Contents Analysis of the Life-Insurance Industry... General Survey of the Israeli Life-Insurance Industry General Issues...

Transcription

1 Contents 1. Analysis of the Life-Insurance Industry... 5 a. Premiums and Distribution of Types of Insurance... 5 b. Life-Insurance Assets Portfolio... 8 c. Participating Portfolio Share of Investments in Participating Portfolio Cash Investments Stock Investments d. Analysis of Insurance Companies' Yields General Survey of the Israeli Life-Insurance Industry a. Life-Insurance Industry Developments in Committee for Examination of Actuarial Assumptions b. Approval of New Policies Assured-Yield Policies Lump-Sum Wage-Indexed Policies Unit-Linked Policies General Issues a. Reporting to the Insured b. Insurance Rate c. Participating Policies Tables Table C-1 Gross Premiums by Types of Insurance and Rate of Change, Table C-2 Life-Insurance Premiums, by Groups, Table C-3 Total Life-Insurance Premiums, by Quarters, Table C-4 Distribution of the Assets Portfolio, Table C-5 Distribution of Assets in the Participating Portfolio, Table C-6 Gross Weighted Yield, Net Weighted Yield, and Premiums, Table C-7 Gross and Net Yields, by Groups, Table C-8 Highest and Lowest Net Yields,

2 Table C-9 Cumulative Comparison of Provident Funds and Participating Life-Insurance Plans, Figures Figure C-1 Distribution of Life-Insurance Assets Portfolio, Figure C-2 Distribution of Assets in Participating Portfolio, Figure C-3 Distribution of Assets in Participating Portfolio, by Groups, Figure C-4 Cash and Cash-Equivalents in Total Investment Portfolio, Figure C-5 Insurance Companies' Net Yield and Management Fees, Figure C-6 Insurance Companies' Gross Yields, by Quarters, Figure C-7 Gross Yield, by Groups, Figure C-8 Gross Yield of Insurance Companies, by Size of Companies, Figure C-9 Cumulative Gross Yield of Insurance Companies, by Size of Companies,

3 The Life Insurance Department of the Capital Market Division regulates and applies enforcement vis-à-vis insurance companies in respect to life insurance. The department is responsible, among other things, for reviewing life-insurance plans that are submitted to the Commissioner of Insurance for approval, regulating the life-insurance industry in various respects, and handling professional inquiries from the public in this field. This section of the Report reviews developments in the life-insurance industry in 1999, describes new plans approved by the Commissioner of Insurance, and focuses on several latitudinal issues related to the life-insurance industry. 1. INDUSTRY ANALYSIS This section analyzes the insurance companies' business performance in life insurance in The analysis refers to the distribution of assets in the life-insurance portfolio, the distribution of premiums by insurance lines, insurance companies' yields on their participating portfolio, and other indicators 2 A. PREMIUMS AND DISTRIBUTION OF TYPES OF INSURANCE Life-insurance plans are marketed to the public in several forms: 1. Personal plans (for individual insured). 2. Executive plans (through employers), indexed to the Consumer Price Index or to wage. 3. Group plans (companies, service providers, employers). Insurance premium revenues continued to rise in 1999, and the composition of types of plans offered to the public continued to change. 1 All figures are adjusted to December 31, The topic of industry profitability is discussed at length in the chapter on Solvency of Insurance Companies. 5

4 Table C-1 Gross Premiums by Types of Insurance and Rate of Change, (NIS millions, December 1999 prices) Type of insurance Percent change, Percent change, Increase in premiums, (NIS) Personal endowment 1,937 1,930 1, Personal "preferred" 1,121 1,177 1, Executive endowment 1, Executive "preferred" 4,658 5,100 5, ,064 Group insurance Other (1) 1,008 1,376 1, Total 10,653 11,324 12, , "Other" includes disability, health, and nursing-care insurance Premium revenues in 1999 were more than NIS 12 billion, and net of disability, health, and nursing-care insurance which some companies classify differently NIS 10.5 billion. Premium revenues in life insurance grew by more 6 percent, pursuant to the trend in recent years. The types of insurance discussed in the analysis are classical life-insurance lines irrespective of health and nursing-care insurance, which some insurance companies categorize as life insurance (classified as "other"). As Table C-1 shows, life-insurance premium revenues (net of "other") increased from NIS 9.64 billion to NIS billion between 1997 and 1999 a real increase of NIS 0.9 billion and a growth rate of 9.3 percent. The growth between 1998 and 1999 was from NIS 9.95 billion to NIS billion, for a real increase of NIS 0.59 billion and a growth rate of 6 percent. In executive insurance plans, the market share of the preferred-type executive plan continued to grow, from NIS 5.1 billion in 1998 to NIS 5.72 billion in 1999 a real increase of NIS 0.62 billion and a growth rate of 12.2 percent, at the expense of endowment policies, in which the downtrend of previous years continued. 6

