Stability of Insurance Companies

Transcription

1 Stability of Insurance Companies

2 The Capital Market, Insurance and Saving Division Contents 1. Introduction The Structure of the Insurance Sector Characteristics of the Activity Risks and an Assessment of Stability...26 Insurance risk...28 Market risk...30 Liquidity risk...35 Credit risk...36 Re-insurance...39 Capital Adequacy...43 Appendix A: Holding Structures of the Principal Stockholders in Israeli Insurance Companies...48 Appendix B: Active Insurance Companies and Licensing Activities in List of Tables Table C-1 Number of Active Insurance Companies, and Those Also Engaging in Life Insurance...5 Table C-2 The GDP, Life Insurance Premiums and Non-life Insurance Premiums...6 Table C-3 Number of Authorized Insurance Agent Licenses (licensed to market insurance), Classified by Insurance Lines...7 Table C-4 Ratio of Premiums to Agents, in NIS millions...7 Table C-5 Market Concentration and Competition Indices...9 Table C-6 Main Financial Data of the Insurance Companies...13 Table C-7 Yield on Accounting Equity by Insurance Companies, Table C-8 Comparison of Revenue from Management Fees...19 Table C-9 Aggregate Pre-tax Profits from Life and Non-life Insurance Businesses, by Insurance Companies...22 Table C-10 General and Administrative Expenses, in NIS thousands, and the Ratio of General and Administrative Expenses to Total net premiums in retention in Life Insurance, percent...24 Table C-11 General and Administrative Expenses in NIS thousands, and the Ratio of General and Administrative Expenses to Total Life Insurance Reserves, percent...25 Table C-12 The Ratio between Net Insurance Reserves and AveragePremiums net of reinsurance and Average Claims net of reinsurance...29 Table C-13 Rate of the Yield on Equity and the Correlation with the Yield Attained on the Capital Market...31 Table C-14 Ratio of Negotiable Assets to Total Assets, by Companies Table C-15 Ratio of Credit (Other Than Exposure to Reinsurance) to Total Assets, Excluding Avner and Karnit...37

3 Stability of Insurance Companies Table C-16 Credit Components, Excluding Government Bonds and Deposits in Banks...38 Table C-17 Total Credit by Rating (excluding Avner and Karnit),...39 Table C-18 Percentage of Premiums net of reinsurance...43 Table C-19 Composition of the Recognized Equity and the Reserve for Special Risks in Life Insurance in Insurance Companies in 2004, NIS thousands...44 Table C-20 Indices for Examining Capital Adequacy - Equity Development in Active Insurance Companies (Non-consolidated Equity) during the years ,...46 List of Charts Chart C-1 Distribution of Life Insurance Premiums by Insurance Groups, percent...8 Chart C-2 Distribution of Non-life Insurance Premiums by Insurance Groups, percent...8 Chart C-3 Rate of the Yield on Accounting Equity, Chart C-4 Yield on Equity in Banks* and Insurance Companies - Industry Average, Chart C-5 Composition of the Pre-tax Profit by Insurance Businesses (Life and Non-life), percent...20 Chart C-6 Ratio of Profit from Life Insurance and Non-Life Insurance Businesses to Gross Premiums...21 Chart C-7 Rate of the Yield on Equity and the Correlation with the Yield Attained on the Capital Market...31 Chart C-8 Ratio of Negotiable Assets to Total Assets...32 Chart C-9 Insurance Company Assets - Ratio of Assets Traded Abroad to Total Negotiable Assets...34 Chart C-10 Ratio of Cash, Cash Equivalents and Negotiable Assets to Current Liabilities (excluding Participating Life Insurance Plans)...36 Chart C-11 Distribution of the Risk by Reinsurers...42 Chart C-12 Indices for Examining Capital Adequacy - Ratio of Equity to Total Assets, Ratio of Equity to Reserves in Life Insurance and Non-life Insurance...47

4 The Capital Market, Insurance and Saving Division 1 Introduction The contribution of the insurance sector to the economy is in the creation of opportunities for households and companies to effect transactions at reduced risks. This sector also contributes to the economy by its recruitment of long-term sources of capital, sources that increase the potential for long-term investments. Many reforms have been implemented in recent years in the insurance market, whose aims are to improve consumer welfare, to enhance competition, to increase the sources of credit and to prevent conflicts of interest. The latest changes having material impact on the economy are the acquisition of the new pension funds, which had been controlled by the Histadrut, and the fact that the insurance companies are now the entities managing the funds of the vast majority of members (approximately 94% of the active members in the new pension funds are depositing money to funds controlled by the insurance companies). Previously, the pension market had been blocked to the insurance companies. The changes that took place indicate the official entry of the insurance companies into this market; now they are managing assets at the assessed volume of about NIS 24 billion (new pension funds as at December 31, 2004). Many potential sources of financing, which can finance the real activity in the economy, are today concentrated in the insurance companies. Some of these sources are the insurance companies nostro reserve funds, the life insurance reserve funds, members accruals in pension funds, and, once the Bechar Committee reform is implemented, additional sources should be added, assuming that the insurance companies will be acquiring some of the provident funds and mutual funds from the banks.

