in life insurance fundamentally misleading

Where life insurance policies are advertised as an investment, yield information is also expected. However, the concept of return on a life insurance policy is generally misleading. If a return is quoted in relation to the maturity payment in the case of scheduled policy implementation, then for the purposes of comparison with other capital investments it must always be based on the full gross premiums, not just on savings portions that the customer cannot even recognize.

But even then, the term “return” is misleading, since early termination and surrender often result in no return at all or even a negative return. It is therefore difficult to compare a life insurance policy with an investment, but naming the yield obscures the differences and misleads the customer. If he wants to cancel credit and insurance prematurely, this can only be done at a considerable loss – often nothing remains of the mentioned yield.


Risks and negative scenarios are concealed

In model calculations, often only an “expected course” is given. Other scenarios with worse outcomes are missing, both on the insurance and the loan side. This means that the customer cannot assess the risks that lie in negative deviation from the expected course.

Later it turns out that the bad results that actually occurred were not unlikely from the beginning, but that this risk was not made transparent to the customer. Had he known this – he or his lawyer will say – he would never have entered into such a construction.

An actuarial expert then quickly determined by how much the result – measured against the customer’s assets – would have been better even with a normal annuity loan, for example. The consequence is then inevitably a liability of the broker and financial advisor for the difference.


by Dr. Johannes Fiala and Dipl.-Math. Peter A. Schramm

by courtesy of (published in Die Zahnarztwoche, issue 10/2009, page 46)

and (published in Landpost, issue 22/2008, page 25)

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

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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