Wonderful example of the esoteric risks in long term life insurance

The FT reported this week on a life insurance contract written by the French insurer L’Abeille Vie back in 1987. Known as a “Fixed Price Arbitrage Life Insurance Contract”, the product was sold to wealthy individuals and offered them the special flexibility to switch at any time between different investment funds at the listed fund price, which back in 1987 was set each Friday. The catch was that a smart (or not even so smart) investor could watch the markets go up or down during the week and would have a whole week to switch in and out of the funds at the previous Friday’s trading price, thereby using hindsight to lock in profits. These products were sold by insurance companies to many customers in the 1980’s and early 1990’s until trading prices became both more transparent and fixed more regularly.

Luckily for the providers, most insurers managed to cajole most customers to switch the terms and conditions and minimise the risk. L’Abeille Vie was less lucky with one canny family who not only refused to switch but also had taken out additional contracts before the terms were changed.

The company, now owned by Aviva, has contested the validity of the contracts in court but each time the French courts have upheld the claims – now estimated to be in the millions and growing at upwards of 60% pa. Aviva claims to be adequately reserved against these contracts but there is limited transparency around this. It highlights the risks of changing financial markets and prices and the risk in life insurance of offering a guarantee which can last for 20 years or more. This rings bells of the issues which floored Equitable Life in the UK. The company had offered guaranteed annuity options at interest rates of > 4% on many of its older life insurance policies. When annuity rates fell well below this level, the company realised it had under-reserved to the tune of around GBP 4.5 billion. The company was placed into run off and policyholders had to take a hit.

What else is hidden inside life insurance contracts written decades ago when financial markets and rates were very different from today?