Table of Contents. List of Charts. The Capital Market

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1 Life Insurance

2

3 The Capital Market Table of Contents 1. Introduction Analysis of the Line...6 A. Premiums and Distribution of Insurance Types...6 B. The Assets Portfolio in Life Insurance...9 (1) General...9 (2) Participating Insurance Plans Portfolio...11 (3) The Yield of the Insurance Companies...14 (4) Management Fees in Participating Policies...20 (5) Insurance Policies with Several Investment Channels A General Review of the Life Insurance Line in Israel in A. Amendment to the Income Tax Regulations (rules of approval and management of provident funds) B. Procedure for dealing with unclaimed assets and location of beneficiaries of insurance policies...29 C. Insurance of Army Reservists General Issues...33 A. Unit-Linked Type of Life Insurance...33 B. Comparison of death risk rates...35 List of Charts Chart C-1 Gross Premiums by Main Life Insurance Types, Chart C-2 Distribution of Assets Portfolio in the Life Insurance Line, Chart C-3 Ratio of Shares and Bonds to the Total Participating Portfolio, Chart C-4 Distribution of Asset's Share in Participating Portfolio, Chart C-5 Distribution of Assets in Participating Portfolio by Group, Chart C-6 Development of Gross Yield in Participating Portfolio (the I Fund) by Month, Chart C-7 Yield and Management Fees by Insurance Company, Chart C-8 Average Net Yield and Average Management Fees, Chart C-9 Gross Yield of Insurance Companies by Quarter, Chart C-10 Comparison of Risk Rates of Smoking and Non-smoking Male...36 Chart C-11 Comparison of Risk Rates of Smoking and Non-smoking Female...36

4 The Capital Market, Insurance and Savings Division Chart C-12 Comparison of Risk Rates of Non-smoking Male and Female...37 Chart C-13 Comparison of Risk Rates of Smoking Male and Female...38 List of Tables Table C Gross Premium by Insurance Type...6 Table C-2 Distribution of Gross Premiums by Insurance Groups, Table C-3 Distribution of the Total Assets Portfolio in Life Insurance, Table C-4 Distribution of Assets in Participating Portfolio, Table C-5 Market Centralization indices, Table C-6 The I Fund in the Participating Portfolio. Weighted Gross-Net Yield and Management Fees, Table C-7 Maximum and Minimum Gross Yields, Table C-8 Gross and Net Yields by Insurance Groups, Table C-9 Allocation of Investment Profits to the Insured and Management Fees in Participating Portfolio in Life Insurance, Table C-10 Clal Insurance Company Gross and Net Yields, by Investment Channel...22 Table C-11 Direct Insurance Company Gross and Net Yields, by Investment Track...23

5 The Capital Market 1. Introduction The Life Insurance Department of the Capital Market, Insurance and Savings Division deals with a variety of issues related to the regulation and supervision of the activity of insurance companies and insurance agents in the area of life insurance. The department is in charge, among other issues, of the review and approval of life insurance plans submitted to the Commissioner for approval, regulation of various issues related to the life insurance line and dealing with public appeals related to this area. On January 1 st, 2003, the income tax reform took effect. Among other things it sets provisions on taxing profits accrued in savings channels including rules on withdrawal from provident funds and life insurance policies. The reform stipulated that a 15% tax will be imposed on the real interest accrued on new deposits in provident funds (excluding severance payment and annuity funds) which exceed given limit, as well as real interest accrued on the savings component of a life insurance policy which is not a provident fund (the interest on new deposits below the aforementioned limit will be taxed if not all the requirements for tax exemption are met). The tax reform required amendments to the Income Tax Code (rules for approval and management of provident funds) The amendments were mainly in these areas: 1. Management of the components of a provident fund account regulation of the management of contributions to the provident fund and separation between the employer s contribution toward benefits, his contribution toward severance payment and the employee s contribution toward benefits. 2. Allocation of profits and expense to each of these accounts. 3. Regulation of risks insurable by insurance plans 4. Amendment of regulation 44(c) employer s and employee s contributions will be made to the same insurance policy (this amendment will not affect existing contracts). 5. Regulation of the issue of surrender value of the severance-pay component in pension and insurance plans. µ

6 The Capital Market, Insurance and Savings Division Following the reform provisions, a new structure was determined for life insurance products to be marketed from January 1 st, In the new structure there will be a structural separation between the savings component and the risk and expenses components. As part of the regulatory activity and in the light of numerous public appeals received by the office of the Commissioner of Insurance regarding the subrogation of current life insurance policies with the new ones ( twisting ), a draft circular for regulation of the subject was formed and published. The goal of the circular is to promote transparency and adequate disclosure to the insured, in a way that will enable them to calculate and consider their steps, before they cancel an existing policy and acquire a new one. In addition, a circular was published, dealing with rules of locating beneficiaries and handling unclaimed assets in insurance policies. Among other things, the circular regulates management of funds in policies that the insured/beneficiaries did not claim, and the ways to locate these insured/beneficiaries. In 2002 the insurance companies achieved a negative average gross real yield of -6.62% on investment of participating life insurance portfolio assets. Premium total in 2002 was about NIS 14 billion, a decline of 6% compared with Compared with the previous year the assets portfolio of the life insurance line grew by NIS 2.4 billion (a rise of 2.9%) in real terms, to NIS 86.4 billion.