5 The increase in the market share of preferred-type executive insurance plans accounted for 84 percent of total growth in this industry between 1998 and One explanation for this is the superior range of alternatives that the preferred-type policy offers. In personal insurance, the uptrend in preferred-type insurance continued, revenues increasing from NIS 1.12 billion in 1998 to NIS 1.23 billion in 1999 a growth rate of 9.2 percent. Here, too, the changeover trend from endowment-type to preferred-type plans may reflect the greater flexibility of the latter for the insured (in terms of alternatives). The share of group life insurance climbed between 1998 and 1999 from NIS 0.8 billion to NIS 0.85 billion a growth rate of 6.1 percent. Table C-2 Life-Insurance Premiums, by Groups, (Percent) Group End of 1997 End of 1998 End of 1999 Migdal Clal Phoenix Menorah Harel Other Total The large insurance groups maintained their market shares in 1999; the Harel group increased and consolidated its position by acquiring Zion Insurance Co., Ltd. At the end of 1999, the five largest groups possessed 96 percent of insurance premiums. The remaining 4 percent were apportioned among other companies in the industry (ILDC, Ayalon, Direct Insurance, and Eliahu). Notably, Zion was included in the "other" category in and in the Harel group in The industry remained highly concentrated; the three largest insurance groups held a market share in excess of 70 percent, much as in previous years. 7

6 Table C-3 Total Life-Insurance Premiums, by Quarters, 1999 (NIS billions) Qtr. I Qtr. II Qtr. III Qtr. IV Total Premium revenues in 1999 were evenly distributed across the quarters (at approx. NIS 3 billion per quarter). The revenue trend is different in life insurance than in some provident funds (self-employed, severance-pay) and advanced-training funds for the self-employed, in which contributions are higher in the fourth quarter than in previous quarters due to seasonal factors such as end-of-year deposits by self-employed and employers. B. LIFE-INSURANCE ASSETS PORTFOLIO Assets in life insurance are divided among various investment funds assured-yield (Funds A H) and participating (Funds I J). As Figure C-4 shows, in , the assets portfolio grew in real terms from NIS 40.9 billion to NIS 66 billion an increment of NIS 25.1 billion and a growth rate of 61.4 percent. In , the portfolio grew from NIS billion to NIS 66 billion, for a growth rate of 12.8 percent (all figures in real terms) The internal mix of the portfolio (between assured-yield and participating funds) shows an 18.2 percent increase in assured-yield funds, from NIS 34 billion in 1995 to NIS 40.2 in 1999, due to continuing payments into existing plans and a constant portfolio yield. Participating funds increased from NIS 6.88 billion in 1995 to NIS 25.8 billion in This growth traces to the fact that only participating policies have been written since The share of assured-yield funds in total assets has been declining over the years from 71 percent in 1997 to 67 percent in 1998 and 61 percent in There are three main reasons for this perceptible long-term downtrend: 1. Since 1992, all policies written have been of the participating type; with no assured yield. 2. Assured-yield plans have been reaching the end of their term. 3. Insurance companies have been redeeming earmarked bonds 8

7 The composition of the total portfolio of assets in life insurance gives evidence of the modern changes that have marked the development of this industry in recent years. The share of "indexed-life" bonds in the portfolio decreased conspicuously, from 58 percent in 1997 to 46.5 percent in In contrast, the share of government bonds rose from 13.4 percent in 1997 to 17.2 percent in Furthermore, the proportion of loans and deposits with banks and in cash has been rising visibly. All these developments are direct results of the government's decision to stop issuing "indexed-life" bonds for new policies starting in

8 Table C-4 Distribution of the Assets Portfolio, (Percent) Year/Type of asset December 1997 December 1998 December 1999 "Indexed-life" bonds Other government bonds Other securities issued in Israel Bank loans and deposits (excl. demand deposits) Cash and demand deposits with banks Real estate for rent Investment in subsidiaries and insurance brokers Premiums due and agents' balances Accounts receivable and credit balances Deferred acquisition expenses Total assets and credit balances (NIS billion) C. PARTICIPATING PORTFOLIO The participating portfolio accounts for much of the insurance companies' portfolio of assets; its average size relative to the life-insurance portfolio was 39 percent in This assets portfolio was worth NIS 25.8 billion at the end of 1999 as against NIS 19.2 billion a year earlier, for an increase of 35 percent. This growth is the result of the steady uptrend of the industry in recent years, at more than 6 percent per year in real terms, and the strong yields that various assets invested in the capital market earned in

