European Court of Justice opens the door for massive unit-linked policy claims in Dutch mis-selling affair

Introduction

In the Netherlands, several individual claim and class action proceedings are pending in the biggest mis-selling affair regarding unit-linked policies in the Netherlands (known as "woekerpolisaffaire"). It is said that the Dutch insurance market has already reached settlements for an amount of € 3 billion to compensate the excessive costs which were withheld from the premium and holds an additional indemnification reserve amounting to € 2.5 billion in order to compensate pending and future unit-linked mis-selling affair claims. The indemnification reserves may need to be increased considerably in light of the preliminary ruling the European Court of Justice ("the Court") rendered on 29 April 2015.
The need for a preliminary ruling arose in a test case of Dutch life assurer Nationale Nederlanden Levensverzekering Mij N.V. ("NN") against a Dutch claimant (Mr. H.W. van Leeuwen), regarding a unit-linked policy (a life insurance policy with an investment component). An important part of the dispute relates to whether NN - before the policy was taken out - gave sufficient information concerning the costs and premiums deducted by the insurer in respect of the death risk cover.
In short, the Court ruled that the Third Life Assurance Directive (Council Directive (92/96/EEC) of 10 November 1992 on the coordination of laws, regulations and administrative provisions relating to direct life assurance and amending Directives 79/267/EEC and 90/619/EEC ("Third Life Assurance Directive", OJ 1992 L 360, p. 1)) does not preclude an insurance company, on the basis of general principles of domestic law such as open and/or unwritten (pre-) contractual rules, from being required to send to policyholders certain information additional to that listed in Annex II to the Directive, provided that the information required is clear, accurate and necessary for the policyholder to understand the essential characteristics of the commitment and that it ensures a sufficient level of legal certainty, which it is for the referring court to ascertain.
The Court's judgment enables the local courts to rule (in hindsight) that prior to the inception of the policy, the insurer should have provided the policyholder with more information than the specific information which directly follows from the Third Life Assurance Directive. Consequence would be that the insurer is in breach of the (open) principles of contract law and could be liable for the losses suffered by the insured's, including their investment losses.
Below, I will briefly discuss the nature of the insurance product and the background and developments of the mis-selling affair in the Netherlands. I will also discuss the potential exposure for direct insurers and reinsurers in this regard.

The nature of unit-linked policies

An unit-linked policy consists of a life insurance component which covers the risk of death and an investment component with which capital could be build (for mortgage repayments, pension or general capital raising). The sum paid in by the policy-holder (single or regular premium) covers both the life insurance component as well as the investment and administrative costs and commission. Therefore, it was unclear what the extent of the costs was and what part was invested. The part of the sum paid in that is eligible for investment, was invested in stocks, bonds or other investment categories by the insurer in its own name. The policy-holder bears the investment risks.
A case in point is that in his opinion before the Court's ruling of 29 April 2015, AG Sharpston confesses that even after consulting the national file, she finds it difficult to understand precisely how the assurance at issue operated. She initially understood the method to consist of deducting each month several types of costs and the risk premium from the premium paid and investing the balance. However, after examining the information in the national file, it appeared that the deductions were made from the value of the participations in investment funds plus the premiums paid during a year; and then the losses or gains from the investments during that year were added to determine the new value of participations.
Unit-linked policies were very popular from the late 1990's until the early 2000's because of the decreasing interest rates for deposit savings, a favourable stock market climate and tax-efficiency. Until the year 2005, 7.2 million unit-linked policies had been sold in the Netherlands. At the end of 2005, the build up capital of unit-linked policies amounted to € 49.2 billion. The declination of the stock markets in the following years on the one hand and the "hidden" excessive costs and premium (which could not be invested) on the other hand, caused disappointing return of the investments and disappointing capital build with the unit-linked policies. Today, barely any new unit-linked policies are taken out in the Netherlands.

Background of the Dutch unit-linked mis-selling affair

In the autumn of 2006, a confidential report of the Netherlands Authority for the Financial Markets ("AFM") had been leaked. This report stated inter alia that the unit-linked policies are complex and not transparent, that the provision of information about the product was incomplete, insufficient and not even always right and that an important part of the sum paid in, was not invested, but covered the (administrative) costs, commission and premium.
The commotion these findings caused in the (Dutch) market was reason for several interest groups to seek compensation for (former) unit-linked policy-holders, what subsequently made the Dutch State Treasury Agency decide to ask the Dutch Financial Services Ombudsman ("Ombudsman") for recommendations for adequate, quick out-of-court settlements. The Ombudsman noted that the amount of the premium and the amount and structure of the costs of unit-linked policies had been unclear for policy-holders. He recommended to apply a maximum cost reduction of 3.5%.
Until now, also on the basis of the Ombudsman's recommendations, insurers have reached settlements for an amount of € 3 billion, compensating the excessive costs (not the investment losses however) of about 45% of the unit-linked policies which have been taken out in the Netherlands.