7 The Capital Market 2. Analysis of the Line In this chapter we will analyze the life insurance line by these aspects: premium distribution, marketed insurance types, assets portfolio in general and participating portfolio in particular and the yields achieved by the insurance companies on behalf of the insured. A. Premiums and Distribution of Insurance Types Insurance plans are proposed to the insured in three marketing frameworks: 1. Individual and self-employed plans. 2. Executive insurance plans (through the employer) for employees, indexed either to CPI or to wage. 3. Group life insurance plans (through employers, associations and service providers). Table C Gross Premium by Insurance Type (NIS millions, December 2002 prices) Type of Insurance Rate of change, (%) Rate of change, (%) Increase in premiums, Endowment Type Individual 2,125 2,093 1, % -12.7% -297 Adif Type Individual 1,348 1,284 1, % 8.6% 47 Endowment Type Executive 1, % -8.4% -206 Adif Type Executive 6,949 8,292 7, % -7.7% 708 Group Insurance % -0.9% 19 Sub-Total 12,373 13,518 12, % -6.5% 271 Incapacity for Work 1,162 1,251 1, % -1.0% 76 Other (*) % 20.6% 55 Total 13,831 15,060 14,233 9% -5% 402 Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. (*) Other includes health and long-term care insurances.

8 The Capital Market, Insurance and Savings Division In 2002 the total premium was NIS 14.2 billion. After the deduction of disability, health and long-term care insurances (whose classification varies in some of the companies), the premium was NIS 12.6 billion. The premium growth rate in was negative (-6%), for the first time since the marketing of participating insurance plans started. This negative growth expresses, among others, the decline of premium amount in executive insurance (both Adif and endowment products). The premium in individual endowment has declined by NIS 265 million, which constitute some 1/3 of the premium decrease from 2001 to In 2002, life insurance plans of the Adif type were 72% of the total gross premium (after deduction of disability and other premiums); endowment type plans were 21% and group insurance was 7% (see Chart C-1). Unlike in the previous years, in the Adif type of plans we can see on the one hand a decline of the executive insurance segment (a decline of 7.7% from 2002 to 2002), and on the other hand, a rise of 8.6% of the individual segment from 2002 to 2002 (about NIS 111 million). These changes in trend reflect the economic slowdown and the increase in unemployment which caused the decline in the amount of premiums. The amount of executive insurance premiums has eroded as well, since they are mostly wage linked and the wage rise fell below that of the CPI. In addition, since June 2001 the insurance companies are not allowed to market the endowment type executive insurance, whose premium amount has declined by 8% from 2001 to The increase of the individual Adif type insurance segment is among others, due to the decline of the individual endowment type insurance segment, mostly because the individual Adif type insurance plan is more flexible and more adaptable to the insured needs. We can summarize and state that there was a 4.6% decline in individual insurance.

9 The Capital Market Chart C-1 Gross Premiums by Main Life Insurance Types, 2002 Group Insurance Endow ment Individual 7.4% 14.5% Adif Individual 11.0% Adif Executive 60.6% Endow ment Executive 6.5% Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. Table C-2 Distribution of Gross Premiums by Insurance Groups, (Percent) Name of the Group Migdal Clal Phoenix Harel Menorah Other (*) Total Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. (*) The other group includes the Ayalon, Elyahu, Hachsharat Hayeshuv (ILD), AIG, and IDI Direct Insurance companies. π

10 The Capital Market, Insurance and Savings Division We can see that there was almost no change in the premium distribution among the insurance groups in 2002 compared with previous years. B. The Assets Portfolio in Life Insurance (1) General The total real value of public assets has declined in 2002 by 4.8% compared with 2001, and it stands at NIS 1,214 billion 1. The share of the life insurance plan assets of the total public assets portfolio rose in 2002 from 6.5% at the end of 2001 to the level of 7.2% at the end of 2002 and is NIS 86.4 billion. In comparison, the share of the pension fund assets of the total public assets portfolio rose in 2002 from 10% at the end of 2001 to the level of 11% at the end of 2002, while the share of the provident and study funds assets of the total public assets portfolio declined in 2002 from 10.4% and 4% (respectively) at the end of 2001 to the level of 9.8% and 3.9% (respectively) at the end of Chart C-2 Distribution of Assets Portfolio in the Life Insurance Line, Participating Other Assets percent Years Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. 1 All the amounts in this chapter are 12/2002 CPI adjusted. ±