9 Table C-5 Distribution of Assets in the Participating Portfolio, (NIS thousands, December 1999 prices) Year/Type of asset December 1997 December 1998 December 1999 "Indexed-life" bonds 756, , ,052 Other government bonds 6,569,095 8,854,223 10,601,308 Other securities issued in Israel 2,352,402 2,450,507 4,435,682 Bank loans and deposits (excl. demand deposits) 2,835,305 3,917,338 4,930,353 Cash and demand deposits with banks 475, ,222 1,213,744 Real estate for rent 39,893 73, ,838 Investment in subsidiaries and insurance brokers 1,281,703 1,543,622 1,978,520 Premiums due and agents' balances 222, , ,164 Accounts receivable and credit balances 21,468 44, ,416 Deferred acquisition expenses 771, ,336 1,394,869 Total assets and credit balances 15,327,017 19,199,943 25,802,946 As Table C-5 shows, the assets are divided into several main groups, as shown in statements that are released for public scrutiny and forwarded to the Commissioner of Insurance. Government bonds account for about 40 percent of total assets, followed by investments in deposits, loans, and securities, which together add up to another 40 percent. 11

10 As Figure C-2 shows, each investment path in the participating portfolio shows an upturn commensurate with the increase in premiums paid in. The distribution of total assets in the participating portfolio resembles the 1998 distribution. This year, investment in government bonds increased at the expense of investment in shares. 12

11 In distribution by insurance companies, the Migdal Group had the largest market share (38.3 percent, worth NIS 9.7 billion) at the end of 1999, followed by the Clal, Phoenix, Harel, Menorah groups, which together had a 59 percent market share. The remaining 3.2 percent of the market was held by other companies. The three largest insurance groups (Migdal, Clal, and Phoenix) had a 74 percent market share in 1999, collectively 1 percent greater than in This illustrates the continuing state of concentration in the insurance market. Below we survey the characteristics of the insurance companies' investment portfolio from various perspectives, focusing on quarter-by-quarter analysis for SHARE OF INVESTMENTS IN THE PARTICIPATING PORTFOLIO. Investments of assets in the participating portfolio are made in accordance with the Methods of Investment Regulations, which stipulate the types of assets that may be invested and the investment restrictions that apply to them. In 1999, investments from the participating portfolio maintained their 85 percent share in the total investment portfolio, at NIS 22 billion. 13

12 CASH INVESTMENTS As Figure C-4 shows, the component of cash and cash equivalents in the investments segment increased in 1999 from NIS 509 million in the first quarter to NIS 1.2 billion in the fourth quarter a real increase of 135 percent and 4.7 percent of total investments in the participating portfolio. Most of the increase occurred in the fourth quarter, due to several factors that converged at that time: 1. In the course of fourth quarter, the Consumer Price Index in the first quarter of 2000 was expected to be negative. This made short-term saving in unindexed investment paths more attractive and resulted in the possibility of almost risk-free cash investments at higher yields than various alternatives could offer. 2. There were expectation of the passage of new Methods of Investment Regulations that would give insurance companies a broader range and greater flexibility in investing premium revenues. For this reason, companies preferred to accumulate cash in advance of the possibility of having to change their investment vehicles and, in particular, to increase the proportion of stock investment in the total. 14

13 3. In the fourth quarter, the share of stock investments in total assets climbed to the 15 percent limit determined in the Methods of Investment Regulations. Therefore, the insurance companies had to realize part of the share portfolio, among other things, and shift some assets to cash. 4. The Y2K bug raised questions about the Bank of Israel's interest policy; therefore, cash investments were an interim use of portfolio assets until the matter became clear. STOCK INVESTMENTS The stock portion of the investment portfolio increased from NIS 1,562,178 in 1998 to NIS 3,178,885 in 1999 a growth rate of 104 percent. The increase traced mainly to the upturn in total investments. Since the General Share Index climbed on average by 60 percent in 1999 over 1998, following a 31.8 percent yield in 1998 versus 1997, the portion of stock in the insurance companies' investment portfolio reached the limit of 15 percent of total assets (the maximum allowed under the Methods of Investment Regulations). Recently (in the middle of 2000), the limit of stock investments in the total assets portfolio was raised to 25 percent. D. ANALYSIS OF INSURANCE COMPANIES' YIELDS Life-insurance premiums are invested in assets that generate a yield3 in accordance with the company's investment method and policy. A management fee as set forth in the regulations4 is subtracted from this gross yield, eliciting a net yield. The net yield is credited to the insured in accordance with the terms of their policies. The yield that the companies report, both in their financial statements and in their annual report to the insured, is based on the investment of assets in a "model portfolio," in consideration of several assumptions (such as a monthly deposit at the beginning of each month, etc.) that are not necessarily typical of the behavior of insured who pay into lifeinsurance plans. 3 The company weights the yield on all of its assets to elicit a single yield (the yield on the participating portfolio). 4 See section on participating policies and management fees. Nearly all insurance companies choose the option of constant and variable management fees. 15

14 The yields analyzed in this section of the Report are based on reported yields and not necessarily on actual yields credited to the insured, which, as stated, are affected by additional indicators such as the timing and size of deposits. Table C-6 Gross Weighted Yield, Net Weighted Yield, and Premiums, (Percent) Year Gross weighted yield Net weighted yield Management fees Table C-6 presents gross weighted yield, net weighted yield,5 and management fees collected by all companies in The high yields in 1999 were achieved mainly due to the fine performance of the capital market. The insurance companies' relatively high yields in 1999 originated in their unindexed and stock investments, which performed well. 5 The weighted yield is computed by multiplying each company's yield values by the share of its assets in the total for all companies. 16

