Liability traps in the liquidation of life insurance policies

by Peter Schramm ( and Johannes Fiala (
Until 1994, guaranteed surrender values were paid out in German life insurance in the event of cancellation, which were calculated from the actuarial reserve according to the business plan less cancellation deductions. Fair values instead of guaranteed surrender values With the deregulation of 1994, the guaranteed surrender value was abolished and replaced by the fair value. This is what § 176 VVG says about the surrender value to be paid out:
The surrender value is to be calculated as the current value of the insurance in accordance with the recognised rules of actuarial mathematics.
Cancellation deductions can still be made in accordance with § 176 VVG, insofar as they are agreed and appropriate. As an actuarial expert, the author is increasingly involved in reviewing the calculation of surrender values on behalf of policyholders. In addition to the question of appropriate cancellation deductions ? for which there are fundamental elaborations of the German Actuarial Association ? the calculation of the fair value also plays a role. It is precisely here that the discussion among actuaries that began a few years ago has not been brought to a conclusion ? the effects of the sharp fall in interest rates were not even foreseeable at the time.
It cannot be assumed that the current value ? as is mostly practiced at present ? always corresponds to the actuarial reserve plus pro rata accumulated surpluses. Rather, he can ? for example in the event of a sharp rise in interest rates ? under it, but also ? with sharply falling interest rates ? are above that.
Therefore, when interest rates are very low, customers may have a ? ultimately also legally enforceable ? The insurer is entitled to a higher surrender value than the insurer calculates.
Current value with different guaranteed interest rates
As an example, two endowment insurance contracts are compared ? once with an actuarial interest rate of 4 % (guaranteed interest rate), once with 2.75 %. Both contracts for a sum insured of EUR 100,000 mature in 10 years. If one ignores costs and risk premiums and assumes for the sake of simplicity that no more premiums are to be paid, the actuarial reserve at an actuarial interest rate of 4 % today amounts to EUR 67,556, but at 2.75 % it amounts to EUR 76,240. In addition, there are any surpluses accumulated to date, incl. Proportionate (discounted) final surpluses ? both will be left aside here for the time being for the sake of simplicity.
As long as the total interest ? Actuarial interest plus surplus interest ? is at least 4 % in each case, is it justified to use only a current value of EUR 67,556 in the first contract and EUR 76,240 in the second? in each case therefore in the amount of the actuarial reserve ? …to be applied. For example, if the total interest rate is 5%, the first contract will receive only 1% interest surplus annually, but the second will receive 2.25% (difference between the total interest rate of 5% and the calculated interest rate of 2.75%). The interest rate is based on the actuarial reserve, not on the current value. This therefore results in a higher maturity benefit in the second contract overall, which also justifies the higher present value. If, in both cases, the existing actuarial reserve is paid out at the same total interest rate until the maturity of the maturity benefit ? interest payable plus excess interest ? If the present value is discounted by 5 % and exactly this 5 % is used again for discounting to the present value, the present value in both cases is just the actuarial reserve again. However, even then it must be asked whether a lower market interest rate would not be appropriate for discounting to the present value ? graded according to the market interest rate of safe investments for the remaining term of the policy. In that case, the customer would already be entitled to a higher current value than the one usually charged by the insurer.
Surrender values or fair values increase as capital market interest rates fall
How is the case to be assessed if the achievable interest rate continues to fall (e.g. to 2.5%) and thus no surplus interest is paid on both contracts? Then, in both cases, only the maturity benefit of EUR 100,000 guaranteed at maturity in 10 years would come into effect. Is it then still comprehensible why these EUR 100,000 should currently have a lower current value if the actuarial interest rate is 4 % ? compared to the current value at 2.75% actuarial interest?
If the present value for the contract with 2.75% actuarial interest is correctly calculated at EUR 76,240, then a present value of only EUR 67,556 appears ? in the amount of the actuarial reserve ? for the contract with an actuarial interest rate of 4 % is obviously too low. Under certain circumstances, an even higher current value could be assumed for both contracts ? is in fact ? as an example ? discounted with a market interest rate of only 2.5%, the guaranteed maturity benefit of EUR 100,000 even has a present value of EUR 78,120.
Effect on accumulated surpluses
So what does this mean for the accumulated current surpluses? As an example, only accrued interest surpluses in the case of so-called interest-bearing accumulation are dealt with here. These are on a separate account, so to speak ? the accumulation credit ? of the policyholder and are paid annually at the accrued interest rate ? mostly in the amount of the total interest ? interest. If both example contracts currently have an accumulation credit of EUR 10,000 and the accumulation interest rate is at least 4%, the same effect on the profit participation results purely from the existing accumulation credit at maturity. As current value are then uniformly 10,000 EUR payout justified with repurchase ? the accrual interest rate is significantly higher than the market interest rate over the longer term, even more. The situation is different if the insurer no longer declares a surplus interest in the two contracts. Then it is for reasons of equality ? namely with the insured persons who have agreed to the formation of annual additional bonus insurance sums instead of interest-bearing accumulation ? is also required to set the accrual interest rate at the same level as the interest rate charged on the contract. Depending on the case, the 10,000 EUR current accumulation credit will then earn interest at 4% or only at 2.75%. In the result this leads with expiration to 14,802 EUR and/or only 13,117 EUR ? in the first case, an increase of 13 %.
