Life insurance: calculation of surrender value
Life insurance companies owe re-bill and back pay
– see also article on surrender value of life insurance policies
The BGH judgements of 12.10.2005 (Ref. IV ZR 162/03, 177/03, 245/03) and the Constitutional Court with its decision of 26.07.2005 (Ref. 1 BvR 80/95) have a massive influence on the contracts of life insurers and the accounting practice for an existing life insurance policy. In the opinion of the authors, the BGH has thereby succumbed to a common fallacy among laypersons regarding the calculation of the surrender value. Hopes of subsequent payment are likely to prove unfounded in the case of most life insurance policies terminated in the first few years, because the BGH ruling contradicts the statutory regulations and is therefore unlikely to hold up before the Constitutional Court. On the other hand, the statutory regulations nevertheless already provide the opportunity for increased surrender values.
Consumer protection accusations For many years, the billing practices of insurers have been in the crossfire of criticism, and not only because the lobbying of the financial groups have pushed through numerous legal easements in their favor.
Already years ago a judgement (Az. 74 047/83, LG Hamburg) was issued, which allowed to say “Life insurance for old-age provision is legal fraud”. Those who cancelled their life insurance after only about two years had to realize that the surrender value was “zero”. The paid premiums were particularly charged with acquisition costs (sales costs incl. agent commission) and a cancellation deduction. In fact, the money was not gone – it had just been (kept) by someone else. The courts apparently did not want to leave it at that.
Liability of intermediaries Experts say that more than half of all life insurance policies are terminated before they reach their original term. This increases the acquisition costs pro rata temporis, because the commission remains the same in terms of amount – even if the contract term and thus the customer’s payments are much lower at the end. A liability of the financial adviser for faulty consultation can come thereby into question, in addition, an immorally too high brokerage or commission.
Banks and insurance brokers like to combine life insurance with a fixed loan when financing – especially when financing the construction of a home, this has considerable economic disadvantages. After all, experience shows that paying off your own four walls takes ten years longer and costs considerably more than an annuity loan: Many a builder-owner has lost his home in a compulsory auction as a result of such additional charges. For years, these so-called “interest rate inflation or leverage transactions” have also been a source of controversy, with intermediaries being ordered to pay damages.
Expropriation of the insured persons From the protection of property by the Constitution, also from the freedom of action with the protection against unequal negotiating position, the Constitutional Court concluded that the legislature had to formulate a statutory regulation by the end of 2007 for the participation of the insured persons in de facto existing assets of the insurers acquired with insurance premiums. In practice, insurers can write off their securities and real estate under commercial law – the insurance customer then receives an insufficient share of this. The so-called “cross-charges” of the insurers are also intransparent. Insurance regulation does not adequately protect the insurance customer from being disadvantaged.
Repayment of cancellation deduction to insurance customers In the opinion of the Federal Court of Justice, clauses concerning cancellation deduction, i.e. cancellation costs (“penalty fee”), were not sufficiently transparent and therefore invalid. Consumers could therefore have a check carried out (even in the case of contracts that have long since been terminated) as to whether the insurer still has to pay something in arrears.
Repayment of acquisition costs to insurance customers Acquisition costs are usually distribution costs – depending on the contract and company, also depending on whether it is a foreign or domestic insurance, the acquisition costs can be 7% or significantly more. These costs were usually offset against the premiums from the first two years of the customer’s premium payment.
The Federal Court of Justice has put an end to this practice and, by judicial interpretation of the contract, has stipulated that the insurance customer must as a rule get back at least just under half of the premiums paid in when the contract is terminated (rule of thumb). This means that even in the case of insurance contracts that have already been terminated and settled, the insured person is often entitled to additional substantial back payments in individual cases.
15 million contracts affected The BGH thinks 10 – 15 million contracts could be affected by its rulings. It remains to be seen when the legislator will issue a regulation (by the end of 2007) – the insurance industry now has the task of developing “transparent” clauses for future contracts, i.e. clauses that are comprehensible to the consumer from the outset. The requirements of the Constitutional Court will also have to be taken into account.
The labor court Stuttgart (Az. 19 Ca 3152/04) went in its judgement of 17.01.2005 still another step further: Afterwards employees have to accept with a salary conversion no load with conclusion costs at all!
Here, the employee is protected even more than the “normal” insurance customer, because the employee is always entitled to a surrender value calculated from the sum of paid premiums – without deduction of acquisition costs, brokerage commission, etc. The employee is also entitled to a surrender value calculated from the sum of paid premiums. This affects employers with deferred compensation models for employees.
New lawsuits – unsolved problems As a rule, consumers are not spared the need to have the insurers’ recalculations checked by an expert, even as a result of the case law of the higher courts. Especially since there is “even more in it” for the consumer than has been judged so far, because the current market value is what matters by law.