5 Stability of Insurance Companies 2 The Structure of the Insurance Sector Twenty-five insurance companies are operating in Israel (including Avner). Three of these are government companies: the Natural Disasters Fund in Agriculture, which insures against natural disasters in agriculture; Inbal, which insures government activities; and the Israel Foreign Trade Risks Insurance Corporation, which engages in long-term foreign trade risk insurance (exceeding one year). Table C-1 Number of Active Insurance Companies, and Those Also Engaging in Life Insurance Total companies Of which, engaging in: Life Insurance Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division In recent years, there has been a marked trend of mergers and acquisitions of insurance companies. The number of insurance companies diminished from 31 in 2000 to 25 in Following is a list of insurance groups, and their member companies: The Clal Group includes the Clal, Arieh, and Clal Credit Insurance companies. The Migdal Group includes the Migdal and Hamagen insurance companies. The Phoenix Group includes the Phoenix and Hadar insurance companies. The Menorah Group includes the Menorah Insurance Company (the merger with Manolife was completed in 2001). The Harel Group includes the Ishpuz, Dikla, Shiloah, Zion, Sahar-Zion, Yehuda and Harel insurance companies. The Hachsharat Hayeshuv Group includes the Hachsharat Hayeshuv, the New BSSCH, and the Ashur insurance companies. The Direct Insurance Group includes the IDI Direct insurance company. The Government Group includes the Natural Disasters Fund, Inbal and BSSCH. The AIG Group includes the AIG and Ezer insurance companies. 1. See holding structures in Appendix A.

6 The Capital Market, Insurance and Saving Division Other companies - Ayalon, Eliahu, Shomera, Shirbit, Agricultural Cooperative Society, Continental (a special manager was appointed to handle its liquidation), Agricultural Insurance - Cooperative Society, and the Avner Corporation. The insurance sector is one of the key sectors in the economy. The volume of its activity in relation to the gross domestic product increased from 4.1% of the GDP in 1999 to 6.1% of the GDP in Table C-2 The GDP, Life Insurance Premiums and Non-life Insurance Premiums 2, in NIS billions, percent GDP GDP of the business sector Total life and non-life insurance premiums , Percent of the GDP 4.1% 4.6% 5.2% 5.4% 6.3% 6.1% Business sector s percentage of the GDP 5.9% 6.4% 7.4% 7.8% 9.1% 8.7% Source: Publications of the Central Bureau of Statistics, insurance company reports and data processed by the Capital Market, Insurance and Savings Division. Insurance marketers are individual insurance agents and corporations (some insurance agencies are owned by insurance companies). Some insurance companies market insurance directly, such as AIG and Direct Insurance. In 2004, 936 insurance agencies (agentcorporation) were authorized to operate in at least one of the insurance lines (property insurance, personal accident insurance within the scope of non-life insurance, life insurance and marine insurance) In the section, Stability of Insurance Companies the data for the years up to and including 2003 are adjusted to the CPI in respect of December The data for 2004 are nominal data. 3. For further details on the subject of licensing of insurance agents, see section Insurance Agent Licensing Department.

7 Stability of Insurance Companies Table C-3 Number of Authorized Insurance Agent Licenses (licensed to market insurance), Classified by Insurance Lines Line Life 5,834 6,732 6,322 6,820 7,103 7,032 Non-Life 4,746 5,871 5,178 5,471 5,820 5,424 Life + Non-life 3,724 4,411 4,167 4,488 4,522 4,511 Marine Total individual agents licensed in at least one line 8,564 8,761 8,844 8,689 8,509 8,265 Source: Capital Market, Insurance and Savings Division - Insurance Agent Licensing Department. This table shows that there has not been any significant change in the number of insurance agents in recent years. However, an indication of the increased use of the insurance instrument, and of an improvement in the means of distribution can be seen in Table C-4. This table indicates a consistent rise in the premiums to agents ratio, from a level of approximately NIS 2.6 million in 2000 to about NIS 3.9 million in Table C-4 Ratio of Premiums to Agents, in NIS millions Ratio of Premiums to Agents, in NIS millions Source: Capital Market, Insurance and Savings Division - Insurance Agent Licensing Department. Market Concentration and Competition Indices The insurance sector in Israel is characterized by high market concentration (but lower than in the banking sector). Chart C-1 clearly illustrates this concentration. The concentration in the life insurance line is high according to all indices, compared to the concentration in the non-life insurance line. The five major insurance groups rake in about 95% of the proceeds

8 The Capital Market, Insurance and Saving Division from life insurance policy sales, compared to about 69% of the proceeds from sales of nonlife insurance policies. Chart C-1 Distribution of Life Insurance Premiums by Insurance Groups, percent 5% The Five Major Groups All Other Companies 95% Chart C-2 Distribution of Non-life Insurance Premiums by Insurance Groups, percent 31% The Five Major Groups All Other Companies 69%

