Life insurance: Reversal made easier

Millions of investors trust their bank advisors and insurance brokers. The risk that the investment decision proves to be wrong is borne by the customer. The prerequisite for this, however, 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 with 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 adviser 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 concentration of issuer risk. Furthermore, this investment advice was not suitable because the certificates were allocated to the area of equity investments, i.e. the share of equities had not been reduced by this investment. As the Court of First Instance pointed out, the adviser could not object to the fact that some of the certificates related to other shares.

Misadvice without a view to issuer risk, bulk risk and asset classes
A clean consultation of the customer must be investor and object-fair. 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 these special risks which result from the particular circumstances of the investment object. While the information provided to the client about these circumstances must be correct and complete, the valuation and recommendation of an investment object must merely be justifiable, taking into account the aforementioned circumstances ex ante. This does not apply if the adviser has committed himself beyond this, for example to procuring the best product. These principles must also be observed when investing in life insurance policies, as decided by the Federal Court of Justice (BGH, judgement of 14.06.2007, ref. 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 rescission.
Life insurance: High administrative costs, often unprofitable, rarely flexible
In particular, the specific risks of an investment product must be explained. In the case of certificates, it is not uncommon for commissions of around eight percent to be calculated in – without the customer being aware of it. Whether the investment is returned without interest at all at the end of the term depends, for example, on whether the issuer of the security has not already gone bankrupt or been liquidated. In the case of 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 around 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 in the event of premature termination – let the customer sue, some insurers think, and instruct the programmers to design the in-house software accordingly. In addition, there is also an issuer risk in the case of life insurance policies, which an advisor or a consultant must take into account. The insurance intermediary can only judge this when he has come to terms with the accounting practice, the leeway possible under supervisory law and the extensive possibilities for intervention by the insurance supervisory authority, up to and including the prohibition of payment and the reduction of even “guaranteed” claims.Anyone who is familiar with the situation on the capital markets must know that the returns, adjusted for investment risks, administrative costs and inflation, have generally no longer 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 generating a negative return on balance.
Expected returns as a trap
Insurers, intermediaries, consumers and consumer advocates have persuaded each other that life insurance policies are investments that should be measured by their return. In fact, however, the premium paid belongs to the insurer, who promises to provide insurance benefits 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 inception of the policy must always be lower than the value of the future premiums to be paid – insurance cannot function any other way. Anyone who arrives at a positive return has simply calculated incorrectly.For example, if you forget to discount the payments correctly to the start of the policy in accordance with simple principles of financial mathematics, or if the customer assumes an above-average life expectancy.However, negative real returns can never be a reason to forego old-age provision. Just as no one who preserves food for the winter asks how high the return is after the effort of boiling or drying and taking into account the loss of nutritional value, vitamins and taste or due to mice and mold.The answer can only be: Old-age provision is worthwhile even if less comes out than has been paid in.

Dr. Johannes Fiala
Peter A. Schramm

(, 08.2012)

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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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