LIFE INSURANCE ANNUAL REPORT, 1998

LIFE INSURANCE ANNUAL REPORT, 1998

CONTENTS General Survey... 4 Analysis of the Life Insurance Industry... 6 1. Types of Insurance Lines... 6 2. Distribution of the Portfolio of Assets... 8 3. Analysis of Insurance Companies Yields... 13 4. Activity of the Life Insurance Department in 1998... 16 General Issues... 19 1. Mutual Insurance... 19 2. Mutual Insurance in Israel... 20 Tables Table C-1 Gross Premiums by Types of Insurance and Rate of Change and Growth, 1996 1998... 7 Table C-2 Distribution of Premiums by Types of Insurance, 1996 1998... 7 Table C-3 Distribution of Assets in the Total Life Insurance Portfolio, 1997 1998... 11 Table C-4 Balance of Assets and Growth Rate of Participating Policies in Insurance Companies, 1997 1998... 12 Table C-5 Weighted Yield (by Reserve) of Investment Income in Life Insurance, 1998... 13 Table C-6 Highest and Lowest Net (Unweighted) Yields, 1996 1998, and Average Net Yields in Past Five Years... 13 Table C-7 Average Net Yield in Provident Funds and Life Insurance... 14 Table C-8 Gross and Net Yields, 1996 1998... 15 Table C-9 Comparison of Mutual Insurance with Group Life Insurance... 21 Table C-10 Pension Plans... 27

Figures Figure C-1 Distribution Premiums by Types of Insurance, 1998... 8 Figure C-2 Distribution of Portfolio of Assets in Life Insurance, 1994 1998... 9 Figure C-3 Proportion of Indexed-Life Bonds in the Total Life-Insurance Portfolio, 1994 1998... 10 Figure C-4 Net Yield and Management Fees, by Insurance Companies, 1998... 14 Appendices Appendix C-1 Survey of Main Life-Insurance Plans... 23 1.Life Insurance without Saving Component... 24 2.Insurance Plans with Saving Components... 25 Appendix C-2 Reporting to the Insured Explanation of the Annual Report... 36 Appendix C-3 Comparison of Participation-type Executive Insurance Plans (with Insurance Companies) with Comprehensive Pension (with New Pension Funds) and Provident Funds... 39 Appendix C-4 Definitions of Terms as Set Forth in the Income Tax (Rules for Approval and Management of Provident Funds) Regulations, 5724-1964... 56

Term insurance policies have been available in Israel for more than forty years. During that time, various rates for these plans have been developed. At first, insurance companies sold level-premium risk plans, in which the insured paid a constant premium throughout the insurance period. Since such plans are considered relatively expensive, the companies began to offer adjustable plans, in which premiums changed once every fifteen years. During this time, the mortality tables were also revised, from A24 29 to A49 52 (a more sophisticated table, better suited to the 1960s and 1970s). Over the years, insurance companies began to sell risk policies in which premium adjustments were made more frequently. The breakthrough came in the early 1990s, when the companies began to offer a less expensive risk insurance with a premium adjustment once every five years. Today, the premium in the best-selling risk plan is adjusted every year. In recent years, the companies have begun, moderately, to introduce differential risk rates that distinguish between men and women and between smokers and non-smokers. Since 1998, when a wave of rate changes occurred, almost all insurance companies have been making this distinction in their rates. Below are the main reasons for the decrease in rates in 1998: 1. Different underwriting methods began to develop in the United States in the 1940s, when the rates distinguished between men and women. Differentiation between smokers and non-smokers was introduced in the 1970s, and a preferred-risks method was developed in the course of the 1990s. 1 2. When Direct Insurance, Ltd., entered in the life-insurance industry in 1998, it introduced a risk-type insurance plan with an annually adjusted premium. Apart from the sale of direct insurance by telephone, new methods of medical underwriting were introduced, such as differentiation in rates between men and women and smokers and non-smokers. Until the advent of Direct Insurance, hardly any plans of this type had rates that made these two distinctions; rates were identical for everyone. The new underwriting method makes it possible to lower rates for non-smoking insurance candidates. Women, whether 1 See Section 3 below.