9 Stability of Insurance Companies Table C-5 Market Concentration and Competition Indices Concentration and Competition Indices by Gross Premiums in the Life Insurance Line Concentration and Competition Indices by Gross Premiums in the Non-life Insurance Line HHI CR CR Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. The Herfindahl-Hirschman Index 4 (HHI) measures the level of concentration in any specific market sector. The Index ranges between 1 (full concentration - one entity controls the entire sector) to 1/N (maximum dispersion - the optimal situation). N is the number of entities operating in the sector. For example, in 2004, 13 companies were active in life insurance; therefore, the index for maximum dispersion is During the last two years, the HHI in the life insurance line reached 0.214; that is, the situation today is 2.6 times worse than the optimal situation. In non-life insurance, in order to arrive at the precise implications of the calculation of the deviation from the optimal situation, specific lines must be taken into account, rather than all non-life insurance premiums, since not all companies are active in all lines. In the compulsory motor vehicle insurance line, 19 companies were active in The HHI is 0.07, and the deviation from the optimum is 1.3 times off the optimal dispersion. Therefore, there has been an improvement compared to the situation in 2001, when the deviation had been two times worse than the optimal dispersion When we examine the reasons for the differences in market concentration, it is important to keep in mind that 25 companies are operating in non-life insurance, compared to only 12 companies in life insurance. Furthermore, life insurance includes a savings component and a risk component at differing rates, and constitutes a long-term contract, which includes obstacles making it difficult for insureds to switch companies. On the other hand, non-life insurance includes solely a risk component, and the contracts in non-life insurance are usually for one year (although sometimes there are longer contracts). Thus, insureds under non-life insurance are able to switch companies more easily than insureds under life insurance. 4. The Herfindahl-Hirschman Index is calculated by totalling the squares of the shares obtained by dividing each entity s premiums by the total premiums in the line.

10 The Capital Market, Insurance and Saving Division 3 Characteristics of the Activity 2004 was another successful year for the insurance sector in Israel. Insurance companies showed very good business results in 2004, although they were lower than their record year in The insurance companies yield on capital reached a ratio of 25% in This ratio reflects a decline of about 12 percentage points from the record yield achieved in At the same time, the companies accounting equity grew at the rate of about 49% between 2002 and 2004 and totalled NIS 9.1 billion. Improved capital adequacy and improved stability of the insurance companies can be discerned: the significant rise in the companies capital in 2004, totalling about NIS 1.4 billion, was not the result of an increase in the volumes of activity as expressed in the premiums. Assuming that no change occurred in the risk that the insurance companies assumed per monetary unit (expressed in shekels), even though there was a slight increase in the volume of premiums in the economy (i.e., in the risk), nevertheless, there was a significant rise in the companies capital. The insurance companies profit is influenced by premiums that the insurance companies collect in consideration of the risk that they assume, by the profit on their investment activities (profits accruing on investments of amounts of insurance reserves), from the insurance benefits that they pay as a result of the insurance events that occurred and from their operating expenses (mainly payments to their product distributors and their general and administrative expenses). The aggregate, post-tax profit from insurance business (NIS 2.14 billion) is about 16% lower than the aggregate profit in There has been a decline in the profitability of the life insurance line (NIS 1.83 billion before tax - a 13% decline compared to 2003), and a decline in the profitability of the non-life insurance lines (profit of NIS 1.76 billion before tax in a decline of about 20% compared to 2003). Revenue from investments constitutes a key component in the financial results of the insurance companies, and the main explanation for the decline in profitability compared to the previous year is the effects of investment revenue. In 2004, although the non-life insurance sector suffered an underwriting loss, the transition to profit in this line was created due to the investment profits. The total loss from non-life insurance business, excluding the investment profits, is approximately NIS 87 million. This indicates a downtrend in the underwriting loss (the underwriting loss reached about NIS 550 million in 2003). An analysis of the underwriting loss in 2004 shows that in product liability insurance lines 10

11 Stability of Insurance Companies - both directors liability insurance and professional liability insurance - the underwriting loss reached about NIS 118 million; neutralizing this loss leads to an underwriting profit of about NIS 31 million. Investment profits are important since they influence both the profits of non-life insurance businesses and the profits in life insurance businesses (through the management fee from the participating portfolio, which are calculated as a proportion of the total assets with the addition of a proportion of the profits from investments 5 ). This also finds expression in assured-yield life insurance plans, in the financial margin between the quoted yield on earmarked bonds that insurance companies receive from the State and a lower yield rate assured by the insurance companies to their insureds in the plan. The year 2003 was a record year for revenues from investments. The life insurance investment portfolio generated profits of nearly NIS 11 billion, while the nostro investments in the non-life insurance portfolio generated profits totalling approximately NIS 2.8 billion. In 2004, the revenue from investments was lower and reached a total of about NIS 7.5 billion in life insurance, while the revenue from investments in non-life insurance totalled about NIS 1.85 billion. A substantial portion of the profits from investments in life insurance was credited in favor of the insureds savings, particularly in the participating portfolio. The lower profitability of the insurance companies in 2004 compared to the previous year is attributable to the change in the yields in the capital market, which were lower in 2004 than in This drop in income is so significant that, notwithstanding the favorable affects deriving from the increase in the premiums and the decrease in insurance benefits paid, which stems, inter alia, from the improved employment situation in the economy, the yield rate this year did not reach that of the previous year. In 2004, the total aggregate revenue from non-life insurance premiums rose by about 1.7% compared to The health insurance line was the most significant line contributing to growth in the non-life insurance sector. On the other hand, a decline was recorded in the compulsory motor vehicle insurance line. In 2004, the revenue from life insurance premiums rose to a total of about NIS 14.2 billion. The reasons for this are the recovery in the economy, the improvement in the state of businesses and employment, as well as employees job security. This recovery was accompanied by an increase in deposits to existing insurance plans (due to pay raises), and in sales of new policies. The insurance companies paid about NIS 426 million less in life insurance benefits to 5. In participating policies issued up until , the prevalent maximum management fees were 0.6% of the accrued savings, and 15% of the real profits. In policies issued as of the prevalent management fees are 1% of the accrued savings. 11