11 The Capital Market Between the years , the life insurance assets portfolio grew in real terms from the level of NIS 61.2 billion at the end of 2002 to the level of NIS 86.4 billion at the end of 2002, a real growth rate of 41.1%. In the assets portfolio grew in real terms by NIS 2.4 billion (a 2.9% growth) compared with , when the assets portfolio grew in real terms by NIS 4.34 billion (a 5.8% growth). The moderation of the assets portfolio s growth rate can be attributed, among other things, to the negative yields recorded by the companies in 2002 and the decline in the amount of new premiums in the wake of the economy s continuing slowdown trend. The uptrend of the share of the participating portfolio of the total assets portfolio has continued in 2002, due to the fact that since 1991 the only plans marketed to the public are participating plans. In the share of the participating portfolio (of the total life insurance assets portfolio) rose from 31% to 51.2%. Table C-3 Distribution of the Total Assets Portfolio in Life Insurance, (Percent) Asset Type LI bonds Other government bonds Other obligation certificates and others Stocks Loans and deposits in banks (excl. on-demand deposits) Cash and on-demand deposits Rentable real-estate Investment in subsidiaries Amounts due from re-insurers Premiums due and agents' balances Accounts receivables and debit balance Deferred acquisition costs Fixed assets Total assets and debit balances (NIS billions) 76,133 83,979 86,408 Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. 12/2002 CPI adjusted. 2 See Annual Report 2001 Life insurance chapter page 28 ±±

12 The Capital Market, Insurance and Savings Division In 2002, the downtrend of the share of LI bonds of the total life insurance assets portfolio has continued from the level of 41.2% in 2000 to the level of 35.3% at the end of In addition, one can see that in accordance with the negative trends which characterized the stock market in 2002, a 5% decline in the share of investment in stock of total assets portfolio has occurred compared with a 16% increase in the share of investment in bonds. (2) Participating Insurance Plans Portfolio The main attribute of the participating insurance plans is that the investment profit or loss, less the management fees, is credited or debited to the insured. The investment is subject to the provisions of the Supervision of Insurance Business Regulations (methods of investment of funds and capital by the insurer and its obligations management 2001, (henceforth the Investment Methods Regulations) through rules set from time to time by the Inspector of Insurance. Table C-4 Distribution of Assets in Participating Portfolio, (NIS millions 12/2002 CPI adjusted.) 2000 Share of total assets, 2000 (%) 2001 Share of total assets, 2001 (%) 2002 Share of total assets, 2002 (%) LI bonds Other government bonds 13, , , Other obligation certificates and others 1, , , Stocks 4, , , Loans and deposits in banks (excl. on-demand deposits) 6, , , Cash and on-demand deposits. 1, , , Rentable real-estate Investment in subsidiaries , Amounts due from re-insurers Premiums due and agents' balances Accounts receivables and debit balance 2, , , Deferred acquisition costs Total assets and debit balances 31, , , Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. ±

13 The Capital Market In 2002 the total assets of the participating portfolio grew by 5.97% compared with a growth rate of 26.8% in While in 2001 the share of investment in government bonds of the participating portfolio declined and the share of stocks increased, in 2002 the trend reversed itself and the share of investment in government bonds of the participating portfolio has increased compared with the decline in the share of stocks. A second consecutive year of more than 50% growth in the amount of investment in certificates of other obligations was recorded in This uptrend is attributed mostly to the rise in the amount of investment in non-government bonds, a continuous growth since the new Investment Methods Regulations came into effect in April Chart C-3 Ratio of Shares and Bonds to the Total Participating Portfolio, 2002 (percent) Stocks Government Bonds Other Bonds Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. In Chart C-3 one can see that in the first and last quarters of 2002, a considerable rise of the share of other bonds of the participating portfolio occurred following the better yields recorded in these quarters in the corporate bonds market, compared with the yields in other channels of investment in the capital market. ±

14 The Capital Market, Insurance and Savings Division The first quarter of 2002, has recorded a sharp drop of the share of stocks of the participating portfolio due to the steep declines recorded in the stock market at the same time. On the other hand, following the sharp climb of rates recorded in the stock market in November 2002, the share of stocks of the participating portfolio increased in the fourth quarter. Chart C-4 Distribution of Asset s Share in Participating Portfolio, (percent) LI Bonds Other Other Stocks government obligation bonds certificates and others Loans and deposits in on-demand banks (excl. deposits on-demand deposits) Cash and Rentable realestate Investment in subsidiaries Amounts due from re-insurers Premiums due and agents balances Accounts receivables and debit balance Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. ±