Although the accumulation credit would obviously justify a different current value because of the difference in interest rates, insurers usually pay exactly the nominal accumulation credit in both cases ? so here 10.000 EUR ? off. In fact, however, with an accrual rate of 4 %, a 13 % higher current value would be justified. The current practice in determining surrender values means that the same future claim today would have a lower current value the higher the guaranteed interest rate was calculated. It is very doubtful that this is so tenable under the wording of the law.
Effect on recognised provisions for decapitalisation
Should it be determined ? for example due to relevant court rulings ? that such a recalculation of surrender values has to take place in the event of low interest rates, insurers would also have to take this into account in their actuarial reserves shown in the balance sheet. For the actuarial reserve may not be less than the surrender value to which it is entitled by law. However, this would require a considerable allocation and would be a burden on the companies. Such an allocation requirement is also addressed in Section 341f (2) of the German Commercial Code (HGB): “When forming the actuarial reserve, account must also be taken of interest rate obligations entered into vis-à-vis policyholders if the current or expected income from the company’s assets is not sufficient to cover these obligations.
The question of calculating the surrender value or time value is an actuarial and legal one. If, for reasons of contractual law, it should turn out at the latest that higher surrender values or fair values have to be calculated due to the fall in interest rates, this would probably also have to be followed by the accounting. Looking at the above example, one can imagine the impact this can have on life insurance companies. And precisely on those that already only grant the guaranteed interest rate in each case due to weak earnings. In the case of Equitable Life, however, it was only a court ruling that led to the underbalancing becoming indisputable, which almost led to insolvency. In the event of a significant drop in interest rates and the resulting increase in surrender values, the termination of a life insurance policy would become increasingly attractive, so that the drop in interest rates would have an immediate effect. Therefore, it cannot be assumed that insurers can spread the solution to the problem of too low investment income over the entire remaining contractual term of the policies ? cf. § 341f para. 2 HGB.
Liability problem
A liability problem for the bank could also arise in the case of bank realisations of life insurance policies if the calculation of the surrender value by the insurer is accepted without verification. The very fact that higher purchase prices can often be obtained for used policies on the secondary endowment policy market indicates that the current values of some policies may be higher than those calculated by insurers. Banks are therefore recommended to determine the current market value independently of the insurer and to obtain supplementary offers from the secondary market for life insurance policies prior to realisation.
Broker liability
The unchecked liquidation of a life insurance policy and then using that money to pay off debt or for a better performing investment can carry significant liability. The broker must ensure that the insurer does not unjustifiably charge acquisition and cancellation costs, which may not be deducted according to the ruling of 13.05.2005 of the OLG Düsseldorf. Intermediaries, but also tax advisors, are obliged, if they do not want to make themselves liable, to examine the alternative of the secondary market (e.g. Cashlife).
Liability of the insurer
For the broker, an expert opinion on the question of correct billing offers a way to simply get rid of his own responsibility and delegate the liability or responsibility to an expert. At the latest with the liquidation of a life insurance policy, it must be checked whether the surrender value has been stated too low by the insurer: this should be the case relatively often. The costs of an expert for an initial assessment of larger contracts are usually a fraction of what can be expected from the insurer as an additional payment.
It is simply a question of the right to information and, if necessary, re-invoicing: it would be a mistake to think that the policyholder’s money is hidden exactly in the cover pool!
Banking Liability
Bank liability also often comes into question from various points of view. Time and again, banks sell a fixed-rate loan (which, as we know, offers permanently higher interest income for the bank) in combination with a life insurance policy: this alone puts almost all credit institutions under liability, because the annuity loan is cheaper in financial terms. This is not only true for home financing. Tax advantages ?below the line? are the exception.
Further typical liability traps for the bank is the concealment of the total costs from interest for the fixed loan and repayment (sersatz) by payment into a LV (or a building saver!): The consumer credit law had already given that the total price (also with splitting into credit and LV) is to be indicated: Here substantial costs can be saved, because then only 4% (four per cent!) interest is entitled to the bank (retroactively!) as a rule. Those mediators, who recognize this, can often invest such ?free reserves? well for the customer. And finally it can be that the credit with a LV should be redeemed, but the amount from the LV with expiration is not sufficient: Also in this case it can be that the bank has simply ?bad luck?, because sometimes the courts say that the bank gets then only this money from the LV and no cent more. This case is typical for BauFi.
about the authors: Dipl.-Math. Peter Schramm, actuary DAV, actuarial expert, publicly appointed and sworn by the IHK Frankfurt am Main for actuarial mathematics in private health insurance
Johannes Fiala Lawyer, Master of Business Administration, Master of Mediation, Banker (IHK) Certified Financial and Investment Advisor (A.F.A.)

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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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