12 The Capital Market, Insurance and Saving Division insureds in 2004 compared to One possible explanation for this is the significant drop in redemptions of accrued savings in life insurance policies, due to the improved employment situation in the economy. The improved employment situation led the public to be less in need of redeeming their savings for the sake of daily subsistence. Another possible explanation is the decrease in twisting. Insurance agents initiated this, pursuant to the instructions from the Commissioner of Insurance regarding fair disclosure of details to insureds. Such disclosure prevents life insurance policies from being redeemed when it is not economically profitable. In non-life insurance as well, there was a reduction in the claims paid and in the provision for pending claims, at a total of some NIS 364 million. This reduction in the insurance companies expenses contributed together a total of about NIS 790 million to the aggregate pre-tax profits. Approximately NIS 577 million are the reduction in operating expenses in life insurance. The vast majority of the reduction derives from a decrease in the expenditure for agents commissions. Up until the end of 2003, most of the commission was paid to the agent during the year in which he sold the policies, even though the insurance companies received the revenue deriving from the policies over many years. That being the case, the Commissioner of Insurance promulgated a circular letter obligating the insurance companies to implement the parallel principle, and to defer the recognition of the expense across the years in which the revenue is expected to be received. As a result, pursuant to promulgation of the circular letter, commissions to agents are paid over a period ranging between seven and 15 years, depending upon the insurance line at issue. In non-life insurance, when most of the insurance contracts are signed for a short period, there is less of an impact due to equalizing the commission payments over the years, and in total, the rise in operating expenses totalled about NIS 114 million. 12

13 Stability of Insurance Companies Table C-6 Main Financial Data of the Insurance Companies (on the basis of Consolidated Balance Sheets) Rate of Change between the Years Item Profitability Net profit (after tax) 967,609 2,557,056 2,140, % % % Profit from life insurance businesses (before tax) 1,107,362 2,102,740 1,830, % % 89.90% Profit from non-life insurance businesses (before tax) 1,026,658 2,196,666 1,761, % % % Premiums and Claims Premiums in life insurance 13,966,887 13,827,363 14,241, % 3.00% -1.00% Premiums in non-life insurance 17,230,402 17,482,555 17,785, % 1.70% 1.50% Total payments to insureds in life insurance 7,164,465 7,936,447 7,510, % -5.40% 10.80% Claims paid and provision for pending claims in non-life insurance 10,894,316 12,924,681 12,560, % -2.80% 18.60% Investment Profits Investment profits in life insurance -373,171 10,906,532 7,551, % % % Investment profits in non-life insurance -24,513 2,869,779 1,848, % % % Operating Expenses Commissions, general and administrative expenses - life insurance 3,346,433 3,388,915 2,812,320 Commissions, general and administrative expenses - non-life 3,373,948 3,544,192 3,658,638 insurance Balance Sheet Data Total Balance Sheet 130,173, ,679, ,334, % 9.20% 13.40% Total assets in the participating portfolio in life insurance 40,708,099 52,322,459 60,509, % 15.60% 28.50% Total assets in the assured-yield portfolio in old life insurance 43,952,900 44,601,894 44,543, % -0.10% 1.50% Equity and Dividends Accounting equity 6,136,903 7,776,390 9,140, % 17.50% 26.70% Dividend distributed* 300, ,492 1,006, % 9.60% % Yield on equity** 17% 37% 25% Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. Notes: * Dividend taken from the non-consolidated financial statements. ** Calculated by dividing the profit by the average equity. 13

14 The Capital Market, Insurance and Saving Division Equity and Yield Chart C-3 Rate of the Yield on Accounting Equity, % 35% 30% 19% 24% 24% 20% 15% 10% 0% Rate of the yield on the Accounting Equity, percent Rate of the yield on the Average Accounting Equity, percent Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. Note: * Based on data taken from the non-consolidated Financial Statements. The explanations for the differences in the yield on equity may be twofold - explanations that relate to profitability and explanations that relate to capital. Profitability factors that influence the relation between: 1. The difference in insurance activities pure and simple - i.e.: successful companies have a different underwriting profit than companies with lower profitability; 2. The quality of the investment decisions - i.e.: one yield on the insurance reserves in non-life insurance, and a different yield attained by insurance companies on the accrued savings in the participating portfolio, from which companies management fees are derived. The larger the companies life insurance reserves are, the larger are their investment profits. 3. The ages of the insurance companies - the older companies have income from the interest margins in classic life insurance plans. These plans were sold until the end of 1991 and assure a fixed interest yield to their insureds, while the insurance companies enjoy government Chetz-type bonds that bear higher CPI-linked interest. The companies do not have deferred acquisition expenses in respect of these plans, and therefore, the capital requirements for them are lower. 14