15 The Capital Market Chart C-5 Distribution of Assets in Participating Portfolio by Group, 2002 (percent) Phoenix 17% Menorah 9% Other 4% Migdal 35% Harel 13% Clal 22% Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. Review of the distribution of participating portfolio assets among the insurers reveals no change in Migdal Group possesses the largest market share (about NIS 14.9 billion which are 35.4% of the market). The next in market share are Clal, Phoenix, Harel and Menorah (with participating portfolios of NIS 9.4, 6.9, 5.4 and 4 billion respectively). The three biggest groups concentrate among themselves 74% of the participating portfolio market share. For the analysis of the insurance market s centralization we have used two indices: 1. The Herfindahl-Hirshman Index (HHI), which is the sum of the squares of all insurance companies shares in the total participating portfolio assets. 2. The CR3 Index, which sums up the ratio of the market share of the three largest insurance groups to the total of the participating portfolio assets. These are the results of the centralization indices: ±µ

16 The Capital Market, Insurance and Savings Division Table C-5 Market Centralization indices, Index HHI CR Source: The Capital Market, Insurance and Savings Division. As we can see, this year as well the Herfindahl-Hirshman Index is This result indicates an ongoing centralization of the insurance sector similar to the centralization of the banking system in Israel, which itself is considered highly centralized. The comparable indices are approx in the UK and in the USA. (3) The Yield of the Insurance Companies. The life insurance premium is composed of three components: risk premium, savings premium and a expenses component 3. Normally the expenses component is part of the risk premium. In some of the new life insurance plans the expenses component is allocated to the savings premium or represented independently. In addition, we should bear in mind that additional expense components are deducted from the accrued savings. The management fees included in the expenses are made up of fixed management fees of 0.6% of the accrued balance of the contributed funds and variable management fees of 15% of the real profit on the annual yields (subject to the management fees regulations). Please note that the subject of the forthcoming analysis is the real yield achieved by the companies, i.e. the yield less the CPI change. Since 1992, the savings component has been invested in the capital market and is affected by the assets portfolio composition and its yield (henceforth fund I). There is a distinction between the gross yield, which is affected by the investment policy and the way it was implemented over the relevant period among others, and the net yield, which is credited to the insured according to his policy terms after deduction of the management fees. 3 Except pure risk life insurance policy. ±

17 The Capital Market The analyzed yields in this part of the report are based on the reported yields rather than on the actual yields credited to each insured which are affected by additional factors (such as the timing of contributions, their size, etc.). Table C-6 The I Fund in the Participating Portfolio. Weighted Gross-Net Yield and Management Fees, (Percent) Year Weighted Gross Yield Weighted Net Yield Management Fees (fixed and variable) Source: The Capital Market, Insurance and Savings Division The weighted yield is calculated by multiplying each company s yield value by their respective share of total assets. The yields recorded in 2002 were the lowest since The negative yields can be attributed to several factors and especially to the decline in real terms of local stocks and bonds indices (-25.2% and -6.2% respectively), a decline which went on during the better part of The relatively high rise of the CPI only emphasized the negative trend in real terms. Due to the negative yields the insurance companies did not collect the variable management fees, and therefore the presented management fees for 2002 reflect mostly the fixed management fees. The yields standardized standard deviation is an index which enables the examination of the distribution of the yields achieved for the insured. A high standardized standard deviation (in 1998 for example) indicates a relatively high level of variation in the way the companies manage their investments. In the last four years the dispersion level is relatively not high. In 2002 the standardized standard deviation (absolute value) rose to the level of ±

18 The Capital Market, Insurance and Savings Division Table C-7 Maximum and Minimum Gross Yields, (Percent) Year Maximum Gross Yield Minimum Gross Yield Standardized Standard Deviation Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. percent Chart C-6 Development of Gross Yield in Participating Portfolio (the I Fund) by Month, 2002 January February March April May June July August September October November December Source: Annual statements of the insurance companies, processing by the Capital market, Insurance and Savings Division. ±

