• Germany: Landmark Decisions in the Mis-Selling Of Unit-Linked Life Insurance Policies
  • August 14, 2012
  • Law Firm: Norton Rose Canada LLP - Montreal Office
  • In a series of landmark decisions, the German Federal Court (BGH) held for the first time that unit-linked life assurance policies often qualify as investment products, and are therefore retroactively subject to much more stringent case law rules developed by German courts over recent years.

    As a result, a large life insurer is likely to be liable for hundreds of millions of euros not only in mis-selling charges, but also on the basis of “guaranteed payments” set out in the policy schedule, irrespective of a general reference to the standard terms and conditions where such payments were qualified as partial surrender benefits based on a corresponding reduction of the fund units allocated to the policy.

    It appears that, in reaching its decision, the court considered the following:

    1. The policy schedule itself (not just the standard terms and conditions or the customer information leaflet) should have contained a specific explanation that the regular payment of benefits were meant as a partial surrender triggering a cancellation of fund units (as opposed to payments promised by the insurer irrespective of any capital gains in the unit holding).
    2. The insurer should have drafted its standard terms and conditions in a way that does not require the policyholder to make the connection between several clauses in different places in order to understand certain issues.
    3. Where the standard terms and conditions provide for the insurer’s discretionary right to unilaterally change the relevant value of units (e.g. in connection with a partial surrender), they should have stated why certain unpredictable developments might reasonably require such a change, together with the specific reasons, parameters and maximum scope for the change.
    4. With regard to the extensive risk catalogue contained in the prospectus for the underlying fund, which even included the risk of total loss, the insurer should have clearly incorporated the prospectus disclosures into its own information and advice, instead of declining responsibility for the content of the prospectus and specifically excluding it from the relevant contract documentation.
    5. The insurer should have provided information and advice to the policyholders regardless of the fact that the policies were mediated by independent financial advisers selected by, and obliged to act in the interest of, the policyholder.
    6. The insurer’s information and advice should have specifically addressed the inherent risks of the product, including for example:
    • the particular risks in the underlying funds and/or the amount of fees and charges and their effect on returns which could reasonably be expected, without any overstatement in “non-binding” sample calculations;
    • discretionary rights of the insurer to use capital gains in smoothing returns not just for the portfolio, but also for other with-profit pools operated by the life insurer; and
    • discretionary rights of the insurer to stop surrender payments in case of an adverse development of the value of the underlying fund.

    The life insurer had distributed the unit-linked policies to German customers through networks of independent financial advisers. With or without the knowledge of the life insurer, the financial advisors had persuaded their clients to take out loans to finance the single premium contributions. Clients had expected to be able to finance repayments on the loan with the benefits obtained under the policy. Sample calculations showing capital gains of 8.5 per cent per annum were used as marketing material, whilst only the small print alerted the customer to the insurer’s own assessment of 6.0 per cent per annum.

    In the opinion of the court, the life insurer should have taken into account that German customers were mostly used to the traditional participating life assurance policies offered by German insurers. These policies provide for a combination of (conservatively calculated) guaranteed benefits and additional discretionary benefits which are derived from the overall profits of the insurer across its entire business. On the other hand, the combination of the unit-linked policies with the loans used to finance the premium contributions was not a decisive factor.

    The court held that none of the following aspects were sufficient to exclude or mitigate the insurer’s liability:

    • German insurance contract law and previous case law clearly states that the insurer is not subject to any duties of information and advice where the product is mediated by an independent financial adviser selected by, and obliged to act in the interest of, the customer; these provisions are, however, superseded by the qualification of the policy as an investment product.
    • The policy schedule and the marketing material contained numerous general references to the standard terms and conditions.
    • The standard terms and conditions contained a clause explaining that there was a risk of “very little capital gains”, which were, however, toned down by reports on the satisfactory investment experience of the life insurer's customers in the past.
    • The customers had been orally informed during the sales process that the regular payment of benefits would normally be lower than the interest owed on the financing loan.

    The only defence available to the life insurer is that - in the respective case - the  customer and the intermediary had in fact arrived at a different common understanding of the product features than could have been inferred from the standard documentation, for example with regard to the qualification of the regular payments set out in the policy schedule as partial surrender benefits. This will have to be re-examined by the lower courts on the merits of each case, together with the respective amount of compensation and damages payable by the insurer.

    The generality of the approach and the qualification of unit-linked policies as investment products are unprecedented in German jurisprudence. Also, the decisions do not attach any significance to the fact that unit-linked policies (without guaranteed benefits or participation rights) have been known and widely sold in the German market for a long time. In any case, the outcome clearly favours policyholders with a higher risk appetite at the expense of buyers of more conservative products.

    The decisions were made in five test cases. While about 35 more cases are pending with the German Federal Court, many more cases are expected to follow.