15 Stability of Insurance Companies Capital factors that influence the relation between: 1. The companies lines of activity - the capital requirements as stipulated in the Insurance Business (Control) Regulations (Minimum Equity Required from an Insurer) prescribe that equity is determined according to the self-retention in the activity in the non-life insurance lines. On the other hand, due to the activity in the life insurance lines, the minimum equity requirement is only at the height of the deferred acquisition expenses, as recorded in the insurer s financial statements. Consequently, companies that engage extensively in the life insurance line, which includes premiums and reserves at the scale of millions of shekels, are required to put up less capital relative to the activity. Companies engaging extensively in the non-life insurance lines must hold equity according to the reserves net of reinsurance. This requirement causes the difference in capital, since each company has a different distribution policy (according to how it wants to transfer risk) in all matters pertaining to that portion of the reserve kept net of reinsurance and that portion being transferred to re-insurance. 2. The composition of the capital that is recognized for control purposes - some companies recruited more secondary capital 6 than primary capital, while other companies recruited much smaller volumes of secondary capital. A few companies do not hold any secondary capital at all. Understandably, to the extent that the equity is kept low and replaced by secondary capital, the higher the potential for a rise in the yield on equity, since the company s profitability remains without any substantive change when secondary capital is issued (the change is only in the higher financing expenses, net of a tax benefit). Some companies make it a practice of holding capital at a rate that is only a few percentage points higher than the minimum capital requirement. 3. Corporate holding structure - controlling stakes in banks and insurance companies require an additional holding of capital. 4. Dividend distribution policy - some companies make it a practice of holding capital at a rate that is only a few percentage points higher than the minimum capital requirement. The balance of the capital surplus they distribute as a dividend. 6. Such as Menorah, whose ratio of secondary to primary capital is 46%. 15

16 The Capital Market, Insurance and Saving Division Table C-7 Yield on Accounting Equity by Insurance Companies, Company Annual Yield - percent Average Annual Yield Dikla 36% 38% 42% 59% 50% 45% Harel 52% 79% 26% 67% 47% 54% IDI 14% 24% 17% 34% 39% 26% Ayalon 41% 36% 23% 39% 36% 35% Eliahu 25% 24% -35% 61% 33% 22% Menorah 43% 50% 28% 52% 32% 41% Avner -9% 33% 60% 54% 32% 34% Clal 19% 22% 14% 30% 26% 22% Migdal 31% 36% 13% 33% 24% 28% New BSSCH 58% 21% 8% 21% 21% Clal Credit 1% 4% 1% 16% 20% 8% Hamagen 18% 25% 8% 32% 19% 20% Hadar 24% 12% 5% 17% 19% 15% Shirbit 9% 4% 1% 12% 18% 9% Hachsharat Hayeshuv 9% 9% 5% 15% 16% 11% Phoenix 22% 8% 17% 25% 16% 18% Arieh 17% 10% 3% 21% 16% 13% AIG -53% 5% 29% 50% 14% 9% Inbal 5% 4% 2% 5% 4% 4% BSSCH 18% -3% 2% 7% 3% 5% Shomera 2% 3% 1% 8% 3% 3% Agricultural Insurance 0% 5% - 3% 1% 2% Ezer -55% -19% -49% 12% 0% -22% Natural Disasters Fund 0% 6% -5% 4% -1% 1% Ishpuz 5% 8% -3% - - * 2% Sahar-Zion 20% 36% 20% - - * 15% Industry weighted average 19% 24% 15% 35% 24% 24% Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. Notes: * Amalgamated into the Harel Insurance Company in 2003 ** Based on data from the non-consolidated financial statements 16

17 Stability of Insurance Companies Comparison of Yield on Equity in Banks and in Insurance Companies Chart C-4 Yield on Equity in Banks* and Insurance Companies - Industry Average, Insurance Companies Banks Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. * The yield on equity in banks for 2004 is an approximate calculation according to data from the five major banks. Chart C-4 shows that the insurance companies yield on equity is far higher than the banks yield on equity. However, the volatility in the insurance companies is higher and derives from the dependency on the yield that insurance companies attain in the capital market. The insurance companies yield on equity in 2004 reached about 25% compared to the banks 12% yield. We compared income relative to capital from the management of financial assets of the two largest insurance companies compared to the two largest banks in the economy. Banking corporations, like insurance companies engaging in life insurance, are not required, of course, to provide equity because of operations in the management of their customers financial assets in provident funds and mutual funds (hereinafter: Money being Managed in Trust ), just as insurance companies are not required to do so in a participating portfolio. The comparison shows that the yield on capital in the Migdal and Clal insurance companies (9.1% and 5.7% respectively) is higher than the yield on capital in the banking corporations Hapoalim and Leumi (3% and 2.2% respectively), as presented in Table C-8. 17

18 The Capital Market, Insurance and Saving Division A few of the reasons for the differences in the yield on capital: 1. The equity that the banks and insurance companies hold derives from the volume of their operations in other businesses and sectors. Therefore, the absolute volume of the banks capital relative to the management fees deriving from Money being Managed in Trust is larger. 2. Insurance companies purchase re-insurance, which reduces the insurance risk applicable to them. On the other hand, the banks in Israel undertake all the risks inherent in their operations, and therefore, the banks capital being used as a cushion to secure their liabilities is higher. 3. The balance sheets of the insurance companies show reserves for special risks in life insurance at the rate of up of 0.2% of the total risk. Accordingly, part of the cushion for absorbing losses in insurance companies is not a component of equity, but rather is a reserve presented under the liabilities items. Furthermore, within the scope of the overall global trend, the international supervisory and standardization bodies are attempting to institute comprehensive regularization of the capital requirement from insurance companies, based on the particular level of risk inherent in their operations. This regularization should eliminate the technical requirements existing today regarding capital requirements and base them on advanced statistical models for determining capital requirements. It can be assumed that the capital requirements will be increased following the transition to risk-based capital requirements. This regularization is expected to be implemented within the next three years. 18