15 Group Table C-7 Gross and Net Yields, by Groups, Company name Gross yield (Percent) Net yield Avg. net yield in past 5 years Migdal Migdal Shimshon Hamagen Clal Clal Aryeh Ararat Phoenix Phoenix Dolev Hadar Noga Harel Shiloah Sahar Zion Menorah Menorah Manulife Menorah Other Ayalon Eliahu ILDC Direct Insurance Acquired by the Harel group in the course of

16 Table C-7 shows the yields attained by insurance companies in ; Figure C-5 shows yields and management fees collected in All insurance companies except for Eliahu and Ayalon attained gross yields of over 10 percent in 1999 and net yields in excess of 8 percent. The highest yields were achieved by the companies in the Clal group (Aryeh, Ararat, and Clal) followed by those in the Menorah group (Menorah and Manulife) Although Direct Insurance7 did not attain the highest gross yield among the companies, it gave its insured the highest net yield because it did not charge a management fee in In contrast, Ayalon and Eliahu had the lowest gross yields at 8.2 percent and 9.3 percent, respectively. The disparities among the companies are due mainly to differences in each company's investment policy. The transition from the "old world, in which the government assured yields indirectly by issuing insurance companies with earmarked bonds, to a "new world" in which yields for the insured are determined in accordance with yields attained in the capital market prompted insurance companies to adjust the way they deal with investments in the capital market. 7 Direct Insurance, Ltd., invests in three ways. The company's weighted yield was computed as the weighted average of company assets relative to these three investment methods. 8 Direct Insurance, Ltd., is allowed to charge management fees for each of the investment paths and in accordance with the regulations. 18

17 Importantly, an additional 0.5 percent of yield to the insured in a long-term insurance plan can increase the insured's savings by more than 9 percent on average. In the past few years, the large insurance groups have taken internal actions to establish professional investment departments and have been making greater use of outsourcing. Table C-8 Highest and Lowest Net Yields, (Percent) Year Highest net yield Lowest net yield Avg., past 5 years Table C-8 shows the highest and lowest yields in recent years. Every company outperformed its 1998 yield in 1999, thereby boosting the multiannual average yield. The increase in average net yield over the past five years traces to the inclusion of 1999 (a good year in the capital market) in the calculation instead of 1994 (a bad year on the capital market). 19

18 Figure C-6 shows the gross yield in 1999 relative to other investment options in the capital market. Relative to the yields of insurance companies in 1999, the general bond index9 climbed by 6.4 percent and the indices of indexed and unindexed bonds increased by 4.8 percent and 13.8 percent, respectively. Since the indices were low (and, consequently, indexed bonds achieved poor yields), insurance companies, for considerations that included low inflation, preferred to invest their money in bank deposits, which paid higher returns, and in unindexed bonds. Comparison of quarter-by-quarter net yields in 1998 and 1999 shows that although the third quarter of 1998 was better than the corresponding quarter in 1999, the capital market obviously had a better year in Consequently, 1999 was a good year for insurance companies, which attained higher yields than they had in previous years. Figure C-7 shows that large insurance groups (Migdal, Clal, and Phoenix) attained higher yields than the small groups (Ayalon, Eliahu, and ILDC), in accordance with the companies' investment policies. These policies vary from company to company and are commensurate with company size and goals during the year. 9 Bond indices include government and corporate bonds but not Treasury bills. 20

19 The "Other" category (composed of insurance companies that operate without a group affiliation Ayalon, Eliahu, ILDC, and Direct Insurance) attained lower yields than insurance groups that operated jointly. The quarterly yield rates of these companies, as shown in the figure, were improved by the high yield attained by Direct Insurance in Additionally, the Menorah group has been reporting stable yields over the years. Even in 1998, a year of poor yields, the Menorah group managed to keep its yield stable. The Migdal group, which had the lowest yield in 1998, recovered and stationed itself in the middle of the industry relative to other companies and to the net weighted average yield. 21

20 Figure C-8 shows gross yields in by size cohorts. The Migdal, Clal, and Phoenix groups are categorized as large, the Harel and Menorah groups as medium, and the other insurance companies as small. Since 1997, the small companies have consistently had lower yields than the medium and large companies. Although in 1999 large insurance companies attained higher yields than medium companies according to the cumulative data, the medium-sized companies achieved higher yields during the period because in 1998 the large companies attained lower yields than medium-sized companies and, especially, small companies. 22

