Contents. List of Tables. The Capital Market, Insurance and Saving Division Annual Report 2004

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1 Life Insurance

2 The Capital Market, Insurance and Saving Division Contents Introduction Life insurance sector structure Operational characteristics... 7 Profit from life insurance business... 7 Life insurance premiums Life insurance reserves Management fees in life insurance policies Agent commissions and other life insurance expenses Life insurance programs Life insurance asset portfolio Insurance company returns Risks and Stability Assessment List of Tables Table V-1 Market share of insurance companies in Table V-2 Concentration indices for life insurance companies... 6 Table V-3 Profits from life insurance business (Solo balance sheet data), Rate of change of market share Table V-4 Life insurance premiums by company Table V-5 Company market share Life insurance reserves Table V-6 Company market share Life insurance reserves Table V-7 Management fee revenues for participating portfolio by company And ratio of management fees to total life insurance profits, in NIS Thousands Table V-8 Share of life insurance profits of total life insurance reserves by insurance group Table V-9 Ratio of agent commissions to life insurance premiums in NIS Thousands...19 Table V-10 Ratio of general and administration expenses to total reserves and pending life insurance claims by company Table V-11 Gross premiums by insurance type, Table V-12 Distribution of life insurance asset portfolio, Table V-13 Participating portfolio Gross/Net weighted return and management fees,

3 Life Insurance Table V-14 Gross / net returns, by insurance group Table V-15 High and low gross returns, Table V-16 Benchmarks for evaluating risks and stability Table V-17 Securities to total assets Table V-18 Ratio of policies redeemed to average reserve amount - sector List of Charts Chart V-1 Market share of premiums reported in Chart V-2 Management fees for life insurance programs in participating portfolio out of total life insurance profits, in % Chart V-3 Market share - general and administration expenses vs. reserves and pending life insurance claims Chart V-4 Gross premiums by life insurance type, Chart V-5 Distribution of asset portfolio in life insurance sector, Chart V-6 Gross return in participating portfolio (Fund YUD ) Chart V-7 Gross return and management fee by insurance company,

4 The Capital Market, Insurance and Saving Division Introduction The Life Insurance Department of the Capital Market, Insurance and Savings Division handles a range of issues regarding regulation and control of life insurance companies and agents. The department is responsible, among other things, for reviewing life insurance programs submitted to the Commissioner of Insurance for approval. The life insurance sector consists of 12 companies, 5 of which hold about 95% market share, both by assets and by premiums. In 2004 life insurance sector profits dropped by about 13% compared to 2003, mainly due to lower yield on assets. Nevertheless, the ratio of management fees out of total profit in the life insurance business remains 51%, similar to the previous year. The average profit ratio out of total sector reserves is at 2%, similar to previous years was a year of changes in the life insurance market. The major changes were reforms of the life insurance product market and of the agent commission structure (leveling of commissions throughout the policy term). Starting in January 2004, marketing of old products such as ADIF and MEORAV ceased, and instead the companies started marketing new life insurance programs, where the premium consists of 3 components - savings, expenses and insurance coverage. Unlike in the past, these components are transparent and readily visible to the insured. In 2004 life insurance companies achieved an average gross yield of 8.6% on the participating portfolio. In most of the months this year the yield on assets was positive. Total management fees collected for asset management was at 1.86%. Total life insurance assets rose, in real terms, to NIS 106 Billion. The participating portfolio assets are 58% of total assets. Total life insurance premiums in 2004 went back to its level in 2002, and it stands at NIS 14 Billions. It is important to note that total premiums for new products are estimated at NIS 550 Million, and the majority of premiums are still due to old products ('ADIF' and 'MEORAV') - about 82%. Commissions paid to agents also declined, due to the move towards leveling of commissions from 26% to 12% of premiums.

5 Life Insurance 1. Life insurance sector structure Twelve insurance companies, which are licensed for life insurance business, operate in Israel. Most companies hold marketing licenses for life insurance products which include a savings component. The life insurance sector is relatively highly centralized the five largest companies hold a 95% share of premiums and of total life insurance assets. In this part we shall analyze the sector structure, looking at market share of reserves, life insurance assets and premiums. We shall also examine the level of concentration in the sector by commonly used benchmarks. Group name Table V-1 Market share of insurance companies in 2004 (in %) Share of reserves in participating portfolio Share of assets in participating portfolio Share of gross premiums Migdal Group Clal Group HaPhoenix Group Harel Group Menora Others (*) Total Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division * Others: Hachsharat HaYeshuv, Ayalon, Eliyahu and direct insurance companies. Comparison of concentration benchmarks between distribution of total asset portfolio and that of reserves in participating portfolio is aimed at testing whether marketing of participating programs, starting in 1991, has changed the trend of concentration, compared to old assuredyield programs. Furthermore, the purpose of comparing asset portfolio and gross premiums distribution is to test the effects of dynamic changes on the life insurance market. From the above analysis one may see that the companies concentration is more evident when looking at reserves and assets. Analysis of premiums shows a slightly lower degree