19 Stability of Insurance Companies Table C-8 Comparison of Revenue from Management Fees between Two Major Insurance Companies and Two Major Banks (in NIS billions - data as at December 31, 2004 Bank Hapoalim Bank Leumi Clal Migdal Equity Assets of provident funds and mutual funds Assets of participating life insurance portfolio Revenue from management fees Revenue from management fees, net of tax (44.52% tax rate) Revenue, net of tax divided by equity 3.0% 2.2% 5.7% 9.1% Share of revenue from 1% management fees, net of 4.4% 2.3% 3.8% 5.7% tax, in relation to equity Share of management fees out of managed assets 0.7% 1.0% 1.5% 1.6% Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. The prevalent annual management fees in provident funds are at the rate of about 1% of the value of the managed asset portfolio. Table C-8 shows that if management fees at this rate were to be instituted on savings amounts in participating life insurance that the insurance companies are managing, then their share of the capital would be 5.7% in Migdal and 3.8% in Clal, compared to 4.4% in Hapoalim and 2.2% in Leumi. This means, the differences in the yield on the entities capital would narrow, while they would be even higher in Hapoalim than in Clal. Profitability of the Insurance Companies The composition of the insurance companies profits varies greatly from year to year. These differences derive, inter alia, from a difference in profitability - both underwriting profit and investment profits, which vary according to the behavior of the capital market - and from a different level of operating expenses, which depends, inter alia, on the size of the companies. 19

20 The Capital Market, Insurance and Saving Division Table C-9 presents the differences in the composition of the insurance companies profits. For example, in the Clal Group, the profit rate from life insurance business in 2002 was 66%, it dropped to 49% in 2003 and rose to 59% in In the Migdal Group, the profit rate from life insurance business was 91% in 2002, dropped to 85% in 2003 and continued to drop in 2004 to 73%. The surge in the proportion of profits from non-life insurance business in 2002 (see Chart C-5) derives from the suspension of the activity of the Avner Corporation in Chart C-5 Composition of the Pre-tax Profit by Insurance Businesses (Life and Non-life), percent 100% 80% 37% 36% 31% 48% 51% 51% 60% 40% 63% 64% 69% 52% 49% 49% 20% 0% Life Insurance Non-life Insurance Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. 20

21 Stability of Insurance Companies Chart C-6 Ratio of Profit from Life Insurance and Non-Life Insurance Businesses to Gross Premiums 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 15.3% 12.9% 8.0% 8.6% 4.2% % Ratio of Profit from Non-life Insurance Business to Gross Premiums, excluding Avner and Karnit Ratio of Profit from Life Insurance Business to Gross Premium Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. This year there were moderate fluctuations in the ratios of profit from insurance businesses to premiums in the sector. In life insurance, this ratio fell from 8.6% last year to 7.8% this year (3.4% since 2002). In non-life insurance (excluding Avner and Karnit), the ratio of profit to gross premiums dropped to 12.9%, compared to 15.3% in In non-life insurance, the competition amongst the companies led to a negative underwriting profit, and move to a positive profit due to the profits from investments of the non-life insurance reserves. 21

22 The Capital Market, Insurance and Saving Division Table C-9 Aggregate Pre-tax Profits from Life and Non-life Insurance Businesses, by Insurance Companies Profits from Life Insurance Businesses Profits from Non-life Insurance Businesses Ratio of the Profit Component from Life Insurance Businesses company Arieh 34,264 34,101 38,614-7,017 59,833 42, % 36% 48% Clal 198, , , , , ,279 61% 51% 62% Clal Credit ,520 6,099 10,752 0% 0% 0% Clal Group 232, , , , , ,532 66% 49% 59% Migdal 299, , ,524 8,432 70, ,479 97% 90% 79% Hamagen 18,781 70,943 26,515 19,696 56,378 51,066 49% 56% 34% Migdal Group 299, , ,848 30, , ,477 91% 85% 73% Hadar 74, , ,240 14,329 37,653 35,354 84% 74% 78% Phoenix 160, , ,534 52,265 60,533-53,974 75% 82% 129% Phoenix Group 235, , ,774 62,863 98,186-18,620 79% 79% 105% Menorah 128, , ,631 88, , ,736 59% 69% 71% Menorah 128, , ,631 88, , ,736 59% 69% 71% Sahar-Zion 14, , % Harel (formerly Shiloah) 114, , ,091 39, , ,333 75% 61% 58% Dikla ,873 75,145 88,137 0% 0% 0% Harel Group 129, , , , , ,470 39% 54% 50% Hachsharat Hayeshuv 14,158 15,028 8,494 6,879 36,655 36,901 67% 29% 19% New BSSCH ,516 7,780 16,242 0% 0% 0% Hachsharat Hayeshuv Group 14,158 15,028 8,494 22,394 44,435 53,143 39% 25% 14% IDI - 5,981 8,642-81, ,731 7% 7% Direct IDI 3,772 5,981 8,642 58,458 81, ,731 6% 7% 7% BSSCH ,525 1, % 0% 0% Inbal % 0% 0% Government Group ,123 1,934 1,591 0% 0% 0% AIG 451-2, ,920 26,354 26,609 2% -11% 3% Ezer ,481 1, % 0% 0% AIG Group 451-2, ,438 28,266 26,272 7% -10% 4% Shomera ,091 4,268 2,053 0% 0% 0% Eliahu 44,653 32,045 30, , , ,130-74% 13% 14% Ayalon 19,259 21,052 26,625 54,498 92, ,147 26% 19% 20% Agricultural ,651 15,326 0% 0% 0% Insurance Avner , , ,507 0% 0% 0% Shirbit ,863 14,712 22,942 0% 0% 0% Total by Insurance Groups 1,107,362 2,102,740 1,830,164 1,026,658 2,196,666 1,902,437 52% 49% 49% Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. Note: The table contains data based on the non-consolidated financial statements of the insurance companies. Group data is also based on consolidated financial statements. Therefore, totalling of the data from non-consolidated financial statements of companies that are members of groups might not add up to the data of the Insurance groups. 22