21 Table C-9 Cumulative Comparison of Provident Funds and Participating Life-Insurance Plans, (NIS) Year Provident fund Insurance plan NIS 1000 = 1/ Table C-9 shows that provident funds usually achieve higher yields than insurance companies. During the four years reviewed, the cumulative difference between the two saving mechanisms was 3.6 percent. This difference may be attributed to the Methods of Investment Regulations, which allow provident funds to make bolder investments than insurance companies. 23

22 2. GENERAL SURVEY OF THE ISRAELI LIFE- INSURANCE INDUSTRY 1999 In the course of 1999, the Commissioner of Insurance approved several life-insurance plans that enhanced the industry's development. Additionally, the Committee for Examination of Actuarial Assumptions presented the Commissioner with its recommendations concerning pension policies. In 2000, the insurance companies presented various pension policies to the Commissioner for approval; at the present writing, they are in various phases of the approval process. A. LIFE-INSURANCE INDUSTRY DEVELOPMENTS IN 1999 COMMITTEE FOR EXAMINATION OF ACTUARIAL ASSUMPTIONS In January 1998, the Commissioner of Insurance appointed a committee to examine the actuarial assumptions under which insurance companies in Israel estimate their liabilities for pension payments, as included in their financial statements. Since developments in science and life quality have increased life expectancy, there is reasonable concern that the mortality base for the computation of pension discounting has become inadequate. In other words, the premises on which insurance companies base themselves when they calculate their pension-insurance rates make no reference to the lengthening of life expectancy. For reason of tax benefits, the rate of pension takeup has been very low thus far. Furthermore, the discounting base built into the policies assures a larger payout when insured choose a pension than when they take a lump sum. This is due to the covert assumption that the insured, collectively, would prefer to receive a nonrecurrent lump sum that would release the company from its liability to pay an assured pension. Consequently, the assured-pension option in the policy is a dead letter. However, changes in tax benefits, along with a possible change in the public's preferences in pension savings, may change the share of insured who prefer the pension option. 24

23 The committee recommended a narrowing of the disparity that has come about between future entitlements (the company's pension liability to its insured) and the sum actually accumulated in the reserves. This narrowing is to take place gradually during the period remaining until retirement age, i.e., age sixty-five. BELOW ARE THE COMMITTEE'S MAIN RECOMMENDATIONS IN RESPECT TO THE ADJUSTMENT OF INSURANCE RESERVES: a. For existing policies: accumulation of reserves in consideration of the probability of choice of the pension option. b. New policies, issued after the Commissioner's directives concerning calculation of the reserve: calculation of the total reserve that will be needed in view of assumptions that the Commissioner will find acceptable, in which the basic premise is that all insured will choose the pension option. MAIN FACTORS THAT AFFECT THE COMPUTATION OF PENSION- INSURANCE RESERVES Mortality For the past thirty-five years, most insurance companies have calculated their reserves on the basis of the British Mortality Table a(55), which presents mortality rates in Great Britain. Additionally, since we know today that the average life expectancy is rising steadily (due to improvements in health care and lifestyle), the factor of rising life expectancy should be taken into account (by using an index to adjust the mortality tables to the population data to which the tables refer) by lowering men's age by three years and women's age by two years. The British Table a(90), based on the experience of British insurance companies in , is also used. This table includes estimates of future mortality and an adjustment for pensions in 1990 in its basis for computation. This mortality table provides a better forecast than Table a(55). The committee recommends that insurance companies calculate their pension insurance reserves on the basis of Table l(92) (a mortality table tailored to the pensioner population of Great Britain), which is better able to predict the future life expectancy of the pensioner population. Additionally, the data in the table should be multiplied by separate coefficients for men and women, since women's life expectancy is higher than men's. 25

24 Probability of Choosing the Pension Option Since the insurance rate was calculated on the basis of invalid assumptions, the reserve needed at the time of pension payout is greater than the reserve actually accumulated. Therefore, the probability of pension takeup at retirement age (the share of insured who will exercise their entitlement to a pension instead of a lump sum) is vastly important. To calculate the probability of pension takeup, the committee recommends the introduction of limits in various elements in the computation in order to ensure the sufficiency of reserves relative to the companies' liabilities. Probability of an insured's reaching retirement age (risk of death): the committee recommends setting maximum mortality rates in this matter, i.e., creating a margin of safety relative to the mortality computations. Probability of cancellation of policy before the insured reaches retirement age (risk of policy cancellation by policyholder/insured). The committee recommends that data be gathered from all insurance companies and that a maximum rate of cancellations be determined. A company that proves to the Commissioner of Insurance that its situation is different from that limit, i.e., that it has a lower rate of cancellations, shall be allowed to deviate from this limitation. Probability of an insured's choosing the pension option at retirement age: the committee recommends that the Commissioner of Insurance, after investigating the matter at the overall industry level, set a minimum level of probability for the industry in choice of the pension option by insured who reach retirement age in order to determine how to compute the reserve. Margin of Safety Since each of these factors is shrouded in uncertainty, the committee advises that each separate factor be treated conservatively in the process of computing the reserve, thus ensuring that the margin of safety will be reflected in an increase in the reserve. 26