6 The Capital Market, Insurance and Saving Division of concentration. Still all three measures indicate that Migdal maintains its position as the largest market share owner. Furthermore it would seem that the fact that Menora, Migdal and Clal acquired new pension funds Mivtahim Yoter, Makefet Ishit and Meitavit, correspondingly, as part of the sale process conducted by the Old Pension Fund Regulation Authority 1, may strengthen these groups relative position in coming years. In order to test the degree of market concentration we used two indices: 1. The Herfindahl-Hirschman Index (H.H.I) this index is calculated based on the sum of squares of each insurance company s market share of all participating portfolio assets. 2. The CR5 index this index sums the market share of participating portfolio assets for the five largest insurance groups. Table V-2 Concentration indices for life insurance companies Index 2004 Herfindahl-Hirschman 0.23 CR Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Although the above concentration indices only look at life insurance assets, and do not indicate a material change over the past few years, we can still deduce that the outcome of the above acquisitions by insurance companies will create a change between companies when looking at sector concentration. 1. See 'Pension' chapter

7 Life Insurance 2. Operational characteristics In this part we shall analyze the life insurance sector from several aspects describing activity volumes: Profit from life insurance business, premiums, reserves, management fees and commissions as well as analysis of the scope of life insurance programs marketing. Starting in 2004 life insurance policies went through a structural change. This change affected the activity volumes of life insurance companies in most areas covered hereafter. The new programs differ not only by their management fee levels, but also by the commissions paid to insurance agents and even by their profit margins, which differs fro that of programs approved for marketing before Profit from life insurance business Following are the revenue sources in the life insurance sector: 1. Interest margin on assured-yield life insurance portfolio against insurance reserves due to insurance programs issued from the early 60s up to 1990, insurance companies are eligible to purchase earmarked government bonds, known as HETZ bonds. These bonds are CPI-indexed and assure a yield ranging from 6.2% (in funds A-B which were open for enrollment of new insured members during ), through 5.2% (in funds C-F which were open for enrollment of new insured members during ) and down to 4% (in funds G-H which were open for enrollment of new insured members during ). The yield assured to those policy holders was lower by about 1% than the corresponding yield on the earmarked bonds. Therefore insurance companies have a constant income of 1% of assured-yield insurance reserves. 2. Management fees on participating portfolio for participating life insurance programs issued through 2003, life insurance companies are allowed to levy annual management fees of 0.6% of assets plus 15% of investment returns. In new programs issued starting in 2004, it was determined that management fees for savings management shall be fixed, regardless of investment returns, so that the management fee allowed may be up to 1% per annum, or a higher rate as approved by the Commissioner of Insurance but no more than 2% per year, subject to deduction of management fees from premium (see section 3 below). 3. Management fee on premium in participating life insurance programs issued through 2003, the life insurance premium is typically composed of the savings premium, risk premium and expense component of current premium. The current premium expense

8 The Capital Market, Insurance and Saving Division component is the management fee on premium. In new programs issued since January 2004, the risk component and the expense component are separated, and the total rate of expenses on premium (excluding risk component) was reduced to a fixed 11% rate, or else a progressive rate starting with 13% and gradually declining over several years so that the average management fee shall not exceed 11%. 4. Account management 2 and partial-year fees 3 - in policies issued through 2003 a policy factor (account management and partial-year fee) was charged (about NIS 16 per policy as of 2003), but in policies issued since 2004 no policy factor was allowed in insurance programs approved as insurance funds, and was only allowed in individual programs (at a reduced rate of NIS 12 per policy). 5. Insurance profits from policy coverage such as risk or work disability - if the aggregate premium from all the insured under different policy coverage exceeds the cost of paying claims for the same coverage, and then the companies realize a further profit. 6. Surrender values profit funds withdrawal by the insured prior to the end of the insurance term is subject to a fine. The insured receives his money at surrender values lower than its actual value at the time of withdrawal. The size of this fine depends on the insurance program type (employee or personal, ADIF, MEORAV or new policy), on the insured s seniority in the program as well as on the reason for withdrawal (leaving a job, dismissal etc.). Following are the expense components in the life insurance sector: 1. Payment of claims to insured - upon occurrence of the insurance event, such as death or work disability, the insurance company must pay the insurance amounts to the insured. 2. Agent commissions the major cost in running a life insurance system is payment of commissions to insurance agents for marketing the policies, maintaining the insured file and collection of premiums. In policies issued prior to 2004, the lion's share of commissions was paid to agents in the year the policy was issued and in the following year. In policies issued since 2004 the agent s commission is evenly distributed along the term of the policy. 3. General and administration expenses these expenses are mainly due to operation of the insurer s life insurance division, and include salary and IT expenses, as well as due to insurer s administration of his life insurance investment portfolio. These costs are less volatile than commission amounts, which are directly tied to sales volume. 2. Account management fees, also called Policy Factor are a fixed payment due in addition to premium, and are not proportional to insurance amount and term. 3. Partial year- price reflecting the cost of dividing premium into monthly installments.

