However, BaFin does not focus on models under which consideration is paid out directly to the policyholder, or the holder of such investments, while the provider continues operating the investment in order to generate a return. In fact, under the models that are of interest to BaFin, the provider targets the capital tied to the investment, which the provider would rather see invested elsewhere, i.e. with the provider itself. In these cases, the constituent elements of deposit business may have been fulfilled if the "purchase price" is to be paid out only at a later date and the purported purchase agreement turns out to be an offer for a capital investment.

Deposit business is any banking transaction that is subject to authorisation (see info box "Deposit business"). If no authorisation has been granted, BaFin prohibits the operation of deposit business and decrees the liquidation of the business (see info box "Prohibited deposit business"). As the operation of banking business without authorisation is prohibited in accordance with section 54 of the German Banking Act, any organisation who offers such services – that is to say the members of its corporate organs – risks criminal prosecution.

Case law

After the Administrative Court in Frankfurt am Main (case no. 9 K 646/11.F) and – in interim proceedings – the Higher Administrative Court of Hesse (case no. 6 B 818/10) confirmed the classification of such models as deposit business, the civil courts have now also dealt with matters involving similar investment models and set the relevant contracts aside.¹⁾ Moreover, the Higher Regional Court in Frankfurt am Main affirmed that the executive board responsible for the purchasing company is liable under civil law.

Some providers are increasingly attempting to bypass the authorisation requirement under the German Banking Act by including clauses in their contracts that provide for a qualified subordination (qualifizierter Rangrücktritt or qualifizierter Nachrang) of the investors' claims in order to exclude the repayability of the funds accepted, with repayability being a typical element of deposit business. In practice this means that the (purchase price) claim is subordinated to the claims of other creditors of the particular provider, with this subordination being qualified in that the claim for repayment is excluded for as long as and to the extent that the repayment would give rise to grounds for the initiation of insolvency proceedings against the provider. Only recently, a civil court deemed a subordination clause in the context of the purchase of insurance policies to be a general term and condition that is invalid in the specific contractual arrangement, as it unfairly disadvantages the other contracting party.²⁾

To the extent that such subordination clauses are invalid under civil law, the constituent elements of deposit business are not precluded. In addition, from a prudential perspective, the repayability of the funds, and thus a constituent element of deposit business, can only be excluded by way of a subordination agreement if investors, in light of the structure and the presentation of the capital investment offer, have to proceed on the assumption that they themselves will have to assume financing responsibility for the provider. However, in BaFin's opinion, it must be assumed that investors specifically do not want to assume any financing responsibility if they can expect, in view of the specific structure of the offer, that they will subsequently be paid a "fixed purchase price" in return for the assignment of their investment, with the amount of such purchase price being dependent on the paid-out surrender value of the investment.

Modified offer presentation

Moreover, providers are also seeking out other ways to bypass the authorisation requirement, for example by opting for a more neutral wording of their offers, refraining from making marketing statements such as "payout at double the surrender value". On various websites, prospective customers wishing to terminate their life insurance policy or other investment early can enter the details of their investment on a web-based form and then receive a "personalised offer". At first glance, it is usually not clear exactly what business model is hiding behind such an offer. The following aspects would indicate that it is, in fact, deposit business subject to an authorisation requirement:

• The life insurance policy or the investment is terminated – in most cases cancelled – and the seller can opt to have the surrender value paid out in part or not paid out at all.
• The purchase price is calculated on the basis of the surrender value (doubling after eight years, for example).
• The purchaser markets its offer by claiming that it would yield a higher return than the investment itself.

For the investor, it is difficult to get a clear idea of offer structures that split the contractual relationships so that one provider purchases the investment, while its proceeds are used to fund a capital investment for the investor with another provider. These models also target the capital tied up in the original investment and may qualify as deposit business.

