Leveraged business: immediate annuity – bank loan – savings plan

Chance of high profit – but also high risks
Leveraged transactions are in practice referred to by financial service providers as “savings annuity”, “savings annuity”, “lex- annuity”, “interest rate differential transaction”, “loan-financed annuity”, “immediate annuity”, “leveraged annuity”, “guaranteed annuity”, “loan-financed life insurance”, “leveraged life insurance”, “fixed loan with repayment substitute”, “leveraged pool”, “loan-financed investment”, “fixed loan with repayment substitute”, “leveraged investment fund”, “loan-financed participation”, “special loan scheme”, “UK life insurance combined with a loan”, “financed unit-linked life insurance”, “snow annuity”, “mixed leveraged annuity”, “leverage effect”, etc. denoted. The public prosecutor’s office is dealing with this under the aspect of fraud or capital investment fraud. BaFin sometimes examines such transactions from the point of view of whether the necessary permission under the KWG has been granted.
Initial case and model
Dr. Peter Fleißig, a physician with a successful practice, 45 years old, one wife, two children, is informed by his financial advisor how he can earn even more money with his unencumbered house (market value 250,000 euros) and even receive an immediate pension. The property is mortgaged: Bank loans with a mortgage as collateral. Of course, the loan is taken out in YEN or francs, because there the money is “apparently cheaper”. The money (loan) is paid into an immediately starting life annuity insurance (life insurance). The pension should also be used to pay the interest on the loan, and incidentally the pension should help supplement the family income. In addition, a savings plan (further life insurance with investment) is concluded: With this money, the mortgage loan (repayment) is to be repaid at the end. The Bank shall have this contract assigned to it as security.
Actually, this model cannot go well before taxes, because the return on the annuity is usually less than the cost of the loan. According to tax law, however, such annuities are only taxable at the so-called income share, i.e. only partially. The loan interest is deductible as income-related expenses.
The horse’s foot in tax analysis
There is no supreme court decision on this: an individual case decision by the tax courts or tax offices is required – and this is rarely obtained before the contract is concluded, to be on the safe side. There is the question of whether an intention to make a profit or total surplus (before tax!) will be provable at all: Without the investment and a link to the loan and the pension, this will hardly succeed. This is a model which, by the way, often only pays off if the tax burden is constantly (!) high.
The termination
Investor Dr. Fleißig only notices the risks after years. Just when the stock market is experiencing a massive drop in prices, the bank calls with a request to strengthen the collateral. Dr. Fleißig has expanded his practice and cannot offer any additional security. The bank sets a deadline and threatens to terminate the agreement. The intermediary helplessly berates the bank, because the credit institution was informed about the model before the loan was signed. Dr. Fleißig has his tax advisor do the math: If the contracts are terminated (prematurely), a loss of 300,000 euros remains – his inherited house will then be auctioned off. Dr. Fleißig thinks about how he should explain this to his wife.
The risks
The investor was not advised about the following risks: An individual case decision or binding information from the tax authorities is not available. The tax office can turn the calculated after-tax profit into the opposite with the stroke of a pen. Even if the tax office recognizes the model, it can in principle be cancelled at any time by the legislature. References to expert opinions of so-called tax experts and circulars of the tax authorities do not help either. No life annuity insurance gives a guarantee for the total return. With the minimum interest rate for German life insurance policies, the model does not pay off. Future profits are uncertain. Only very few companies on the European market can be trusted to actually achieve the non-binding projections of a 6-7% return (and more) over the terms of such models of 10 to 20 years. Numerous freelancers and self-employed people have bought their investments (funds, real estate, etc.) on credit: Due to the exchange rate risk, many a loan customer has later noticed that, in addition to the seemingly low interest rate, he actually had to pay back considerably more because the foreign currency had become more expensive for him. Depending on how the stock market situation has developed at the time the loan matures, there is a risk that the expected return will not have been achieved by the time the loan matures. Then the loan has to be extended or the investment has to be sold at low prices in a bear market. Dr. Fleißig has the risk that the loan will not be renewed, an option in the loan agreement is missing and, above all, the bank can demand additional collateral at any time. Without a fixed interest rate, and possibly also for the extension option, rising interest rates may at any time result in an additional burden that is no longer bearable, leading to the realisation of the collateral by the Bank. Then the model bursts like a soap bubble. The model calculations assume that the investor has a certain tax situation. If the income is lost for a longer period of time, e.g. due to an accident or illness, or if there is a separation and divorce, the model usually no longer pays off. It is a speculation with various assumptions: This can be called a bundle of risks, because numerous parameters must be met for it to work. Without hedging measures through contractual arrangements (vis-à-vis banks and insurance companies), this can be a time bomb.
Consultant liability – documentation
The mediator’s advice was not documented. Dr. Diligent has not signed any instructions. He is considering suing for inadequate counseling. Dr. Fleißig recalls that he was not informed about currency or leverage risks. The BHG ruled on such a case, in which the bank had demanded additional collateral for the loan due to a fall in the exchange rate: the customer was unable to provide additional collateral, and as a result the collateral (including the insurance) was realised. Consequence: Compensation – similar risks await the advisor with the financed immediate annuity if no information is given about conceivable risks (occupational disability, accident, loss of income, tax changes, etc.) or if these risks are not covered as far as possible. BGH judgment 09.07.1998 – III ZR 158/97, BGH judgment 13.05.1993 – III ZR 25/92, BGH judgment 04.02.1987 – IV a ZR 134/85.
Consultant liability – trade journals
The trade press must be read by the agent: The customer must be given the information: This also applies to incorrect or false information in the trade press. Even in the case of leverage transactions, the investor can claim years later that he would never have decided to invest if he had known the information from the trade journal. Typical examples: Financed capital investment (rented property, closed real estate fund, combinations of loan and life insurance, etc.). Here there is the chance for investors to take the agent and/or the financing bank into liability. The seller of an investment (insurer, real estate seller) is also generally responsible if the intermediary made incorrect calculations that became the basis for the investment decision. BGH judgment 5 June 2000 – III Z’RR 305/98 BGH judgment 9 March 1999 – 1 StR 50/99 BGH judgment 6 April 2001 – V ZR 402/99.
Tax advice
In numerous calculation examples, costs or expenses are not or far too low or tax credits are overstated. The investor can thus invoke a consulting error. In the case of public companies and builder-owner models, prospectus liability comes into question (BGHZ 71, 284 and BGHZ 111, 314). As soon as the investment intermediary makes his knowledge and experience available to the investor, an advisory contract is concluded. In this way, the intermediary guarantees (also for the partners behind the intermediary in their circle of obligations) the correctness of the model calculations for the individual case (BGH judgement 6 April 2001 – V ZR 402/99 and BGH judgement MDR 00, 405).
Tip for brokers, advisors, customers
Numerous banks like to finance according to the “umbrella principle”: when it is sunny, the loan is available – when it rains (market price adjustment, reduction of surrender value, reduction of final bonus, etc.), the credit institution demands an increase in the loan collateral or “flattens” the leverage transaction by realising it. A possible safeguard: agreement of a clause in the loan agreement – e.g. after assignment of the policy to the bank as collateral – such as “otherwise as a bank loan” or “without further collateral”. However, this means that the bank also bears a risk and may also be exposed to greater responsibility. Advantage: Such a hedge is more likely to ensure that the bank financing the loan closely examines how the loan collateral is to be valued, even if the capital investment develops differently than hoped.
Courtesy ofwww.finanztip.de.

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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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