9 Life Insurance Table V-3 Profits from life insurance business (Solo balance sheet data), Rate of change of market share (in NIS Thousands and %) Company Change in profit from life insurance business Market share Migdal 299, , , % -35.8% 23.2% HaMagen 18,781 70,943 26, % -62.6% 1.4% Migdal Group 318, , , % -38.4% 24.6% Clal 198, , , % 13.6% 18.4% Arie 34,263 34,101 38, % 13.2% 2.1% Clal Group 232, , , % 13.5% 20.5% HaPhoenix 160, , , % -10.6% 13.1% Hadar 74, , , % 15.8% 6.7% HaPhoenix Group 235, , , % -3.1% 19.8% Harel 129, , , % -8.0% 17.4% Menora 128, , , % -2.0% 13.5% Eliyahu 44,653 32,045 30, % -5.1% 1.6% Hachsharat 14,159 15,028 8, % -43.5% 0.5% HaYeshuv Ayalon 19,260 21,052 26, % 26.5% 1.4% IDI Yashir 3,772 5,981 8, % 44.5% 0.5% AIG 451-2, % % 0.1% Total - Solo 1,126,306 2,121,653 1,842, % -13.2% 100.0% Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Note: Table data is based on solo financial statements of insurance companies, and not on data appearing in unified report. Therefore they do not reflect internal deals made between group companies. Nevertheless the difference between totals based on unified data versus totals based on solo reports is not material. (*) 'Sahar Zion' merged with Harel Group' on January 1, Profits in the life insurance sector were at NIS Billion, a 13.2% decline from 2003 profits, despite a 2.6% rise in premiums collected by the companies. The main cause for lower profits is the decline in yields achieved on participating portfolio assets in 2004 compared to 2003 (in 2003 the gross yield was 21% compared to 8.6% in 2004). This caused management fees to decline by some NIS 149 Million, a 13.8% drop compared to 2003.

10 The Capital Market, Insurance and Saving Division Life insurance premiums The premium received from the insured has three major components: Risk to cover risk of death, savings accrued by the insured for retirement, and premium-based management fee. The allocation of premiums to the above components varies between companies and between life insurance programs. In the long term, the older the policy the lower the insurance company s expense level (mainly the agent commission component), and the management fee on the savings component are higher as savings balances increase. Table V-4 Life insurance premiums by company (In NIS Thousands and %) Market Premiums Premium change Company share Migdal 4,158,562 3,893,546 3,943, % 1.27% 27.69% HaMagen 687, , , % -1.31% 4.52% Migdal Group 4,845,885 4,545,926 4,586, % 0.90% 32.21% Clal 2,979,747 2,889,062 2,972, % 2.88% 20.87% Arie 383, , , % 8.17% 2.85% Clal Group 3,303,451 3,211,703 3,342, % 4.06% 23.47% HaPhoenix 1,278,954 1,287,816 1,307, % 1.56% 9.18% Hadar 966, ,855 1,027, % 5.85% 7.22% HaPhoenix Group 2,245,932 2,258,671 2,335, % 3.40% 16.40% Harel 1,900,922 1,888,399 1,957, % 3.63% 13.74% Menora 1,294,688 1,307,921 1,333, % 1.96% 9.36% Hachsharat HaYeshuv 295, , , % % 1.70% Ayalon 187, , , % 3.77% 1.44% Eliyahu 172, , , % 2.90% 1.07% IDI Yashir 36,858 48,025 71, % 48.84% 0.50% AIG 9,419 13,097 16, % 23.10% 0.11% Total 14,293,023 13,896,011 14,241, % 2.49% % Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Life insurance premiums showed an increase in 2004, for the first time since Looking at the data shows that premium revenues in 2004 were similar to those of at about 4. Note that an increase in premiums does not necessarily reflect profit margins. 10

11 Life Insurance NIS 14.2 Billion. The reversal of the trend over the past four years is mainly explained by the broad market emerging from recession. The recession period saw massive redemption and freezing of policies. Indeed we can see that except for HaMagen and Hachsharat HaYeshuv, all other companies saw a rise in premiums compared to Hachsharat HaYeshuv saw the steepest decline in premium revenues over the past two years some 18%. This decline is mostly explained by the decline in old MEORAV type premiums. By comparison, the five largest companies saw a small increase of 2% to 3.5% in premium revenues. Note that the direct insurers ( IDI Yashir and AIG ) saw especially steep growth rates. This may indicate the relative flexibility of direct insurers marketing compared to that of traditional companies. Still we cannot ignore the fact that the absolute size of these companies' insurance portfolios is much smaller than other companies'. 40% Chart V-1 Market share of premiums reported in versus previous years (in %) 35% 30% 25% 20% 15% 10% 5% 0% Clal Migdal Haphoenix Harel Menora Hadar Arie HamMagen DirectInsurance Ayalon Eliyahu Hachsharat Hayeshuv A.I.G Premiums for 2004 Premiums prior to 2004 Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division 11

12 The Capital Market, Insurance and Saving Division Table V-1 shows the changes in insurance companies' market share for premiums received for policies issued in 2004 (for policies whose marketing was approved since 2004) compared to premiums received for policies issued in prior years (mostly ADIF and MEORAV type policies). Total premiums in the life insurance sector reflects many years historical data, while the data shown in table V-1 show the premium distribution based on new sales during 2004, and reflect only last year's activity for insurance companies. These data indicate an increase in market share for Clal, Harel, HaPhoenix and Eliyahu groups, as well as Direct Insurance' and AIG, together with a decrease in market share for Migdal Group as well as Harel, Menora and Hachsharat HaYeshuv. The start to marketing of new policies in 2004, and the end to marketing of MEORAV - and ADIF -type policies, required the companies to reorganize, and this fact slowed down the marketing of new policies in the first half of 2004, mostly among the large companies. Therefore it can be assumed that these data do not indicate a change in the concentration mix for the sector, but rather reflect different levels of readiness in 2004 to market the new policies. This would explain why Migdal s premium collections for policies in 2004 decreased compared to Clal. Life insurance reserves Life insurance reserves are held vs. the insurance company s insurance obligations, and are reported on the company's balance sheet. According to statute regulations, insurance companies keep life insurance assets separate from other company assets. Tables V-5 and V-6 below will show the insurance companies market share compared to their life insurance reserve, which reflects the company s obligation to its policyholders, in both the participating portfolio and the assured-yield portfolio. In 2004 the upward trend continued in the volume of the participating life insurance portfolio. At the end of 2003 life insurance reserves in the participating portfolio were 56% of all life insurance reserves, and this ration increased to 59% of all reserves by the end of This trend corresponds to the fact that issuing assured-yield insurance policies stopped back in 1990, as mentioned above. In 2004 insurance companies achieved an 8.63% yield on the participating portfolio (vs. about 21% yield in 2003). In comparison, the assured-yield portfolio's yield is fixed, as it is mostly invested in earmarked bonds yielding between 4% and 6.2%. Therefore, the increase in share of participating reserves vs. those of assured-yield is also due to their different yields in , and not only to new deposits. Total life insurance reserves (assured-yield and participating) in Migdal and Clal groups in rose by 45.4% and 48.8% correspondingly. 12