23 Stability of Insurance Companies Economies of Scale The daily management operations of insurance companies and management of the asset portfolio involve current costs throughout the life of the policy. Table C-10 provides details on the ratio of general and administrative expenses. The table shows the percentage of net premiums in the life insurance line. It was found that, amongst the major companies, there are efficient companies, such as Clal and Migdal, and other companies that have a percentage of general and administrative expenses that is similar to the small companies. In the Harel Group for example, its ratio of general and administrative expenses is 11.88%, which is similar to the percentage in Ayalon %. From reviewing the older companies appearing in Table C-11 we can see that the ratio of general and administrative expenses to the life insurance reserves of Ayalon are almost twice the ratio of expenses in the older companies, Migdal, Clal, Menorah and Phoenix. It is important to remember that the age of the insurance company has significance in terms of the types of policies in respect whereof insurance reserves exist: older companies have large reserves due to the classic life insurance plans. These plans were sold until the end of 1991, and assure a fixed interest yield to the insureds. The insurance companies are holding Chetztype government bonds, which bear higher CPI-linked interest. Management of a Chetz bond portfolio apparently involves lower current costs than management of a portfolio of similar size in the capital market. A better ability to maintain insurance policies also played a role in the old plans not being redeemed or cleared, and thus, higher reserves were able to be sustained. The ratio of insurance reserves, against which Chetz bonds are held, to total life insurance reserves at Ayalon was 21%, while in the old, major companies - Phoenix, Harel, Clal and Migdal - this ratio reached 47%, 40%, 41% and 43% respectively. One can see in Table C-11 that economies of scale are in play, and that the ratio of general and administrative expenses to life insurance reserves is lower in companies with large insurance reserves; for example, the expense ratio of Hachsharat Hayeshuv is 50% higher than the ratio of the major companies. The expense ratio of the Harel Group is higher (1.6%) than the average expense ratio of the other four major insurance companies (average of 1.05%), and is similar to last year s ratio. However, examination of the group s development trend shows that the group is becoming more efficient. 23

24 The Capital Market, Insurance and Saving Division Table C-10 General and Administrative Expenses, in NIS thousands, and the Ratio of General and Administrative Expenses to Total net premiums in retention in Life Insurance, percent Administrative & General Ratio of General & Administrative Net Premiums in Retention Expenses Expenses to Premiums net of reinsurance Arieh 35,050 37,940 38, , , ,012 11% 12% 11% Clal 171, , ,184 2,625,155 2,700,275 2,808,289 7% 7% 7% Clal Group 206, , ,277 2,931,646 3,018,543 3,168,301 7% 8% 7% Migdal 261, , ,326 3,902,375 3,716,397 3,869,309 7% 7% 7% Hamagen 42,999 40,164 55, , , ,927 9% 6% 6% Migdal Group 316, , ,455 4,575,502 4,348,253 4,477,183 7% 7% 7% Hadar 77,199 85,565 84, , , ,895 9% 10% 9% Phoenix 95, , ,820 1,243,018 1,255,098 1,277,982 8% 10% 8% Phoenix Group 172, , ,961 2,118,377 2,125,203 2,202,299 9% 10% 8% Menorah 133, , ,836 1,202,654 1,204,989 1,246,749 10% 10% 11% Menorah 133, , ,836 1,202,654 1,204,989 1,246,749 10% 10% 11% Sahar-Zion 60, ,958-0% 0% 13% Harel (formerly Shiloah) 147, , ,138 1,329,100 1,776,278 1,844,063 12% 12% 11% Harel Group 208, , ,138 1,799,058 1,776,278 1,844,063 12% 12% 12% Hachsharat Hayeshuv 25,445 23,785 21, , , ,414 11% 11% 11% Eliahu 12,207 14,257 11, , , ,365 9% 11% 8% Ayalon 19,754 22,258 22, , , ,119 12% 12% 11% IDI 15,491 20,408 29,030 28,472 39,373 59,924 48% 52% 54% AIG 10,084 9,981 11,130 6,573 9,568 11,474 97% 104% 153% Total for line excluding direct insurance companies 1,078,309 1,125,141 1,117,251 12,965,056 12,800,530 13,280,553 8% 9% 8% Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. Note: The table contains data based on the non-consolidated financial statements of the insurance companies. Group data is also based on consolidated financial statements. Therefore, totalling of the data from non-consolidated financial statements of companies that are members of groups might not add up to the data of the Insurance groups. 24