19 The Capital Market The monthly yields reflect a similar situation in other capital market indices. The trend was relatively fluctuating and mostly characterized by negative yields. We ought to remember that 2002 was characterized by a deteriorating security situation, a rise in unemployment and a rates fall in stock exchanges all over the world affecting the Israeli capital market. The negative (-2.19%) yield of March can be explained mostly by the decline in stock indices (such as Tel-Aviv 100) and the general stock index. The negative yield in June was recorded due to the decline in stock and bond rates. A positive yield of 2.57% was achieved in November following the sharp rise in stock and bond indices and a negative monthly change of the CPI. Group Migdal Clal Phoenix Harel Table C-8 Gross and Net Yields by Insurance Groups, (Percent) Company 2000 Gross Yield Net Yield The Average Gross Yield in the Last Five Years The Average Net Yield in the Last Five Years Migdal Hamagen Clal Aryeh Phoenix Hadar Shiloh Sahar-Zion (1) Menorah Ayalon Other Elyahu Hachsharat Hayeshuv (ILD) Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. (1) The 2000 data relates to 'Sahar' only. On January 1 st, 2001, Sahar and Zion merged. ±π

20 The Capital Market, Insurance and Savings Division Chart C-7 Yield and Management Fees by Insurance Company, 2002 (percent) percent Gross Annual Yiled 2002 Management Fees 2002 Hadar Hamagen Migdal Clal Aryeh Shiloah Sahar Menorah Phoenix Ayalon ILDC Eliahu Insurance Companies Source: Annual statements of the insurance companies, processing by the Capital market, Insurance and Savings Division. percent Chart C-8 Average Net Yield and Average Management Fees, (percent) Avarage Net Yield for the Last 5 Years Avarage Management Fees for the Last 5 Years Shiloah Phoenix Migdal Hamagen Hadar Sahar Ayalon Clal Aryeh Eliahu ILDC Menorah Insurance Companies Source: Annual statements of the insurance companies, processing by the Capital market, Insurance and Savings Division.

21 The Capital Market In Chart C-8 one can see that in light of the negative yields achieved in 2002, some companies have achieved a lower average yield over the last five years, but at the same time they have collected higher management fees, even though the variable management fees mechanism provides for management fees proportional to the yield. (4) Management Fees in Participating Policies The management fees an insurer can charge for managing the insured s investments were set in the Supervision on Insurance Business Regulations (terms of insurance contracts) According to these regulations, the insurer can collect the management fees in one of these ways: a. Collection of 1/12 of 0.84% of the assets balance per month. b. Collection of 1/12 of 0.6% of the assets balance per month (known as the fixed management fee ) plus 15% of the accrued real profit after the deduction of the fixed management fee (known as the variable management fee ). The second way is the more common one among insurance plans (except a small number of insured in insurance plans which offer specialized investment channels). Table C-9 Allocation of Investment Profits to the Insured and Management Fees in Participating Portfolio in Life Insurance, (NIS million, December 2002 prices) Migdal Clal Phoenix Harel Menorah 2001 Investment profits for the insured Management fees Total Ratio of management fees to investment profit (percent) 23.0% 22.4% 23.1% 21.8% 19.5% 2002 Allocation to the insured Management fees Total Ratio of management fees to investment profit (percent) -8.6% -8.9% -9.8% -8.6% -12.6% Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. ±

22 The Capital Market, Insurance and Savings Division An important point to be emphasized is that according to the regulations, the variable management fees are collected from the insured when the company s yield is positive, as are the profits on behalf of the insured. When the yield is negative, as was the case in 2002, the insurance company does not participate in the profit (which is actually a loss). In such a case, a countervailing mechanism kicks in and prevents the insurance company from collecting the variable management fees until the profit for the insured in periods successive to the loss period cover the negative profits the insured did not participated in. Due to the negative yields in 2002 in the range of -1.4% to -8%, the insurance companies would not be able to collect the variable management fees in the next months. The length of this period depend on two variables: the negative yield achieved by each company in the participating portfolio in 2002 and the yield it will achieve in the next months and even in the years. Inasmuch as the company s loss in 2002 was lower (in absolute terms) and inasmuch its profits in 2003 and on will be higher, the company will be able to collect variable management fees sooner. The aforementioned method of collecting management fees for managing the insured s funds might create two major problems which are aggravated in a period of losses: 1. Cross subsidization between different insured, especially between the new insured that joined the insurance after the period of loss and the existing one, because the new insured will benefit from the reduced management fees due to fact that the company does not collect the variable management fees after a period of losses, as explained above. The new insured did not suffer losses in the losses period but do enjoy this period s implications. 2. High sensitivity of the companies to the impact of the variable management fees on the line of profit from insurance business, as demonstrated in the table and in the insurance business reports by the insurance companies. The variable management fees are dependent on investment results and when they are negative, it is immediately reflected in a sharp decline of the revenue from investments. Such high volatility makes it difficult to maintain stability in the profit and loss line, not to mention that in 2002, the sector along with other sectors, was hit hard by the severe economic slowdown. (5) Insurance Policies with Several Investment Channels Some of the insurance companies ( Clal Group, Direct Insurance and Migdal Group ) make it possible to invest the premium and accrued savings in investment channels other than the general investment fund shared by all the insured in the participating portfolio. The investment management area in the insurance companies rose to prominence in the recent