13 Life Insurance Table V-5 Company market share Life insurance reserves Participating portfolio, in NIS Thousands and % Company Reserve amount 2002 Reserve amount 2003 Reserve amount 2004 Reserve change Market share 2004 Market share change Migdal 11,850,052 15,105,218 17,587, % 29.4% 0.8% HaMagen 2,759,489 3,115,005 3,647, % 6.1% -0.6% Migdal Group 14,609,541 18,220,223 21,235, % 35.6% 0.3% Clal 8,286,934 10,530,870 12,238, % 20.5% 0.5% Arie 908,522 1,161,193 1,447, % 2.4% 0.2% Clal Group 9,195,456 11,692,063 13,685, % 22.9% 0.7% HaPhoenix 3,760,654 4,660,406 5,459, % 9.1% 0.0% Hadar 3,099,831 3,754,836 4,375, % 7.3% -0.2% HaPhoenix Group 6,860,485 8,415,242 9,834, % 16.5% -0.1% Harel 5,314,791 6,609,110 7,625, % 12.8% 0.0% Menora 3,924,533 4,661,621 5,351, % 9.0% -0.5% Eliyahu 335, , , % 0.7% 0.8% Hachsharat HaYeshuv 689, , , % 1.4% -0.3% Ayalon 470, , , % 1.2% 0.1% IDI Yashir 20,341 37,313 63, % 0.1% 0.1% Total 41,420,794 51,309,122 59,723, % % 0 Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Yet one can notice that changes in reserve market share for participating policies are negligible and only amount to fractions of a percent. The mix of life insurance reserves also affects the companies profitability. Management fees in the participating portfolio for policies issued up to Dec. 31, 2003 add up to 0.6% of assets plus 15% of investment profits. Therefore in years where yields achieved are much higher, as was the case in 2004, management fees increase dramatically. For new policies approved for marketing since Jan. 1, 2004 management fees were set at 1% of savings per year, but the insurance company may charge up to 2% per year, subject to approval of the Commissioner of Insurance. Since insurance companies got approvals for policies where different management fees are due, it is currently difficult to estimate the expected margin on these policies. 13

14 The Capital Market, Insurance and Saving Division Table V-6 below shows insurance companies market share for reserves in assured-yield portfolio, whose investments yield an interest margin of about 1% (difference between yield assured by the government to insurance companies, and yield assured to individual policyholder). Here too there was no significant change to market share, other than a slight increase in the large groups' share. Compared to participating portfolio reserves, those of the assured-yield portfolio have remained at similar levels to previous years, and thus contributed to the increased gap between participating portfolio reserves and assured-yield portfolio reserves, to the extent of NIS 20M within two years - due both to the superior yields achieved in the participating portfolio and to the fact that assuredyield policies are no longer being marketed. Company Table V-6 Company market share Life insurance reserves Assured-yield portfolio, in NIS Thousands and % Reserve amount 2002 Reserve amount 2003 Reserve amount 2004 Reserve change Market share 2004 Market share change Migdal 13,708,258 13,432,554 13,856, % 23.2% 0.6% HaMagen 1,320,914 1,255,391 1,289, % 2.2% 0.0% Migdal Group 15,029,172 14,687,945 15,145, % 25.4% 0.6% Clal 8,604,666 8,559,743 8,776, % 14.7% 0.6% Arie 906, , , % 1.4% -0.2% Clal Group 9,511,473 9,432,330 9,605, % 16.1% 0.5% HaPhoenix 5,084,737 5,055,296 5,139, % 8.6% 0.2% Hadar 1,087,852 1,041,909 1,039, % 1.7% 0.0% HaPhoenix Group 6,172,589 6,097,205 6,179, % 10.3% 0.2% Harel 5,646,485 5,293,255 5,304, % 8.9% -0.7% Menora 3,560,998 3,439,512 3,410, % 5.7% -0.3% Eliyahu 472, , , % 0.7% 0.0% Hachsharat 490, , , % 0.8% 0.0% HaYeshuv Ayalon 203, , , % 0.3% 0.0% IDI Yashir % 0.001% 0.0% AIG 5, % 0.0% 0.0% Total 41,093,253 40,067,535 40,766, % % 0 Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Management fees in life insurance policies Management fees for participating life insurance policies, issued up to 2004, could be collected in one of the following two ways: 14