25 Stability of Insurance Companies Table C-11 General and Administrative Expenses in NIS thousands, and the Ratio of General and Administrative Expenses to Total Life Insurance Reserves, percent General and Administrative Expenses in NIS thousands, and the Ratio of General and Administrative Expenses to Total Life Insurance Reserves, percent General and Administrative Expenses Ratio of General and Administrative Expenses to Life Insurance Reserves Arieh 35,050 37,940 38, % 1.80% 1.60% Clal 171, , , % 1.00% 0.90% Clal Group 206, , , % 1.10% 1.00% Migdal 261, , , % 0.90% 0.80% Hamagen 42,999 40,164 55, % 0.90% 1.10% Migdal Group 316, , , % 0.90% 0.80% Hadar 77,199 85,565 84, % 1.70% 1.50% Phoenix 95, , , % 1.20% 1.00% Phoenix Group 172, , , % 1.40% 1.10% Menorah 133, , , % 1.50% 1.30% Sahar-Zion 60, % Harel (formerly Shiloah) 147, , , % 1.70% 1.60% Harel Group 208, , , % 1.70% 1.60% Hachsharat Hayeshuv 25,445 23,785 21, % 1.90% 1.60% Eliahu 12,207 14,257 11, % 1.60% 1.30% Ayalon 19,754 22,258 22, % 2.80% 2.50% IDI Direct 15,491 20,408 29, % 34.20% 30.50% AIG 10,084 9,981 11, % % % Total for line, excluding direct insurance companies 1,093,670 1,138,945 1,127, % 1.20% 1.10% Source: Insurance company reports and data processed by the Capital Market, Insurance and Savings Division. Note: The table contains data based on the non-consolidated financial statements of the insurance companies. Group data is also based on consolidated financial statements. Therefore, totalling of the data from non-consolidated financial statements of companies that are members of groups might not add up to the data of the Insurance groups. 25

26 The Capital Market, Insurance and Saving Division 4 Risks and an Assessment of Stability The nature of the insurance companies business is to assume their insureds risks (it is customary to leave a bit of the risk with the insured in order to prevent any moral hazard and to reduce the adverse selection) in exchange for a premium that the insureds pay in consideration of transfer of their risk to the companies. The salient points in risk management are risk diversification, control over the extent of the exposure, and the maintenance of adequate levels of protection through re-insurance. Life insurance products offer a wide variety of insurance plans - from pure risk to products including only savings components. The insurance plans are drawn up for a long period (from one year to more than fifty years). The insurance sum is usually determined within the framework of the policy terms. In some policies, the lifetime of the policy and the height of the insurance benefits are predetermined (for example, in assured-yield policies), while in other cases, the insurance sum is known, but the period of insurance is not, since it depends on the lifespan of the insured. Non-life insurance products provide a variety of insurance covers over a short period (usually for one year; for example - compulsory motor vehicle insurance and apartment contents insurance). The extent of a claim for payment by the insurer and the date for claims payments is not known at the time of underwriting of the policy. In some insurance lines, a maximum height of the cumulative insurance benefits that the insurer will pay can be determined. The extent of the risk involved in the insurance activity depends on the line of insurance. Thus, for example, the insurance risk that an insurance company assumes under an elementary insurance product is different from the insurance risk under life insurance: for an elementary insurance product, such as motor vehicle property damage, the contract is signed for one year, and the claims are investigated relatively quickly. As opposed to this, a life insurance contract remains in effect for the lifetime of the insured. Under motor vehicle property damage insurance, if the premiums that the insurance company set are insufficient to cover the claims, the company s expenses and leave a sufficient profit (premium deficiency), they can be changed the next year. In life insurance at issue is a long-term contract, and a premium deficiency will only be discovered many years later. 26

27 Stability of Insurance Companies The risks to which insurance companies are exposed can be classified according to various criteria. One way is to classify according to risks deriving from the structure and function of the corporation itself and according to common risks that have an impact on all the companies. Whether the risks materialize or not depends on a variety of external and internal factors. The quality of the risk management at each corporation, as is expressed by the direction and supervision that the board of directors delineates, and by the functioning of the corporation s management, has an impact on the net risk - the risk that remains even after the corporation s actions to minimize the company s risk exposure. Following are structural characteristics of insurance companies that affect the risks associated with their operations: 1. Business diversification - major insurers might have a reduced level of risks due to wider risk diversification, since they are distributed amongst multiple lines. 2. Seniority/years of experience in the industry - it has been found that young companies in the United States were exposed to greater instability than senior companies, due to unprofessional underwriting management, a lack of underwriting experience, and due to expansion into additional insurance lines for which the company had insufficient base data. Although it is true that older companies have long tail claims 7, but they also have more experience in handling such claims. Furthermore, it is reasonable to assume that older companies have amassed considerable equity, which reinforces their stability. 3. The lines of activity - the lines of insurance that a company engages in also have an impact. In elementary insurance, policies for individuals, for the most part, involve a lower risk than the risk in corporate insurance policies. Moreover, claims in lines engaging in long-term contracts involve a greater risk to an insurance company than claims in short-term plans, since the latter can be assessed more accurately and simply. Monoline insurance companies 8 are more exposed to risk upon the occurrence of a onetime event than are companies operating in a few insurance lines, and diversifying their risks. 4. Financial flexibility - companies that constitute part of a broad financial concern have an 7. Long tail claims claims that take a long time to investigate, in relation to the time of its discovery, the nature of the claim and the assessment of the claim sum. For example: in employers liability insurance, harm to employees health might be discovered only after many years of employment; Investigating the nature of such a claim and assessing a monetary compensation in respect thereof take a long time. 8. Monoline insurance companies companies whose business focuses on a single insurance line, such as, foreign trade risk insurance. 27