they smoke or not, pay lower rates than men, whether they smoke or not, because women s life expectancy is longer than men s. 3. Another change that occurred in 1998 was a transition to differential underwriting. This method distinguishes not only between men and women but also between insured at low and high levels of health risk. The health indicators taken into account include cholesterol level, blood pressure, and hereditary illnesses. If all tests are negative, the insured is defined as being of relatively low risk or as a preferred candidate. If the tests are positive, the insured is defined as high- or standard-risk. A preferred insured receives a larger rate discount than a standard insured. This method lowers the rate for insured whose health indicators surpass the standard set by the company. 4. Another factor in lowering rates is the use of more up-to-date mortality tables, such as AF 80 and AM 80, than the older tables that were used until 1997. In computing the rates, the companies also lowered the supplement for active and passive war risks from 0.5 mil, regularly charged until the end of 1997, to 0.2 mil. 5. Since the rates are competitive, the companies keep loading to a minimum. The changes that swept the industry in 1998 and the upturn in competition among companies have resulted in a significant downtrend in rates in term plans.

This section analyzes the insurance companies business performance in life insurance in 1998 (adjusted to the December 1998 Consumer Price Index). The analysis makes reference to insurance companies yields, the distribution of assets in their portfolios, the distribution of premiums by insurance lines, and other indicators. The insurance market began to offer participating policies in 1992. Therefore, we present a lengthy discussion of the participating portfolio and its development over the years. The analysis includes reference to the effects of the capital market on yields in the companies participating portfolio. The performance of the life-insurance industry in 1998 is reflected in earnings, which declined from NIS 797 million in 1997 to NIS 712 million in 1998 (down 10.5 percent in real terms). 1. TYPES OF INSURANCE LINES The insurance market experienced several changes in 1996 1998, both in the level of premiums paid and in the distribution of premiums among types of insurance. The analysis discusses classical life insurance and omits health and long-term care insurance, even though some insurance companies define these as life-insurance products. Life-insurance premiums increased in 1996 1998 from NIS 8.2 billion to NIS 10 billion in 1998, for a real increase of NIS 1.8 billion or 22.8 percent. The share of Adif-type ( preferred ) executive-insurance plans in premiums climbed perceptibly, from NIS 3.7 billion in 1996 to NIS 5.2 billion in 1998 a real increase of NIS 1.5 billion (40 percent) and 80 percent of the total growth in the industry. In contrast, there was a decrease in endowment executive-insurance plans, from NIS 1.063 billion in 1996 to NIS 0.995 billion in 1998. One possible reason for the decline is the smaller range of options offered to insured in Adif-type policies than in alternative plans. In Adif plans, for example, one may stipulate in advance the percent of premium to be allocated to savings and the percent to life insurance. In personal insurance, the Adif segment climbed from NIS 0.98 billion in 1996 to NIS 1.2 billion in 1998 (a real increase of 23 percent) and the endowment segment expanded more slowly, by 6 percent, from NIS 1.8 billion in 1996 to NIS 1.9 billion in 1998. Group life

insurance premiums increased from NIS 0.65 billion in 1996 to NIS 0.78 billion in 1998, by 18.6 percent in real terms. Table C-1 Gross Premiums by Types of Insurance and Rate of Change and Growth, 1996 1998 NIS millions, December 1998 prices Type of insurance 1996 1997 1998 Percent change, 1996 1997 Percent change, 1997 1998 Increase in premiums, 1996 1998 (NIS) Endowment personal Adif personal Endowment executive Adif executive Group insurance Other Total Table C-2 Distribution of Premiums by Types of Insurance, 1996 1998 Percent Distribution of premiums 1996 1997 1998 Endowment personal Adif personal Endowment executive Adif executive Group insurance Other Total