15 Life Insurance 1. Collecting 0.84% per year of the estimated portfolio valuation 2. Collecting 0.6% per year of the estimated portfolio valuation plus 15% of the real portfolio yield after deduction of fixed management fees In actual fact, all insurance companies chose the second option 5. As part of the life insurance sector reform of early 2004 (see 2003 Division Report), the Regulations for Insurance Business (insurance contract terms), 1981 were amended. This amendment allows an insurer to collect management fees not to exceed 1% per year of the estimated valuation of the investment portfolio, unless the Commissioner of Insurance has otherwise allowed, in no case to exceed 2% of the estimated valuation of the investment portfolio. Chart V-2 Management fees for life insurance programs in participating portfolio out of total life insurance profits, in % % 50.6% % Source: Insurance companies reports, processed by Capital Markets, Insurance and Savings Division 5. In addition to management fee out of cumulative savings, insurance companies also charge management fee on premiums as well as other expenses. 15

16 The Capital Market, Insurance and Saving Division As table V-2 shows, in 2004 management fees collected for participating programs were 51% of total life insurance profits. This ration was at 51% for 2003 as well, but in the previous two years the share of participating portfolio management fees of total profits was lower (about 28% and 20% only in 2001 and 200s, correspondingly). Table V-7 Management fee revenues for participating portfolio by company And ratio of management fees to total life insurance profits, in NIS Thousands Company Management Management Management % of profit % of profit fees fees fees % of profit Migdal 63, % 294, % 270, % HaMagen 13, % 59, % 58, % Migdal Group 77, % 354, % 328, % Clal 47, % 219, % 182, % Arie 5, % 24, % 18, % Clal Group 52, % 243, % 201, % HaPhoenix 21, % 103, % 87, % Hadar 17, % 75, % 67, % HaPhoenix Group 39, % 178, % 155, % Harel 28, % 143, % 122, % Menora 21, % 133, % 98, % Ayalon 2, % 8, % 7, % Hachsharat HaYeshuv 3, % 12, % 11, % Eliyahu 1, % 6, % 5, % IDI Yashir % % % AIG 0 0.0% 0 0.0% 0 0.0% Total 226, % 1,080, % 932, % Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Note to table: Table data are based on solo reports by insurance companies, and not on unified reports. Nevertheless, the difference between totals based on unified data versus totals based on solo reports is not material. The share of participating portfolio management fees out of total life insurance business 6 remained at its high 2003 level for three main reasons: (1). Continued positive trend in capital market - this trend continued in 2004 as well. Although the steep increases of Participating Portfolio refers to Fund YUD. This analysis does not refer to the new Fund YUD. Assets in this fund at end of 2004 amounted to about 0.5% of Fund YUD assets, according to Capital Market Division estimates. 16

17 Life Insurance were not repeated, still 2004 was a positive year for the Stock Exchange - the Tel Aviv 25 index rose 22.6% while the Tel Aviv 100 index rose 19%. In prolific years such as 2003 and 2004, management fees for the participating portfolio may be seen as capital gains, since most were derived from the mechanism allowing insurance companies to enjoy 15% of real investment returns, and these follow the increase in bond prices and stock indices, unlike the case for fixed management fees. Such management fees are an on going yieldrelated profit, which increases as the reserves increases. (2) Offsetting management fees for participating policies signed before 2004 in such policies management fees of 15% of real return were collected. In actual fact losses incurred in 2002 were offset against management fees collected in 2003, hence total revenue in 2003 was reduced (3). Total life insurance profits declined in 2004, so even a 14% decrease in management fees left unchanged the share of participating portfolio management fees of total life insurance profits. Table V-8 Share of life insurance profits of total life insurance reserves by insurance group (In %) Migdal 2.60% 1.18% 2.32% 1.35% HaMagen 2.23% 0.51% 1.62% 0.54% Migdal Group 2.55% 1.03% 2.17% 1.21% Clal 1.91% 1.20% 1.55% 1.60% Arie 2.18% 1.94% 1.66% 1.68% Clal Group 1.93% 1.27% 1.56% 1.61% HaPhoenix 1.88% 1.81% 2.72% 2.23% Hadar 1.51% 1.76% 2.13% 2.18% HaPhoenix Group 1.76% 1.80% 2.52% 2.21% Harel 2.61% 1.20% 2.86% 2.41% Menora 2.59% 1.77% 3.13% 2.84% Eliyahu 5.72% 5.52% 3.92% 3.56% Hachsharat HaYeshuv 1.56% 1.24% 1.22% 0.64% Ayalon 3.75% 3.03% 2.75% 3.02% IDI Yashir 10.77% 14.96% 13.86% 12.20% AIG % 54.87% % 75.51% Total 2.32% 1.39% 2.29% 1.81% Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division 17