23 The Capital Market years and today the aforementioned companies offer a variety of investment channels with varying risk levels and the ability to combine different channels. Nevertheless, most funds are managed in the I fund and in the general investment portfolios shared by all the insured of each company. Table C-10 Clal Insurance Company Gross and Net Yields, by Investment Channel (Percent) Track Stocks (at least 85% stocks) Bond (bonds and deposits) Foreign currency (at least 75% currency indexed) Mixed solid (up to 15% stocks) Mixed flexible (15%-50% stocks) Mixed bold (50%-75% stocks) Gross Management fees Net Gross Management fees Net Gross Management fees NIS (*) Weighted average yield Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. (*) Clal markets this channel since 11/2002. Net

24 The Capital Market, Insurance and Savings Division Chart C-9 Gross Yield of Insurance Companies by Quarter, 2002 (percent) General Yield in Insurance General Stocks Index General Bonds Index CPI first quarter second quarter third quarter fourth quarter Source: Capital Market, Insurance and Savings Division. Table C-11 Direct Insurance Company Gross and Net Yields, by Investment Track (percent) Track Solid (bonds and deposits) Moderate (up to 15% in stocks) Stocks (up to 50% in stocks) Weighted average yield Gross Management Fees (*) Net Gross Management Fees (**) Net Gross Management Fees (*) Source: Annual statements of the insurance companies, processing by the Capital Market, Insurance and Savings Division. Net (*) The company did not collect management fees in (**) In 2001, management fees were collected for the second half only.

25 The Capital Market As illustrated by Chart C-9, the year 2002 was characterized by negative indices in the capital market except in the last quarter. The total decline in the general stock index in 2002 was 20%, predominantly due to the sharp falls in the year s first three quarters. The CPI rose steeply in the first three quarters and affected the real yields of the insurance companies. A rise in the indices and some stability in the capital markets were noticeable by the end of The general bonds index which comprises a sizeable portion of the companies assets portfolio achieved a quarterly yield of 2.4%. µ

26 The Capital Market, Insurance and Savings Division 3. A General Review of the Life Insurance Line in Israel in 2002 A. Amendment to the Income Tax Regulations (rules of approval and management of provident funds) Background During the course of the year the Income Tax Regulations (rules of approval and management of provident funds) 1964 (henceforth the Regulations) were amended, regarding among other things, the separation of provident fund components (employee s contributions towards benefits, employer s contributions towards benefits and employer s contributions towards severance payment); allocation of profits to each of these components; expansion of the risk that can be purchased by the current contributions to the provident account; and regulation of severance payment surrender value in pension or insurance plan. After discussions with relevant bodies and after the income tax reform became effective, the following amendments were made: Goals of the amendment A. Adjustment of the Regulations to the provisions of the income tax reform: 1. Management of the components of the provident fund account (employee s contributions towards benefits, employer s contributions towards benefits and employer s contributions towards severance payment). 2. Allocation of profits to each of these components. 3. Allocation of expenses to each of these components. B. Regulation of insurable risks in insurance plan. C. Regulation of options to withdraw benefit funds when the member reaches the age of 65. D. Amendment of Regulation 44(c) Contributions by both the employee and the employer ought to be to the same insurance policy (not applicable to existing contracts). E. Minimum annuity in provident fund for annuities.

27 The Capital Market Details of the amendments A. Adjustment of the Regulations to the provisions of the income tax reform Addition of a provident account management chapter. As part of the reform it was determined that the real interest accrued on new deposits in provident funds (not annuity or severance payment funds) since January 2003 would be subject to taxation if the deposits did not meet the cumulative conditions to get a taxexempt status (deposits up to a deposit eligibility ceiling, age of 60 and 15 years of membership in the fund. The requirement from members over the age of 60 is 5 years of membership in the fund). In light of this, the provident fund has to maintain a bookkeeping system which enables identification at any time of the taxable portion at the time of a tax-exempted withdrawal. Below are the chapter s highlights: 1. Management of the components of the provident fund account The fund has to keep separate records of the employee s contributions towards benefits component, the employer s contributions towards benefits component and employer s contributions towards severance payment component. In addition, the provident fund will maintain the following records for each component: a. Total payments to the provident fund while maintaining distinction between payments until December 31, 2002 and after January 1, 2003 (and a distinction between deposits up to the eligible ceiling and those beyond it). b. An insurance plan will maintain an additional record of total payments after the deduction of all the expenses and insurance coverage costs (henceforth part of the contribution towards the savings component). c. Indexing differentials accrued on part of the payments towards savings. d. Interest and profits accrued on the abovementioned components. e. Interest and profits after deduction of the permitted expenses, due to the structure of insurance plans which include expenses from the current premium. 2. Allocation of the fund s profits to the various account components will be relative to each component s share of the deposit. 3. Allocation of the fund s expenses to the various account components will be according to the expense s type: a. An expense out of the current payments will be allocated relative to each component s share of the deposit. b. Any other expenses will be allocated relative to each component s share of the account s balance.

