Life insurance: Reversal made easier

Millions of investors trust their bank advisors and insurance brokers. The risk that the investment decision turns out to be wrong is borne by the client. However, the prerequisite for this is that the advice given to the customer was sufficient. However, many advisors are unable to do this because they have not even read the small print, such as insurance conditions or issue prospectuses of up to hundreds of pages.

Regional Court (LG) Frankfurt/Main: Only investor- and object-oriented advice

The Frankfurt Regional Court (judgment of 12 September 2011, Case No. 2-21 O 44/11) was based on a case in which the advisor had recommended certificates to the client for risk diversification purposes, although the client had already invested his assets solely in shares. However, this recommendation was inappropriate because it led to a clustering of issuer risk. Furthermore, this investment advice was not suitable because the certificates are assigned to the area of equity investments, i.e. the equity portion had not been reduced by this investment at all. As the court explained, the adviser cannot object that the certificates related in part to other stocks.

Misadvice without a view to issuer risk, bulk risk and asset classes

Proper advice to the client must be appropriate to the investor and the property. The “decisive factors are, on the one hand, the level of knowledge, risk tolerance and investment objective of the customer and, on the other hand, the general risks, such as the economic situation and the development of the capital market, as well as the specific risks arising from the particular circumstances of the investment object. While the information provided to the customer about these circumstances must be correct and complete, the valuation and recommendation of an investment object must merely be justifiable when viewed ex ante, taking the aforementioned circumstances into account. “This, in turn, does not apply if the advisor has committed himself beyond this, for example, to provide the best product. These principles are to be considered also with the investment in life insurances, as decided by the Federal High Court (BGH, judgement of 14.06.2007, Az. III ZR268/06). This means that millions of customers who have been advised “off the peg” can claim damages from the intermediary and, in individual cases, also from the insurer and, for example, demand reversal.

Life insurance: High administrative costs, often unprofitable, rarely flexible

In particular, the specific risks of an investment product must be disclosed. In the case of certificates, it is not uncommon for around eight percent commission to be calculated in – without the customer knowing it. Whether it returns the investment at all without interest at the end of the term depends, for example, on whether the issuer of the security has not already gone bankrupt or been liquidated. With life insurance, the risk of suffering a loss due to the insurer’s insolvency is similarly high. Furthermore, one of the special risks of endowment insurance is that the acquisition costs are offset against the premiums of the first five years – the customer would only get back about half of the premiums paid in the first five years with legally operating insurers. Of course, there are also insurers who often illegally charge the customer much less for early termination – let the customer sue, some insurers think, and instruct the programmers to design the in-house software accordingly. In addition, in the case of life insurance policies there is also an issuer risk which an advisor or intermediary can only assess once he has familiarised himself with the accounting practice, the leeway possible under supervisory law and the far-reaching possibilities for intervention by the insurance supervisory authority, up to and including the prohibition of payment and the reduction of even already “guaranteed” claims. Anyone familiar with the situation on the capital markets must know that returns adjusted for investment risks, management costs and inflation have generally not been positive for years. Even “tax effects” do not change this, so that the recommendation of numerous financial products has for years been suitable at best for achieving a negative return on balance.

Expected returns as a trap

Insurers, intermediaries, consumers and consumer advocates have persuaded each other that life insurance is an investment that should be measured by its return. In fact, however, the premium paid belongs to the insurer, who promises an insurance benefit in return, assumes the risk and has to cover his costs. It is clear to every actuary that the average expected value of future benefits at the beginning of the insurance must always be lower than the value of future premiums to be paid – insurance cannot function any other way. Anyone who comes up with a positive return has simply miscalculated. For example, if the payments are forgotten to be correctly discounted to the start of the insurance according to simple financial mathematical principles or if the customer assumes an above-average life expectancy. However, negative real returns can never be a reason to forgo retirement savings. Just as those who preserve food for the winter don’t ask what the return is after the effort of canning or drying and taking into account the loss of nutritional value, vitamins and flavor or due to mice and mold. The answer can only be: Old-age provision is worthwhile even if less comes out than was paid in.

Dr. Johannes Fiala
Peter A. Schramm

(www.network-karriere.com, 08.2012)