25 B. APPROVAL OF NEW POLICIES To eliminate imperfections in the insurance market and respond to needs of the insured, the Commissioner of Insurance approved policies that have new features. ASSURED-YIELD POLICIES For the first time in the Israeli insurance market, the Commissioner of Insurance has approved an assured-yield policy that is not backed by earmarked (nontradable, fixed-interest) government bonds. These plans assure the insured a fixed and predetermined yield on the savings components of their policies, in contrast to existing life-insurance plans, which expose them to investment risk. Below are the main provisions of the directives of the Commissioner of Insurance in respect to assured-yield life-insurance plans: Premiums for this policy may be paid on a nonrecurrent or periodic basis. If deposits into periodic-deposit policies are not made for six months, new deposits will not be accepted but the assured-yield terms will continue to apply to previous deposits. Each deposit separately, and the interest that it earns, will be indexed to one index, more than one index, or a combination of indices as the insurer stipulates at the beginning of the insurance plan. (This will be done on the basis of an index that is recognized for the purpose of computing indexation and/or exchange-rate differentials.) Indexation of interest may be different from the indexation of principal. The saving term shall be determined on the beginning day of the insurance plan. When an insured has not withdrawn his/her money at the end of the insurance period, the default action will be the transfer of money not withdrawn to a separate and special fund. This money will be invested in three vehicles only: cash, cash equivalents, and tradable debt certificates. The insured (or the beneficiary, as the case may be) may withdraw what he/she is owed at the end of the insurance period, and the proceeds will be indexed to the yield earned on the participating portfolio up to the date of withdrawal, provided that the insured or beneficiary, as the case may be, has given the insurer thirty days' notice of his/her intention to withdraw the money. Accrual data show that accrual in these plans was not substantial in

26 LUMP-SUM WAGE-INDEXED POLICIES In 1999, insurance companies asked the Commissioner of Insurance to approve lump-sum wage-indexed policies. Until the companies made this request, market wage-indexed policies were offered only for pension purposes ("preferred" policies). In these policies, the policyholder purchases a given amount of term risk/death insurance with a long-term saving component that is paid out at the end of the term in pension form. There are also endowment plans, which are not indexed to wage but do pay out the proceeds in a lump sum. The new policies that the companies submitted for approval combine the death-risk factor with saving paid out in a lump sum at the end of the insurance period. Eighty percent of the premium for basic coverage in this plan is accumulated as savings; the rest is applied to the purchase of risk coverage. UNIT-LINKED POLICY Unit-linked policies allow insured/policyholders to choose the types of investment in which accrued savings will be placed, as they prefer. Below are several attributes of a unit-linked policy: a. The policy has several funds that specialize in different types of investment in terms of nature and target customers, so that a policyholder/insured may find the combination best suited to him/her. b. The policy allows the policyholder/the insured to intervene at several points during the policy term to change the mix of investments, as against one point of intervention in the old policies. c. Accrued funds credited to the policy is equal at any time to the money accrued in all investment paths after subtraction of the cost of insurance coverage and addition of earnings on the investment. 28

27 3. GENERAL ISSUES A. REPORTING TO THE INSURED The insurer's annual report provides the insured with information on types of plans acquired, forms of insurance coverage, accrued saving in insurance policies, and surrender values (if any) if savings are withdrawn of before the end of the insurance period. The directives concerning reporting to the insured were recently broadened and will be applied in reports for Below are the main changes in the format of the reports: 1. Glossary a glossary of insurance periods shall be added to the annual report, allowing insured who are not well-versed in basic insurance concepts to understand the reports better. The glossary shall include the following concepts at the very least: term risk/death insurance, endowment insurance, mixed endowment insurance, whole-life insurance, preferred insurance, pension insurance, term insurance, household income insurance, accidental death insurance, loss of working capacity insurance, nursing-care insurance, accident disability insurance, ordinary disability insurance, occupational disability insurance, participating policy, surrender value, and cancellation value. 2. Loans data concerning loans given to insured such as loan proceeds, loan balance, final payback date, etc. 3. Summary of all types of coverage a breakdown including insurance benefits itemized by types of coverage. 4. Management fees a breakdown of management fees collected by the insurance company from the insured during the reporting year. 5. Itemization of yield itemization of the insurance company's gross and net yields during the reporting year and on average for the previous five years. 6. Update of details a detachable form shall be attached to the report, with which the insured may update personal details. Notably, all companies will use a standard format to report to the insured; this will make the reports easier to understand and allow comparison among companies. 29