28 The Capital Market, Insurance and Savings Division 4. Payments for insurance coverage will be deducted from all of the components of the provident fund account except the severance payment component. B. Insurable risks in an insurance plan Since the coverage of incapacity for work has recently become an important and integral part of insurance plans, the insurable risks which can be purchased out of the contributions to insurance plan were expanded (from January 1, 2004) to include death risk and incapacity for work risk. C. Regulation of the option of benefit payments withdrawal when the member turns 60 According to the previous version of the regulation, even if the member had turned 60 and even if he had retired, he could not withdraw his benefits immediately and had to wait six months (if he did not work during this period or to wait 13 months if he did start to work and his new employer did not contribute on his behalf to a provident fund for annuity or benefits. In the new version the benefits withdrawal possibilities were expanded so that a member who turns 60 can withdraw the funds if one of the following conditions is met: 1. The member has retired from his work or reduced its scope by 50%. 2. It has been at least 15 years since his first contribution to the provident fund account, and provided he is not a controlling shareholder. D. Amendment to Regulation 44(c) Contributions by employer and employee will be to the same insurance policy. 1. The previous version of the regulations made it possible for the insured to split employee s and employer s contributions on behalf of a single insured wage between two separate provident funds. For example: Employee s benefits are deposited in a pension fund or a provident fund which is not an insurance plan and the employer s benefits are deposited in an insurance plan. In order to comply with the provisions of Regulation 19(b) in its new version, the regulation was amended so that contributions by employer and employee would be made to the same insurance policy. 2. Nevertheless, a controlling shareholder can deposit his contributions as an employee into an annuity provident fund up to a limit of 5% of his eligible income, as defined by section 47 of the Code, if his employer deposited his payments in an annuity provident fund which is an insurance plan.

29 The Capital Market E. Regulation of severance payments surrender value in insurance plans and pension funds Since January 1, 2004 the regulations stipulate a uniform calculation of the severance payments surrender value in insurance plans and pension funds while maintaining a distinction between an insurance plan which is authorized for benefits and severance payments (capitalized) and an insurance plan for annuity. The current formula for the severance payments surrender value to be effective for members who has joined or will join until December 12, 2003, takes into account the lower of two sums - the total premium paid toward severance payment plus investment profits, or the total CPI indexed premium paid toward severance payment. The formula of the severance payments surrender value in pension funds is according to the income tax regulations. As mentioned above, the regulations stipulate a uniform calculation of the surrender value of the severance payment component. Regulation 46(b) set forth a default option for the calculation of the severance payment component s surrender value in an insurance plan. This surrender value equals the total of premium paid plus investment profit as allocated to the severance payment component minus the expenses allocated to this component (henceforth the accrued severance payments). The same calculation applies to a new general pension fund and a new comprehensive fund as well. An additional track for the calculation of the severance payment component s surrender value was set for the case of a member who is unconditionally eligible to withdraw the balance from each of the insurance plan s account component. This unconditional eligibility must be awarded with the first payment to the insurance plan and it must mature no later than three years of the member s employment with the same employer. If unconditional eligibility was awarded to a wage earning member, there is a distinction between insurance plan types (annuity or capitalized): In an annuity insurance plan the severance payment component s surrender value will be the higher of accrued severance payments or total CPI indexed premium paid toward the severance payment component. This calculation applies to pension funds as well. In an insurance plan which is authorized for benefits and severance payments (capitalized), at the time of the policy redemption the employer can earmark benefit funds to pay for his obligation according to the Severance Payments Law up to the π