Critical review

Whenever providers are claiming that their offer is a "better" investment, investors should carefully scrutinise such offers. It is important for the investor to realise that they may relinquish a contractual relationship with a company that is subject to state solvency supervision (such as a life insurer or a building society) and instead enter into a contract with a company that is not subject to any such supervision and is not monitored by BaFin as to whether it is capable, on a sustainable basis, to perform the contracts entered into with its customers.

As a consequence, the investor's risk exposure to default increases. For offers involving qualified subordination, this risk grows. Irrespective of the business model, whether or not any payment commitment is, in fact, fulfilled always depends, first and foremost, on the other contracting party. Any investor contemplating the sale of his or her life insurance policy should take this into consideration and not just focus on a purchase price that is higher than the surrender value.

Interview with Gabriele Hahn, BaFin Chief Executive Director Regulatory Services and Human Resources:
"Business models with extremely high loss potential"

Ms Hahn, for years, BaFin has been warning investors of the risks of purchasing second-hand life insurance policies, noting business models which violate the Banking Act. Why does it continue to remain necessary to issues such warnings?

These are business models with an extremely high loss potential. Many investors in Germany have investments which are interesting for providers operating under models which do not comply with the law. These may be life or annuity insurance, as well as a building savings contract or even savings deposits. Providers seek to "purchase" these investments, as it were. Often, very large sums of money are involved. If a provider is unable to pay at the end of the term or is simply a fraud, the investor walks away with nothing. That loss is particularly painful when the investment was intended to serve as their retirement fund.

What is it about such offers that investors find so tempting?

Investors often wish to terminate life insurance policies or other investments before they reach maturity, for instance if they are not satisfied with the investment. Sometimes, they have to because they need the money back which they had invested. Others are drawn in by unrealistic returns. So the pool of prospective investors in such products is rather large. In order to win their confidence, providers characterise their business model as a purchase. The term "purchase agreement" does not have any negative connotations and suggests that the investment is a straightforward business transaction. This leads many investors to forget to have a closer look at the business model and the provider.

What does BaFin do to combat dubious providers?

If a provider is operating without the necessary authorisation, we prohibit the transaction and order it to be unwound. However, we cannot prevent providers from taking up such business; we can only react. Yet, the fact that we do react has proven effective: several offers have already been removed from the market. The fact that the responsible persons are opening themselves up personally to criminal prosecution surely also plays a role.

However, there are businesses which are not subject to authorisation, and which are therefore not subject to our supervision. Providers are often highly creative and purposely structure their investment offerings in such a way that they are able to offer products which are not subject to authorisation. However, the fact that a product does not require authorisation in no way reflects the economic viability of the product or the soundness of the provider. This is why investors must closely scrutinise any potential investment. Naturally, they should avoid any illegal investment opportunities from the outset, from fraudulent models to those which violate statutes such as the Banking Act.

How is an investor to know if an investment opportunity is illegal?

There are many ways to find out. For example, investors can search for topics, companies or specific persons online. The BaFin website provides warnings relating to providers operating without authorisation. Investors can also obtain information from consumer protection organisations which are well informed on current business models. However, they must take care not to make the mistake of concluding that because they cannot find anything negative about a business model or provider, this means that the investment is legally permissible, or that their money is safe there.

How can investors assess whether the providers can and will satisfy the agreement – even in the case of legal offers?

They should examine the content of the deal with a critical eye, including the individual terms and conditions and the counterparty. If they cannot find sufficient information, they should not put their assets at risk. They should not fall for advertising or brokers promising them that they will hit the jackpot. And they should know one thing: even if we supervise a company, we do not assess the potential return on their products. And the return should not be the sole deciding factor for investors, anyhow. They also have to weigh this against the risks they are willing to assume.

Ms Hahn, thank you for granting us this interview.

Footnotes

1) Nuremberg Higher Regional Court (case no. 8 U 607/12); Frankfurt am Main Higher Regional Court (case no. 2 U 178/12).

2) The decision has not yet been published.