Adif-type executive plans commanded a 46 percent share of the total market in 1998 as against 39 percent in 1996. The share of endowment-type personal and executive plans declined from 20 percent in 1996 to 17 percent in 1998, and from 11 percent in 1996 to 9 percent in 1998, respectively. The market share of group insurance and Adif-type personal plans was unchanged. 2. DISTRIBUTION OF THE PORTFOLIO OF ASSETS Total assets in life insurance are divided between assured-yield funds that do not share profits (Funds A H) and the participating portfolio (Funds I J). In 1994 1998, the total portfolio of assets climbed from NIS 36.1 billion to NIS 57.8 billion, up 60 percent in real terms, and the increase 1997 1998 was from NIS 53.3 billion to NIS 57.8 billion, 8.5 percent in real terms. In the internal mix of the portfolio, the assets for assured-yield grew by 23 percent in 1994 1998, from NIS 31.6 billion to NIS 38.8 billion, and participating funds increased from NIS 4.5 billion to NIS 19 billion during those years. Assured-yield funds accounted for 67 percent of the portfolio of assets in 1998 as against 71 percent in 1997, 79 percent in 1996, 83 percent in 1995 and 88 percent in 1994. Several main factors explain this long-term downtrend: 1. Since 1992, the plans issued have been of the participating, not the assured-yield, type. 2. Policies based on assured-yield bonds have been maturing.

3. Changes in assured-yield policies are usually made under new, participating investment conditions. For these reasons, the quantity of earmarked bonds held by the insurance companies has been decreasing over the years, but such bonds still account for a large and important share of the portfolio. Redemptions of earmarked bonds in 1997 1998 brought the share of these bonds down for the first time, by 0.94 percent. Several main factors explain the recomposition of the portfolio: 1. Redemption of assets insurance companies were able to obtain a higher yield on long-term government bonds than on earmarked bonds. 2. Policy surrenders insured surrendered life-insurance policies because other financial instruments in the capital market gave them higher yields. Total policy surrenders in 1998 were NIS 2.8 billion, including policies that matured.

In 1998, for the first time, the Finance Ministry allowed insurance companies to redeem earmarked bonds in advance of maturity. 2 That year, several insurance companies redeemed NIS 650 million in earmarked bonds in order to seek higher yields in the capital market. In 1999, bonds have been redeemed via discriminatory tenders, based on the rate of interest, that the Finance Ministry (Capital Market Division) conducted among insurance companies. 3 2 This policy is explained in Chapter 2 Stability Department. 3 See Chapter 2 Stability Department.

Table C-3 Distribution of Assets in the Total Life Insurance Portfolio, 1997 1998 NIS billions, 1998 prices Year/type of asset December 1997 December 1998 Percent change Indexed-Life bonds Other government bonds Other domestic securities Bank loans and deposits (excl. demand deposits) Cash and demand deposits with banks Real estate for leasing Subsidiaries and insurance agents Premiums collectible and net agents account Accounts receivable and debit balances Other assets Total assets and debit balances Increase in Assets in the Profit-Sharing Portfolio December 1997 December 1998 The participating portfolio was worth NIS 19 billion at the end of 1998, up 25 percent in real terms from the beginning of 1998. By insurance groups, the Migdal group held the largest market share at the end of 1998 (37 percent), followed by Clal, Phoenix, Menorah, and Harel Hamishmar, which together held 56 percent. The other companies share was only 7 percent combined. The figures indicate that the insurance market remains centralized, since the three largest insurance groups (Migdal, Clal, and Phoenix) commanded a 73 percent share of the life-insurance market in both 1997 and 1998. The real increase in the assets portfolio of all insurance companies was NIS 3.80 billion. In contrast, increased accrual of assets in provident and pension funds was NIS 0.7 billion and NIS 4.3 billion, respectively (among pension funds NIS 2.9 billion in old funds and NIS 1.4 billion in new funds), all in real terms.