30 The Capital Market, Insurance and Savings Division difference between the CPI indexed payments paid toward the severance payment component and the accrued severance payments. This arrangement is valid only during the first seven years after the policy was issued or after the policy s ownership was transferred to another employer, whichever comes later. F. Minimum annuity in a provident fund for annuity According to section 87 of the Income Tax Code, withdrawal of benefit funds out of a provident fund for annuity in a way other than annuity is subject to the higher between a 35% tax or the tax the member is subject to. In insurance plans for annuity there are cases in which the payable annuity is very low, sometimes in the tenths of Sheqels only. In light of this, the regulation was amended in a way that makes it possible to withdraw funds accrued in annuity plans in a way other than annuity, while for tax purposes these amounts will be regarded as annuity capitalization. The condition for this option are: 1. Age of 60 at least. 2. The annuity is less than 5% of the minimum wage according to the Minimum Wage Law. B. Procedure for dealing with unclaimed assets and location of beneficiaries of insurance policies Following the publishing of the draft circular in 2002, a circular regarding procedure for dealing with unclaimed assets and location of beneficiaries of insurance policies was published in The circular was prepared in cooperation with the office of the Administrator General, who assigns importance to the regulation of unclaimed funds in the financial brokerage lines. The accumulated funds are estimated at NIS tens of millions. According to the circular, if no insured/beneficiary is located during the six months after the insurance event (end of term, death etc.), the money will be transferred to a separate special fund where it will be managed in accordance with the investment methods defined by the Methods of Investment Regulation. If within ten years after the insurance event no insured/ beneficiary has been located, the funds will be transferred to the hands of the Administrator General. These funds should have been paid to the insured/beneficiaries/surviving relatives according to the policy terms and have not been paid due to inability to locate the entitled person/

31 The Capital Market s. Until the issue of this procedure, dealing with unclaimed assets was not regulated sufficiently. Therefore the need to regulate this issue and to cooperate with the insurance companies and the Administrator General who is by law in charge of abandoned assets. The circular specifies the ways of dealing with these issues: 1. Definition of the various insurance events relevant to this circular, such as end of term or death of the insured. 2. Methods for location of the insured and the beneficiaries including addressing the insured, the beneficiary, the insurance agent and the Population Registry. 3. Management of funds of an unaccounted-for insured: a. In the first six months the insurance company will manage the funds according to the policy s stipulations. b. After six months the money will be transferred to a special fund with a separate account for each policy. c. Ten years after the insurance event, the money in the policy s account will be transferred to the hands of the Administrator General. 4. Transfer of funds after insured or beneficiaries have been located by the company or by a third party. 5. Methods of funds transfer to the Administrator General according to the law and after the set period. 6. Reports to the Administrator General and the Inspector of Insurance regarding the located insured, number of policies in the fund, amounts deposited in the special fund, amounts withdrawn from the special fund, management fees collected by the company and the yield achieved by the company in the special fund. The circular can be read and downloaded from the internet site of the Capital Market, Insurance and Savings Division. C. Insurance of Army Reservists In 2002 the legislation of the Law of Benefits Payment to Army Reservists and their Families 2002 (henceforth the Law) was completed and with it the regulation of the army reservists insurance issue which came up for public discussion in recent years. The goal of the Law is to ensure payment of benefits to army reservists who have been injured during and due to their service and to the families of army reservists who died due to their service, in the case that the reservists or their family members are not entitled to benefits ±

32 The Capital Market, Insurance and Savings Division from a provident fund, or that the amount they are entitled to is lower than their entitlements according to the Law. The Law anchors the payment of benefits to the reservists and their heirs in the event of death or incapacity for work due to the reserve service, like the benefits payable to soldiers of the standing army in the case in which the reservist was not a member of a provident fund as defined by the Law, or if he or his heirs are not eligible for benefits from that fund, or if the amount they received from the fund is lower than their entitlements according to the Law. The rights of the reservists and their relatives are defined on several levels: a. Every soldier who was injured or who has died during and due to his army service is entitled, himself or his heirs, to payments by the Rehabilitation Division of the Ministry of Defense according to the Disability Law (benefits and rehabilitation) 1959 or the Law of the Families of Fallen Soldiers (benefits and rehabilitation) b. In addition to the payments by the Rehabilitation Division of the Ministry of Defense, soldiers of the standing army or their heirs are entitled to annuities according to the Law of Service in the Standing Army of the IDF (annuities) c. In order to provide for a comparable coverage in the event of death, disability or incapacity for work, the Law sets forth an additional level of insurance coverage (which the Ministry of Defense purchases on behalf of the reservists in the form of group insurance) for the payment of a lump sum in the case of death and annuity payment in the case of injury and disability. d. The plan does not limit insurances purchased privately by soldiers of the regular, standing or reserve army and which provide coverage for the different insurance events that may occur during the service. The Law regulates the abovementioned paragraph c and complements the insurance coverage the reservist is entitled to by his provident fund up to the limit of his salary, but not less than the average salary according to the National Insurance Law. The State purchases insurance coverage from the insurance companies to cover its payments. The benefit payable to the eligible heirs will be equal to the rights of heirs according to the Law of Service in the Standing Army. The benefit amount will be determined after deduction of the payments the reservist or his heirs are entitled to according to the disability law or the soldiers family law respectively, and after the deduction of all payments the reservist or his heirs are entitled to from the provident funds as they are defined by the Law. This means that if the benefit payable by the provident fund is lower than the benefit payable according to this Law, or

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