Court of first instance (referring court)

Article 31(3) Third Life Assurance Directive (hereinafter: "the Directive") concerns a Member State's facility to require assurance undertakings to furnish information in addition to that listed in Annex II of the Directive.

In the request for a preliminary ruling, the Dutch Court of Rotterdam states that whilst Nationale-Nederlanden complied with the provisions of Dutch law by which the Directive was implemented (these are the provisions referred to in article 2(2)(q) and (r) of RIAV 1998), it infringed so called "open and/or unwritten rules of law" (such as the reasonableness and fairness which govern the (pre-)contractual relationship between a life assurance provider and a prospective policyholder) by failing to give information on the impact of costs and risk premiums on the value of the investment.
In light of this, the question arose whether EU law, in particular Article 31(3) of the Directive, preclude an obligation on the part of a life assurance provider on the basis of open and/or unwritten rules of Netherlands law to provide policy-holders with more information on costs and risk premiums of the assurance than was prescribed directly by the provisions of Dutch law.

Judgment European Court of Justice

The Court ruled that the Third Life Assurance Directive does not preclude an insurance company from being required to send to policyholders certain information in addition to the information listed in Annex II to the Directive, on the basis of general principles of domestic law such as open and/or unwritten (pre-)contractual rules. However, with reference to its judgments in Axa Royale Belge (Axa Royale Belge, C-386/00, EU:C:2002:136, paragraph 24) and Parliament v Council (Parliament v Council, C-48/14, EU:C:2015:91, paragraph 45), the Court held that an obligation to provide additional information can only be imposed where it is necessary to achieving the objective of informing the policyholder and where the additionally required information is clear, accurate and necessary for a proper understanding of the essential characteristics of assurance products proposed to the policy holder, in order to guarantee the insurance companies a sufficient level of legal certainty.
The Court drew the conclusion that it is for the Member States to determine the legal basis of the obligation to provide additional information in order to ensure both effective understanding by the policyholder of the essential elements of the insurance products proposed to him on the one hand and a sufficient level of legal certainty for insurers on the other hand.
Despite it is up to the Member States to determine which additional information need to be provided to the policyholder, the Court further ruled that, when assessing the requirements to be laid down as regards the foreseeability of the obligation to provide additional information, the national court may take into consideration the fact that it is for the insurance company to determine the type and characteristics of the insurance products it offers, so that, in principle, it should be able to identify the characteristics which its products offer and which are likely to justify a need to provide additional information. With this consideration in mind, the local courts could seize the opportunity not to specify the specific information required in addition to the information which directly follows from the Third Life Assurance Directive, stating that the insurers could identify this information on their own. However, the courts need to establish that the additionally required information is clear, accurate and necessary for a proper understanding of the essential characteristics of the unit-linked policies. How the Dutch courts deal with this, will become clear when they lay down their decisions in the several pending proceedings, presumably at the end of this year.

Conclusion

With the leaked report from the Netherlands Authority for the Financial Markets, it became apparent that the pre-contractual provision of information about the unit-linked policies was incomplete, insufficient and not even always right. It was unclear that an important part of the sum paid in, was not invested, but covered the (administrative) costs, commission and premium, what (together with the declining stock markets) caused disappointing return of the investments and disappointing capital build with the unit-linked policies. In this regard, assurers have reached settlements, compensating the excessive costs. However, the investment losses have not (yet) been compensated. The judgment by the European Court has opened the door for massive claims against life assurance companies who have effected these unit-linked policies. It is said that the involved Dutch life assurers have made an indemnity reserve of € 2.5 billion in this respect before the judgment was rendered. This amount may need to be increased in light of the judgment.
For the Dutch life assurers' liability insurers and reinsurers it is therefore highly relevant to verify whether the (circumstances about) these (potential) claims have been notified and to consider or increase an indemnification reserve for unit-linked mis-selling claims.