18 The Capital Market, Insurance and Saving Division One can see that for smaller life insurance companies, whose activity is not focused on life insurance programs with long-term savings components, the ratio of profits to reserves is relatively high. By comparison, for large insurance companies, with extensive marketing of life insurance programs with long term savings component, the ratio of profit to reserves is relatively low. This distinction is true for Eliyahu' and Ayalon insurance companies (despite a decrease for Eliyahu in 2004). Their activities in the life insurance sector are limited when compared to 'Migdal', 'Clal' and 'HaPhoenix'. This is even more evident for direct insurance companies. These operate primarily in pure risk and mortgage product areas. This is explained by the fact that in risk-only life insurance programs, the premium paid by the policy holder includes only the cost of the risk plus a component for company expenses. Insurance reserves for risk only are considerably lower than reserves for insurance programs with savings component, because in such programs the savings component is usually much higher than the risk component. In absence of savings, which are the major share of life insurance reserves for programs with a savings component, the reserves kept by companies for this activity are low. Both Yashir IDI and AIG are still on a growth trend. While Yashir IDI turned profitable in 2002 for its life insurance activity and maintained this profit in as well, AIG is not yet on an even keel, going from profit in 2002 to a loss in 2003 and back to profit in Agent commissions and other life insurance expenses Life insurance programs customarily pay commissions to insurance agents in order to increase sales and maintain the portfolio. It can be assumed that as commissions for sales of life insurance programs decrease gradually over years, so does the redemption rate or policy swapping ('twisting') decrease, and the company's portfolio maintenance increases. By looking at table V-9, one can see that the 2004 reform in life insurance programs did change the commission structure as expected, and even reduced the commissions charged by insurance policies out of premiums for expenses in Among other things, the change to Regulation 4 of investment regulations, which required insurance companies to finance the high sales commissions typical at policy start out of the companies' own capital and not from the participating portfolio, as was the case previously, caused agent commissions to flatten and hence intensified the trend. In total, the average commission charged to premiums in 2004 was 11.7% - a 26% decrease in commission fees compared to 2002 and

19 Life Insurance Table V-9 Ratio of agent commissions to life insurance premiums in NIS Thousands (in %) Commission fees paid Ratio of commissions to premiums Change in commission fees Migdal 638, , , % 13.2% 11.3% -19.8% -12.8% HaMagen 84,052 69,986 62, % 10.7% 9.7% -16.7% -10.6% Migdal Group 722, , , % 12.8% 11.1% -19.4% -12.5% Clal 462, , , % 15.2% 11.7% -5.1% -20.5% Arie 66,824 71,310 55, % 19.0% 13.6% 6.7% -22.6% Clal Group 529, , , % 15.9% 12.1% -3.6% -20.8% HaPhoenix 186, , , % 18.0% 9.5% 24.3% -46.4% Hadar 160, , , % 21.4% 10.2% 29.6% -49.6% HaPhoenix Group 347, , , % 19.5% 9.8% 26.8% -47.9% Harel 331, , , % 18.9% 14.2% 7.5% -22.1% Menora 234, , , % 20.8% 12.6% 16.0% -38.4% Hachsharat HaYeshuv 72,362 43,993 40, % 15.9% 16.7% -39.2% -8.2% Ayalon 29,112 29,815 22, % 15.1% 11.2% 2.4% -23.0% Eliyahu 15,417 14,740 15, % 10.0% 10.0% -4.4% 3.5% IDI Yashir AIG % 1.4% 0.3% -25.0% -70.0% Total 2,282,359 2,249,625 1,666, % 16.2% 11.7% -1.4% -25.9% Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division The change to commission structure also influenced the ranking of companies charging the highest commissions. The company charging the highest commissions in 2004 was Hachsharat HaYeshuv (16.7%). It is followed by 'Harel (14.2%), Arie' (13.6%) and 'Menora' (12.6%). 'Hadar was ranked highest in 2003 for charging the highest commissions and it recorded the steepest decline in charging commissions to premium at 49%. Menora maintained its second place for 3 consecutive years before moving into fourth spot. Ongoing management of life insurance departments and portfolio management incur ongoing 19

20 The Capital Market, Insurance and Saving Division expenses throughout the policy term. Table V-10 shows general and administration expenses as percentage of reserves and pending life insurance claims. We can see that expense ratios for Ayalon and Hachsharat HaYeshuv in are almost double the same ratios for Migdal and Clal. This is due to economies of scale. These allow the company to be operated with a lower expense ratio. The Harel Group is an exception. It reported a high expense ratio compared to the average of the three other large companies. We can presume that this exception is due in part to merger influence on company expenses, as well as its focus on individual policies. Table V-10 Ratio of general and administration expenses to total reserves and pending life insurance claims by company (in NIS Thousands and %) General and administration expenses Ratio of general and administration expenses to reserves and pending life insurance claims Change in general and administration expenses Migdal 256, , , % 0.87% 0.81% -2.05% 2.25% HaMagen 42,188 40,164 55, % 0.91% 1.11% -4.80% 37.26% Migdal Group 299, , , % 0.88% 0.85% -2.44% 7.07% Clal 167, , , % 1.03% 0.91% 18.14% -3.11% Arie 34,388 37,940 38, % 1.83% 1.65% 10.33% 0.40% Clal Group 202, , , % 1.11% 0.98% 16.81% -2.55% HaPhoenix 93, , , % 1.21% 0.96% 28.65% % Hadar 75,744 85,565 84, % 1.70% 1.48% 12.97% -1.66% HaPhoenix Group 169, , , % 1.38% 1.15% 21.63% -8.13% Harel 204, , , % 1.75% 1.64% 5.00% 2.20% Menora 130, , , % 1.50% 1.36% -5.92% -1.93% Eliyahu 11,976 14,257 11, % 1.72% 1.37% 19.05% % Hachsharat HaYeshuv 24,968 23,785 21, % 1.92% 1.59% -4.74% % Ayalon 19,381 22,258 22, % 2.88% 2.53% 14.84% 0.97% IDI Yashir 15,197 20,408 29, % 43.12% 37.44% 34.29% 42.25% AIG 9,896 9,981 11, % % % 0.86% 11.51% Total 1,087,128 1,162,146 1,167, % 1.25% 1.14% 6.90% 0.47% Source: Insurance companies reports, processed by Capital Markets, Insurance and Savings Division Note: Table data is based on solo financial statements of insurance companies, and not on data appearing in unified report. Therefore, they do not reflect internal deals made between group companies. Nevertheless, the difference between totals based on unified data versus totals based on solo reports is not material. 20