28 B. INSURANCE RATE Background Insurance companies usually compute their rates by assigning this task to their actuaries. To prepare the insurance rate and price the insurance risks correctly, emphasis should be placed on the elements of probability and finance elements that commingle in the insurance product. Computing the Rate The computation of an insurance rate is affected mainly by three factors: mortality, load factors, and interest. Mortality mortality tables represent a sample of the population for which the companies wish to develop an insurance product. The tables are generated on the basis of extensive demographic studies and divide this population in view of several indicators. Load factors explained below in regard to the computation of gross premiums. Interest the interest rate on which the rate calculation will be based is determined in view of the company's assumptions concerning its investments. Two rate levels are computed. The first is the net premium, computed by taking into account the pure insurance risk relative to the mortality rates and the interest rate chosen for the computations. In other words, only risks for which the insurance is purchased are factored into the computation. Life-insurance plans are made up of four basic types of insurance, from which the net premium (the premium relative to pure risk) is derived: 1. Pure endowment a policy paid only if the insured is alive at the end of the insurance period. The computation is based on the probability of this occurrence and takes account of the factor of expected interest in the capital market (or that assured by the policy) in computing the insurance benefit, i.e., the current value of all factors. (In other words, a back-accrual is performed.). 2. Term risk/death insurance in this insurance plan, the insurance benefit is paid out if the insured dies during the insurance period. The policy is based on the probability for any period of time, usually a one-year interval, that the individual will be alive at the beginning of the period but not at its end. The current value of insurance benefits is calculated under market-interest assumptions. 3. Health and disability insurance. 30

29 4. Pure saving a policy in which premiums are accumulated as a function of the company's investments. At a predetermined and foreknown date, the accrued benefit is paid to the individual or his/her heirs (irrespective of whether the insured is still alive). By mixing these four components, insurance companies create the insurance products that are available in the market today. In the second phase, the gross premium is discounted by augmenting the net premium by various components such as loading of expenses or special risks. Factors of Influence Mortality data are shown in tables (hereinafter: "mortality tables") that attempt to estimate the number of deaths within a given cross-section of ages and years in the population. Insurance companies use these figures to estimate the expectancy of claims on the account of an insurance product that they intend to sell. Since the mortality process is a random one, it is very likely that the actual number of deaths during an insurance period will be different from that shown in the mortality table. Therefore, the insurance company must create a margin of safety in case more insured die than the mortality table predicts. (Insurance companies must treat statistical deviation from the approximate expectancy shown in the mortality table as a real and palpable possibility.) There are several ways of coping with this situation. For example, a company may choose a mortality table that shows higher mortality rates than those of the population. It may also "fine-tune" the mortality figures by introducing loading coefficients (which it obtains by using a mathematical interpolation of the mortality rates in the tables, multiplying them by various coefficients, etc.) or by adding several years to the actual age of the insured, e.g., three years for men and two years for women. Additional factors may increase the insurance rate: a Extra risk related to war hazards (active and passive). b. Renewal of policy after a period in which the insured did not pay premiums without re-underwriting (i.e., without performing medical examinations that would reveal the insured's state of health). c. Conversion of policy into risk insurance some policies give the insured the option of conversion into risk insurance in certain cases. This conversion carries hazards that should be priced into the policy. 31

30 d. Rate of policy cancellations this factor must be kept in mind because cancellation rate is high. C. PARTICIPATING POLICIES Background Until the early 1990s, benefits and premiums in most insurance plans in the Israeli market were indexed to the Consumer Price Index. These plans earned an assured yield backed by the issue of "indexed-life" bonds to insurance companies. Participating plans were introduced in In these plans, benefits are indexed to earnings on the portfolio but a given proportion of benefits still receive an assured yield backed by "indexed-life" bonds. In 1992, the backing of "indexed-life" bonds for new insurance plans was abolished. Since then, all plans that include a saving component have been of the participating type. Notably, new contributions on account of old policies continue to benefit from assured yields, backed by the issue of "indexed-life" bond issues to insurance companies. Importance of the Participating Policy The introduction of participating policies in 1992 marked the beginning of a new era in Israel's life-insurance market. Until that year, all companies' policies were identical in terms of manner of indexation and assured yield. With the advent of participating policies, the companies began to attain different yields on the savings of the insured. Essence of the Participating Policy The yield in a participating policy is not assured and depends on the results of investments. Therefore, there is no prior assurance of the insurance benefit. A mechanism was created in which the insurance benefit or premium changes commensurate with yield in two directions: (1) insurance benefits that accumulate in the policy are not fixed ex ante, and (2) an assurance of the insurance benefit is given but the company may adjust the premium to reflect yield. The policy is based on three components: inflation, reserve, and yield. For the company to pay the proceeds at the end of the insurance period, it must build up reserves that it invests as prescribed by the Regulation of Insurance Transactions Regulations (Capital Investment Methods, Funds, and Insurers' Liabilities), , and that generate 32

