Luxembourg capitalisation policies
Expert’s voice: questions to Marc Gouden
« Today, Luxembourg capitalisation policies will usually be policies backed by investment funds, and this is where their originality lies. »
Q1. Could you define the Luxembourg capitalisation policy?
The first thing to emphasise about the capitalisation policy is that it is a policy governed by the Insurance Act. It’s a product which will be sold by insurers and not by bankers, for example. There are perhaps two ways to define a capitalisation policy. The first would be to distinguish it from its first cousin, life insurance. At this level, they have two fundamentally different characteristics. The first difference is that with life insurance there is always a person who is insured. Life insurance policies have a random component linked to the term of a human life and therefore the benefit will be paid either when the insured person dies or when he survives. None of this applies to capitalisation policies. Capitalisation policies are entered into for a term which is fixed in advance by the parties, with the possibility of tacit renewal. The second difference compared with life insurance policies is that, in life insurance a beneficiary is always nominated. We might add, for someone’s benefit. However, with capitalisation policies, it is the policyholder himself - or possibly his estate if he dies during the term of the policy - who will receive the lump sum when the policy terminates. This is the first way of defining capitalisation policies, by distinguishing them from life insurance. Alternatively, we could turn to the legal definition of a capitalisation policy and in this regard the law tells us that: “a capitalisation policy is a policy in bearer form which consists of a commitment, in exchange for one or several periodic payments, to provide a benefit fixed in the policy or linked to changes in the value of, or return on, the assets with which the policy is backed”. This legal definition informs us about certain features. One gets the feeling, however, that it may not be a good reflection of the way capitalisation policies are used today. First of all, the law tells us that these policies are bearer contracts. However, my view is that, today in Luxembourg, we no longer use bearer capitalisation securities, where all the rights are enshrined in the security itself and the bearer of the security can exercise these rights. This is a solution which was commonly used in the past, but today I believe that everyone uses only registered capitalisation policies. As for the rest, the law is also silent on the two features which I mentioned earlier, namely the absence of an insured person and the absence of a beneficiary clause. In addition to this, the law gives us two other features which are fundamental to capitalisation policies. They are, firstly, the insurer’s commitment, which is either fixed in advance or may be linked to the growth of the investment funds. And this, I believe, is really one of the unique characteristics of Luxembourg capitalisation policies. The second feature is that it is the policyholder who undertakes to make the payments and these may be either a one-off payment or periodic payments, including regular payments scheduled in advance. Or simply unscheduled payments made when the policyholder chooses.
Q2. How does the capitalisation policies work?
Today, Luxembourg capitalisation policies will usually be policies backed by investment funds, and this is where their originality lies. We find, therefore, that these capitalisation policies operate like units-linked life insurance policies, also known as Branch 23. In other words, at the time of subscription and depending on his objectives, the client will select from the range of funds offered by the insurance company, a certain number of funds in which he wishes to invest. These may be external funds, internal collective funds, or possibly even an internal dedicated fund, i.e. a fund specifically linked to this client's capitalisation policy. Subsequently, during the life of the capitalisation policy, the client is able to switch (or change) the funds. The value of his policy will fluctuate in line with market developments, depending on the valuation of the funds with which his policy is linked. Finally, when the policy ends, the value (i.e. the lump sum which the client will receive) will be equal to the value of the funds at the time when the policy ends. We should point out that capitalisation policies may be surrendered at any time, just like life insurance policies. And if the client decides to surrender, he will receive the value of his capitalisation policy at the time of surrender.
Q3. Why choose a capitalisation policy rather than a life insurance contract?
Capitalisation policies may be taken out both by individuals and legal entities. The benefits from subscription will be quite different for capitalisation policies and for life insurance policies. A company, for example, may well decide to take out a life insurance policy, but then the objective will be to safeguard itself against the possible death of a senior executive. In the case of a capitalisation policy, on the other hand, the objective is clearly to invest any surplus cash which the company may have available to it. We are well aware that today, when interest rates are at extremely low or even negative levels, allowing money to sleep in a savings account does not generate any profit. In the worst case, it costs money. In this way, capitalisation policies - while remaining very simple to operate - make it possible to invest, with a return linked to developments in the financial markets. This also enables the company - as I was saying - to surrender and thus to recover its cash at any time, if it needs it for normal business operations or if it wants to make an internal investment within the company. So instead of the chief executive, who has other things to do, spending his day following the stock markets and giving buy and sell instructions on the stock markets, he can make one simple investment in a capitalisation policy. Choose the appropriate funds and then let the fund managers follow developments in the markets in order to get the best possible return. We should also stress that it is very easy to use a capitalisation policy as collateral for a bank loan. If at any time, the company wants to borrow, it can secure this loan with a pledge or an assignment. This is very easy and, indeed, it is provided for in Luxembourg legislation; and I refer, in this regard, to the excellent contribution of Maître Vilret on this subject. Like life insurance, the Luxembourg capitalisation policies benefit from the famous ‘safety triangle’, namely from a clear separation of the assets held both by the insurer and by the custodian bank. In the event of default by one or other of the parties involved, the safety triangle ensures that there will never be any problems, that the assets may always be found, and that clients may therefore benefit from the super-privilege they enjoy under Luxembourg law. A final word on taxation. Unlike life insurance, which in some countries may benefit from specific tax exceptions for individuals, capitalisation policies are subject to normal fiscal rule of tax on the income generated. But it also has the advantage - over life insurance, for example - that in Belgium the 4.4% tax is not deducted from the premium. And, compared with a direct holding of securities, the tax on stock exchange transactions is thus avoided.
Q4. What is the difference between a capitalisation policy and an accumulation operation?
Luxembourg capitalisation policies are very similar to capitalisation policies as practised in France. However, if we refer to the European definition of a capitalisation transaction, we will see that there are some important distinctions. The EU directive defines a capitalisation transaction as a transaction based on actuarial techniques, which - in return for a one-off payment or for periodic payments fixed in advance - will result in the insurer's obligation to pay an amount fixed in advance, at the end of a period also fixed in advance. Thus, at this level, we have certain fundamental features which are very different from what I explained a few moments ago. First, actuarial techniques or mathematical calculations are used. We are then told that payments made by the policyholder are either a one-off payment or, if they are periodic payments, they must be fixed in advance; this excludes payments made voluntarily at the subscriber's discretion. Above all, we are told that the term, and the amount payable at term, must be fixed at the start of the transaction. Of course, this is not possible with investment funds which evolve in line with market trends. This definition from the European directive has been transposed into Belgian law, with the addition that capitalisation transactions are independent of any random event, in order to distinguish them from life insurance. This is what is known as Branch 26. Belgian Branch 26 is truly based on features which are very different from capitalisation policies as defined by Luxembourg legislation, and as described by me at the start of this interview.