21 Life Insurance Chart V-3 Market share - general and administration expenses vs. reserves and pending life insurance claims 40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Migdal Group Clal Group Haphoenix Group Harel Menora Eliyahu Hachsharat Hayeshuv Ayalon IDI AIG Market share - Reserves and pending Market share - General and Admin. Expenses Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Another way to measure the economies of scale existing in the life insurance sector is shown in chart V-3. This chart shows the companies market share in general and administration expenses vs. their share of reserves and pending claims. Judging by this ratio it seems that 'Migdal enjoys the most economies of scale. It holds a 36% share of reserves and pending life insurance claims, vs. only a 27% share of total general and administration expenses. The chart also shows that Clal Group has an advantage in this area, while IDI Yashir and AIG are at the other end of the scale. Life insurance programs Life insurance programs differ by population type, policy terms and purchased coverage. Thus, for example, a life insurance program may or may not include a savings component, may be sold as an insurance fund (employee insurance or self-employed insurance) which is subject to taxation advantages or as an individual program which is not a provident 21

22 The Capital Market, Insurance and Saving Division fund. Programs themselves differ in terms and management fees (new policies, vs. policies marketed prior to 2004). The following life insurance programs are marketed to policy holders: 1. Individual programs (not approved as a provident fund) and self-employed programs (approved as a provident fund); 2. Employee insurance programs (via employer) for salaried employees (approved as a provident fund); 3. Collective insurance programs (via employers, corporations and service providers). Programs of MEORAV or ADIF types are no longer being marketed as of Jan. 1, Since that date new programs are being marketed to replace the above programs. Furthermore, as part of the BARNEA Committee report conclusions, disclosure requirements of insurance companies regarding premium-based compensation due to life insurance annexes was enhanced, so that premiums due for life insurance annexes, such as severe illness and nursing care insurance, previously reported as part of company revenues from employee and individual programs, are now reported separately. Another change instituted is separate reporting of the premium portion which covers death risk in ADIF type policies and in new policies. 22

23 Life Insurance Table V-11 Gross premiums by insurance type, (in NIS Thousands) Insurance type Individual MEORAV type (legacy) Rate of change in % Rate of change in % Premiums change ,428,203 1,248,916 1,101, % -11.8% -326,755 Individual ADIF type 1,453,177 1,410,031 1,306, % -7.3% -146,546 Individual policies issued since Jan. 1, 2004 Employee MEORAV type (legacy) 108, , , , % -16.1% -174,907 Employee ADIF type 7,197,906 7,136,392 7,004, % -1.8% -192,965 Employee policies issued since Jan. 1, ,447 Pure risk individual insurance 669, , , % 10.2% 101,618 Pure risk group insurance 893, , ,459 Sub-total 12,255,656 11,863,161 12,034, % 1.4% -739,555 Work disability 1,192,019 1,194,149 1,229, % 3.0% 37,595 Nursing care insurance 251, , ,660 Severe illness insurance 251, , ,789 Others (*) 343, , , % 4.4% -83,398 Total 14,293,139 13,896,085 14,241,975-3% 2% -51,164 Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division * Others: Includes health insurance Total premiums in 2004 amounted to NIS 14.2 Billion. Excluding work disability insurance, health insurance and nursing care insurance the premiums amounted to NIS 12 Billion. This represents a 1.4% increase compared to Data indicate continued recovery in volume of life insurance premiums started in 2003 (only a 3% decrease) following the hard recession in 2002 (a 6% decrease). The increase in premiums collected in 2004 is mainly due to the Israeli market emerging from economic recession. Chart V-4 shows that the great majority of premiums in 2004 is still due to ADIF type employee insurance 58%. By comparison, in 2003 this category accounted for 60.7%. This trend of decreasing premiums due to ADIF type policies is expected to accelerate over time. 23

24 The Capital Market, Insurance and Saving Division Employees - Policies issued since Jan 1, % Chart V-4 Gross premiums by life insurance type, 2004 Pure Risk - Individual 6% Pure Risk - Group 7% Individual - MEORAV type (legacy) 9% Individual - ADIF type (YOTER) 11% Individual - Policies since Jan % Employees - MEORAV type (legacy). 4% Employees - ADIF type (YOTER). 58% Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Life insurance asset portfolio Insurance companies invest the premiums received for life insurance programs in investment assets, as do pension funds and provident funds. Insurance companies have investment funds characterized by the extent of guaranteed yield on principal. For example, assets in Fund ALEPH are guaranteed a yield of 4%-5% to policy holder, while Fund YUD assets have no guaranteed yield, and such assets are invested in the capital market, subject to investment regulations. The total nominal value of public asses rose by 10.6% in 2004 compared to 2003, totaling NIS 1,511 Billion. In 2004 the proportion of assets in life insurance programs out of total public assets portfolio decreased by 0.3% in 2004 to 6.7%. By way of comparison, the proportion of pension fund assets balance decreased from 10.2% at the end of 2003 to 9.8% at the end of 2004, while the proportion of provident fund assets out of the total public assets portfolio decreased from 9.8% at the end of 2003 to 9.7% at the end of