Possible Reasons for the Increase in the Insurance Companies Assets Portfolio: 1. Legislative changes Expansion orders issued by the Minister of Labor and Social Affairs in May 1999 allowed insurance companies to sell executive plans wherever they meet legal requirements (in terms of social benefits). There must be mutual consent between employees and employers to conclude the insurance contract. By inference, this is one reason for the sluggish increase in accrual in pension funds. Analysis of the distribution of premiums by insurance lines supports this hypothesis by calling attention to the real increase in the market share of executive insurance plans. 2. Marketing methods Traditional insurance companies sell insurance policies via insurance agents, who provide the potential target clientele with a long-standing and familiar sales avenue. In personal insurance, this gives insurance companies a marketing edge over pension and provident funds. 3. Innovation Insurance companies constantly develop new insurance products that strive to meet clients needs. As evidence of this, additional insurance plans are placed in the market each and every year. Since provident and pension funds do not offer new plans as frequently as insurance companies do, they are less able to meet customers changing needs. Table C-4 Balance of Assets and Growth Rate of Participating Policies in Insurance Companies, 1997 1998 NIS billions, December 1998 prices Name of group Assets, end of 1997 Assets, end of 1998 Increase in assets Percent increase in assets Distribution of assets among groups in 1998 Migdal Clal Phoenix Menorah Harel Hamishmar Other Total

3. ANALYSIS OF INSURANCE COMPANIES YIELDS Since 1992, the insurance companies have been offering participating policies in which the investment yield is not assured but determined by the company s performance in the capital market ( subject to investment regulations ). We discuss these yields below. In 1998, the insurance companies achieved a real average net yield of 0.07 percent, much lower than average real yields in 1997 and 1996 5.57 percent and 2.21 percent, respectively. Two factors that help explain the decrease in yields are the 7 percent decline in share prices and the small rate of increase (0.5 percent) in bonds, both in real terms. It should be borne in mind that in 1997 the share indices rose by 25 percent and bonds by 5 percent, both in real terms. Table C-5 Weighted Yield (by Reserve) of Investment Income in Life Insurance, 1998 Percent Average weighted net yield Standard deviation (weighted yield) Average weighted management fees Table C-6 Highest and Lowest Net (Unweighted) Yields, 1996 1998, and Average Net Yields in Past Five Years Year Highest yield Lowest yield 1996 1997 1998 Average in past 5 years Notably, when insurance companies report negative yields, they include level management fees (which are limited to 0.6 percent per year) but not variable management fees. Participating life-insurance plans (combining a savings component) correspond to provident and pension funds from the savings standpoint. The following table provides a comparison of the alternatives available to those who intend to invest their money in long-term saving.

Table C-7 Average Net Yield in Provident Funds and Life Insurance (1) Percent (1) For greater detail, see chapter on provident funds. Year Average net yield, provident funds Average net yield, life insurance 1998 1.4 (2) 0.07 1997 7.1 5.57 (2) The provident funds 1.4 percent yield represents the total average yield attained by the various funds. In 1998, nine companies recorded negative net yields and no company attained a net yield exceeding 4 percent. In 1997, in contrast, no negative net yields were recorded and only three companies obtained net yields under 4 percent.

Table C-8 Gross and Net Yields, 1996 1998 Percent Company Gross yield, 1996 Gross yield, 1997 Gross yield, 1998 Net yield, 1996 Net yield, 1997 Net yield, 1998 Average net yield in past 5 years Ayalon Eliahu Aryeh Ararat Dolev Hadar ILDC Hamagen Phoenix Clal Migdal Manulife Menorah Maoz Noga Sahar Sela Zion Shiloah Shimshon

Fixed and variable management fees are subtracted from the gross yields shown in Table C-8. In accordance with the regulations, these fees are computed in the following way: 1. Track 1: fixed management fee at 0.6 percent per year of revalued worth of the investment portfolio and adjustable management fee at 15 percent of real yield on the investment portfolio. 2. Track 2: fixed management fee only, at 0.84 percent of revalued worth of the investment portfolio. The companies use Track 1 to compute management fees. 4. ACTIVITY OF THE LIFE INSURANCE DEPARTMENT IN 1998 The Department s activity focuses on several main matters: Commissioner s Authorization of New Life-Insurance Plans Life-insurance plans available in Israel require authorization from the Commissioner of Insurance, including the terms of the plan and the level of premiums. The companies submissions are tested for compliance with the provisions of the law, the Commissioner s directives, and the Division s policy. The Commissioner s authorization is not a substitute for the provisions of the law and does not override the provisions of laws and regulations. Insurance rates are examined as part of a policy that eschews direct intervention in companies activity and aims to examine and safeguard the rights of the insured, on the one hand, and to assure the insurance companies long-term solvency, on the other hand. The Life Insurance Department, in coordination with the Actuarial Department (which examines rates), presents the Commissioner of Insurance with recommendations on whether to approve an insurance plan for sale to the public at large. A database of insurance plans is kept on a new and recently activated computer system. In 1998, the Life Insurance Department authorized 224 new life-insurance policies, including eighty-four in group life insurance, and thirty rates for existing insurance plans. Commissioner s Authorization of Life-Insurance Plans Yearly Authorizations The Commissioner authorizes insurance policies for one year only. At the beginning of each year, the insurance company is authorized to continue offering previously-authorized