If the clauses are invalid, the law applies – in this case § 176 VVG for termination (and § 174 VVG for premium waiver). This states that the surrender value is the current value of the contract. Deductions (cancellation deductions) may then be made from this current value, provided that these are agreed and appropriate. The BGH now states that these deductions are not validly agreed.
Whether this is the case remains to be seen. If the BGH attributes this only to the lack of transparency of the clause on offsetting the acquisition costs by Zillmerisation, this would actually be irrelevant for the agreement on the cancellation deductions, because the cancellation deductions have nothing whatsoever to do with the Zillmerisation of the acquisition costs. Rather, zillmerization is already included in the calculation of the current value before the lapse deduction is made from the surrender value.
Fallacy of the BGH The BGH apparently assumes – as do most customers, by the way – that the current value is calculated from the premiums paid after deducting costs, including acquisition costs, and taking into account interest and risk premiums. In other words, like the development of a savings account – this is called a retrospective calculation.
However, the German Insurance Contract Act (VVG) provides for a present value calculation, and this is carried out prospectively, i.e. on the basis of the promised insurance benefit and the premiums still to be paid. As a simple example, let’s look at this – without any costs other than acquisition costs and without interest. If the contract provides for EUR 1000 in premiums to be paid annually for 20 years and EUR 18,000 to be paid out at the end, because – regardless of how non-transparent and whether agreed at all – the first two annual premiums were offset against the acquisition costs – then the customer receives a surrender value – current value – of EUR 0 after 2 years, even though he has paid EUR 2000. The BGH now believes that this deduction from the EUR 2000 paid is inadmissible because the deduction of the acquisition costs was not agreed transparently.
But that is not the point: according to the law, the surrender value is calculated as the current market value. And that means: the premiums still to be paid for 18 years – also EUR 18,000 – are deducted from the agreed benefit of EUR 18,000, leaving EUR 0 as the current value. These 0 EUR are at the same time the so-called zillmerized actuarial reserve – 2000 EUR are the zillmerized acquisition costs.
However, the fact that this result is ultimately caused by the offsetting of the acquisition costs does not even have to be explained or otherwise agreed according to this legally compliant method of determining the surrender value/time value. Any statement to the effect that acquisition costs will be charged would be purely descriptive with no direct effect – it is not needed for the outcome. The invalidity of a clause describing this circumstance is therefore completely irrelevant; the statutory provision alone is sufficient.
Insurers’ risk of action But what is the current value of a contract? In any case, a discount rate must also be taken into account. The current value of a non-contributory contract, for example, which provides for a benefit of EUR 100,000 in 20 years, is by no means EUR 100,000 at the present time. The insurers discount here with the actuarial interest rate of the contract, i.e. depending on the start of the contract with 4%, 3.5%, 3.25%, 3% or 2.75%. This means that a non-contributory contract providing for a benefit of EUR 100,000 in 20 years has a present value of, for example, EUR 45,639 (at an actuarial interest rate of 4 %) or EUR 58,125 (at an actuarial interest rate of 2.75 %).
Whether these large differences are justified depends on whether compensation is perhaps still being made from other sources, e.g. through interest on surpluses. Because without any further surplus, EUR 100,000 paid in 20 years is worth the same today and does not depend on what interest rate the insurer has calculated. Even in the case of a zero bond, which provides for EUR 100,000 at maturity in 20 years, the current market value does not depend on when the bond (fixed-income security) was originally issued and at what interest rate; rather, it is discounted at a uniformly determinable capital market interest rate today.
Financial Mathematics and Judicial Logic Blatant violations of the laws of reasoning in judgments can render decisions vulnerable to challenge before the Constitutional Court, because logic is an integral part of the constitutional legal system. In particular, consumers could, with expert assistance, also bring the current market value into the field according to the German Insurance Contract Act (VVG) and calculate it in advance in order to achieve additional payouts in the event of premature termination of the contract.
However, if the insurers had put too much emphasis on this legally prescribed calculation method vis-à-vis the BGH, the very question of the adequate calculation of a current value would have arisen. And thus the clearly determinable and usually used – but in principle not always doubtlessly resulting from the law – starting basis “zillmerised actuarial reserve” would have had to be questioned. In view of the current capital market situation, however, this could be even more disadvantageous if insurers were no longer required to calculate the surrender value/time value of contracts with an actuarial interest rate of 4 %, for example, but with a capital market interest rate of perhaps only 3 % or less in the near future.
Control is important If you do not trust the insurer to have calculated the surrender value correctly and transparently, you can have its calculations checked by an independent mathematical expert. This does not require a lawsuit to begin with. But the insurance customer must, also with long since settled and/or canceled contracts, with the insurer a new account first of all require, if he does not want to do without his good money.
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About the author
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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