31 a yield. The yield that the company attains may be higher than the CPI. If this happens, the company's accrued reserves will be unnecessarily large. Practically speaking, the surplus is a "bonus" that accrues in an account parallel to the policy and is paid to the insured or a beneficiary in the case of an insurance event (death of the insured at the end of the insurance period or while the proceeds are being paid out). This "bonus" earns a yield and constitutes savings in every respect. If the company's yield is smaller than the increase in the CPI, the reserve will be too small (a condition known as "malus"). Since the insurance benefit is indexed, the malus is subtracted from the bonus and if the balance in the parallel account is low or equal to zero, the policyholder will have to pay more in premiums. As stated, the participating policies became operative in The investment vehicles in these policies were the following: at least 50 percent of reserves were invested in government bonds, with at least 20 percent thereof but no more than 40 percent invested in "indexed-life" bonds that pay guaranteed 4 percent interest. Up to 50 percent of reserves may be invested in securities; the company may invest up to 10 percent in shares. Another investment vehicle allows the company to invest up to 25 percent in loans, deposits, and income-producing real estate, with a 15 percent ceiling in the case of income-producing real estate. Insurance companies are responsible for optimizing their investments and are given the powers to exercise this responsibility. Management Fees In 1995, the Minister of Finance signed Management Fee Regulations that stipulate the insurance company's share in earnings on account of participating policies. The regulations prescribe two possible ways of collecting management fees: (1) The company may collect fixed management fees at 0.07 percent per month of the revalued investment portfolio. (Rules for old polices apply to policies written before July 1, 1995.) (2) The company may charge a fixed management fee of 0.05 percent per month of the revalued investment portfolio plus 15 percent of the real yield a variable management fee that is calculated at year's end. A company that chooses this option also applies it to policies written before these regulations went into effect. If the investment portfolio records a loss, the loss is subtracted from earnings in subsequent years. (See also Capital Market Division Reports 1 and 2.) 33

32 The Situation Abroad Several types of policies are conventionally offered in other countries. a. Unit-Linked Policies The unit-linked policy separates the risk component from the saving component and acquires certificates of participation in a fund that invests in a diversified investment portfolio. The certificate of participation has a current price on the basis of which the value of the policy is adjusted. The insured chooses the vehicle that he/she finds suitable for the investment of the accrued savings. In this manner, the insured has an influence on the yield that he/she will receive. b. Universal-Life Policies Insurance benefits and premiums may be adjusted at any time at the insured's request. The insured has no influence on how the accrued savings are invested. A comparison of Israeli with foreign policies shows that "preferred"-type policies resemble the Universal Life type and endowment policies are most similar to a policy sold in Great Britain, in which an indexed risk insurance benefit is assured in event of death and savings can be assured in real terms only by increasing the premium. Great Britain Insurance companies in the U.K. have been offering participating insurance plans since the nineteenth century. Over the years, they have developed new insurance lines with different ways of apportioning the earnings. In one method that has been practiced for many years, known as Reversionary Bonus, earnings are distributed pursuant to a company decision that reflects all types of earnings (mortality, investment, cancellations, etc.). The bonus rate announced at the beginning of the insurance period is preserved, more or less, throughout the insurance period. This forces the companies to be conservative in distributing bonuses. Over the years, the companies recorded good yields due to rising share prices and, for this reason, amassed large reserves that they distributed to the insured in the form of a supplementary bonus at the end of the insurance period. In the 1970s, with the increase in variance of yields on investments, the various capital markets developed a current participation method that is customarily known as Unit-Linked, 34

33 in which life insurance is indexed to the value of the investment portfolio. (See expanded discussion elsewhere in this chapter.) This type of policy is still being offered. United States American insurance companies have developed a product known in the U.S. as variable life insurance. Several factors led to this development, including the need to preserve the real value of the insurance benefit and the wish to develop a new insurance product. In the variable plan, the insured chooses types of investment on the basis of several options offered by the company, and the yield is determined in view of the results of the company's portfolio investments. The American policies pay a defined insurance benefit and the surrender value of the policy is determined on a daily basis in accordance with the value of the investments. This is unlike Israeli policies, in which the surrender value is known throughout the insurance period. Policy Adjustments Since participating insurance plans do not have the advantage of a fixed and foreknown yield, changes relative to existing policies were needed, foremost in regard to investments and the effect of the investment results on residual components of the participating policy, such as: 1. Death benefit. 2. End-of-period benefit. 3. Post-cancellation benefit. 4. Surrender value. 5. Insurance premium. In a participating policy, the insured has an interest in the results of the investments, unlike the old policies that paid constant yields. Therefore, the new policies make it necessary to address issues in the field of investments. "Preferred"-Type Participating Life-Insurance Policies The investment methods stipulated in the regulations changed substantively. Accrued savings are revalued each month in accordance with the investment results, there is no assured interest rate, and the yield is a function of investment results. 35

34 Earnings are distributed on a monthly basis. The company calculates the "cumulative balance" per insured on the basis of the mix of premiums earmarked for savings in basic insurance and the premiums earmarked for pure savings and bonuses. The insurance company charges monthly management fees in accordance with the foregoing provisions. Thus, the monthly yield on the investment portfolio is determined. 36