25 Life Insurance 120% Chart V-5 Distribution of asset portfolio in life insurance sector, % 80% 57.1% 52.6% 51.2% 45.3% 41.1% 60% 40% 20% 42.9% 47.4% 48.8% 54.7% 57.9% 0% Participating Other Assets Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division In the period the life insurance assets portfolio increased in real terms from NIS 69 Billion at the end of 2000, to NIS 106 Billion at the end of 2004 a growth rate of 53.4% in real terms. In the asset portfolio grew by NIS 8.9 Billion in real terms (a 9.1% growth) compared to , when the asset portfolio grew by NIS 12.3 Billion in real terms (a 14.5% growth). The slower growth in asset portfolio value in 2004 is mostly due to decreased returns achieved in 2004, compared to returns achieved in In the share of participating portfolio (out of total life insurance asset portfolio) increased from 42.9% to 57.9%, due to the fact that only participating programs have been marketed since The higher the return on participating programs compared to return on assured-yield programs, so will grow the share of participating portfolio out of the total portfolio. 25

26 The Capital Market, Insurance and Saving Division Asset type Table V-12 Distribution of life insurance asset portfolio, (in %) Asset distribution in total life insurance portfolio Asset distribution in participating portfolio Life indexed (LI) bonds 35.3% 30.8% 28.4% -6.8% 1.6% 1.3% 1.2% -0.4% Other government 18.7% 20.8% 21.4% 2.7% 35.8% 35.8% 35.1% -0.7% bonds Corporate bonds 8.2% 10.3% 12.3% 4.1% 12.7% 15.4% 17.8% 5.1% Stock 7.8% 11.3% 12.5% 4.7% 15.6% 20.2% 20.9% 5.3% Loans and bank deposits Cash and cashequivalent Rental property rights Investment in subsidiaries Amounts receivable from reinsurers 20.1% 17.7% 16.8% -3.4% 19.8% 15.6% 14.6% -5.2% 3.2% 3.0% 3.2% -0.1% 5.0% 3.6% 3.8% -1.2% 1.2% 1.5% 1.6% -6.8% 1.2% 1.8% 1.9% 0.7% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 1.6% 1.6% 1.6% 0.0% 2.3% 2.0% 1.9% -0.4% Premium due and agent balances 0.7% 0.6% 0.6% -0.2% 1.3% 1.0% 0.8% -0.4% Accounts receivable 0.2% 0.1% 0.2% -6.8% 0.3% 0.1% 0.2% -0.1% Deferred acquisition costs 2.5% 2.0% 1.2% -1.3% 4.5% 3.1% 1.8% -2.8% Fixed assets 0.2% 0.2% 0.2% 0.0% 0.0% 0.0% 0.0% 0.0% Total 100% 100% 100% 100% 100% 100% Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Due to assured-yield programs no longer being marketed, the downward trend in the share of Life Indexed (LI) bonds out of total life insurance asset portfolio continues, with their share dropping by 6.8% from 2002 to Assured-yield LI bonds were mostly replaced in the participating portfolio by stock investments, which carry high risk, and corporate bonds. On the other hand, the share of participating portfolio assets allocated to government bonds, which are less risky, has decreased. This trend may be explained by two facts: Firstly the 26

27 Life Insurance new investment regulations which came into effect in April 2001; secondly the continued trend of stock appreciation on the Tel Aviv Stock Exchange in Insurance company returns Since 1992 life insurance policy assets (premiums earmarked for savings) are invested in the capital market and are affected by the asset portfolio composition and their returns (Fund YUD and other investment channels). A distinction should be drawn between gross returns, affected among other things by the investment policy and its execution in the relevant time period, and net returns which are credited to the policyholder according to his policy terms after deduction of management fees. Up until 2003 management fees for savings management included a fixed management fee 0.6% of cumulative balance of allocated funds and a variable management fee 15% of real return. Since 2004 in new programs this management fee is fixed, at a rate not to exceed 2% per year of savings balance. The returns showed in this part of the report are based on reported returns, rather than on actual returns credited to each policyholder. These actual policyholder returns are affected by other elements, such as timing and amount of deposits. Table V-13 Participating portfolio Gross/Net weighted return and management fees, (in %) Year Gross weighted return Net weighted return Management fees. (fixed + variable) Source: Annual reports of insurance companies, processed by Capital Markets, Insurance and Savings Division Note to table: The weighted return is calculated by multiplying each company s return by its share of assets out of total assets for all companies. 27

28 The Capital Market, Insurance and Saving Division Returns in participating portfolio for 2004 were relatively high compared to the previous five years, and they reflect the continued positive trend in Increased returns in participating portfolio are linked to increases in both stock and Shekel bond indices. In 2004 the TEL AVIV 25 stock index rose by 22.6% while the TEL AVIV 100 stock index rose by 19%. Stocks accounted for 15% of the participating portfolio this year, and contributed to the gross return of 8.36% achieved for the participating portfolio. This is evidenced in table V-13. The positive trend in the bond market continued from the previous year, though price increases were more sedate compared to The yield on SHACHAR bonds was 5.6%, GILON bonds yielded 4.5% and GALIL bonds yielded 3.7%. Negotiable government bonds were 35.4% of participating portfolio assets in 2004, and the above yields further explain the positive returns earned by the portfolio. There are two types of management fees charged by insurance companies: Fixed management fee a certain % of cumulative savings balance and variable management fee dependent on portfolio return. Most variability in management fees over time is due to the latter. When high returns are achieved in the participating portfolio, the variable management fee increases, and the converse occurs in years when returns are low. 28

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