insurance policies for another year. The Department does not re-examine all existing insurance plans; it considers a sample examination adequate. In a departure from the policy in previous years, authorization of plans for 1999 included approval of each plan individually. This allows the Department to monitor plans newly added to each insurance company s menu of plans and to purge it of discontinued plans. Commissioner s Authorization of Life-Insurance Plans Authorization of Provident Funds Certain life-insurance plans are recognized as provident funds and come under the Income Tax (Rules for Approval and Management of Provident Funds) Regulations, 5724-1964. In 1998, the Commissioner of Income Tax empowered the Commissioner of the Capital Market to authorize insurance plans as provident funds, i.e., to approve tax benefits for insurance plans, in consultation with, and with the monitoring of, the Income Tax Commission. Tax authorizations for 1999, like authorizations for plans, were itemized at the levels of insurance plans and the tax clauses of relevance for each. This method of authorization creates, for both the Life Insurance Department and the Income Tax Commission, a database with up-to-date information on the tax benefits given to each type of insurance plan. Concurrently, the provident-fund authorizations are issued for insurance plans that are eligible for them, as part the authorization of the plan. Development of New Plans The forces that have affected the financial market in recent years have not overlooked the insurance market. Insurance companies have begun developing insurance plans that give the insured greater ability to manage their savings by means of their built-in savings component; the companies are also developing insurance plans that will give the insured financial protection by means of an assured yield on investment of the savings components. The Life Insurance Department devotes much of its efforts to the groundwork for such plans. Unit-linked insurance plans Since 1992, only participating life-insurance plans have been offered. In these plans, the contributions of all insured are pooled in one investment portfolio (a participating portfolio). To diversify the investment possibilities of the insured, the industry is offering new plans that allow insured to invest their money in several channels. These plans allow the insured, at the beginning of and during the insurance period, to choose among a

variety of investment paths. This creates a convergence between two major processes that the Division is attempting to assimilate in the insurance market: a. Separate earmarking of funds for saving and for insurance coverages separation of money for saving from money used for insurance coverage, and attribution of actual expenses to each use. This improves disclosure to the insured immeasurably and enhances the practical ability of each insured to exercise control. b. Flexibility of insurance plans in order to make savings funds transferable and portable among different savings paths within a given company or outside it. The insured may withdraw money at any time and transfer it to a different investment path or a different insurance company. The Life Insurance Department has recently approved plans of these types for two insurance companies and is processing additional applications. Assured-yield insurance plans In the wake of numerous requests from insurance companies, the Office of the Commissioner has decided to allow insurance companies to offer assured-yield life-insurance plans. The main provisions of the proposed arrangement resemble the rules for the approval of savings plans under the Encouragement of Savings Law, mutatis mutandis. Licensing of Activity in Life Insurance In early 1999, A.I.G. Gold Insurance, Ltd., was given a license in principle to be active in comprehensive life insurance. The company does not intend to sell term insurance policies until the second half of 1999. Auditing of Insurance Companies In 1998, the Department provided professional services for two audits at insurance companies, mainly in respect to mutual insurance.

1. MUTUAL INSURANCE The subject of mutual insurance has been studied recently in all respects, material has been gathered, and audits were launched, for reasons that include an accounting and economic examination. In the course of determining policy in this matter, several issues were taken up, e.g., the status of the funds, insurance coverage, reserves, and comparison of domestic developments with world standards in this type of insurance. The characteristics of mutual insurance in Israel are described below. The principles remain fluid; the Department s policy has not yet coalesced in its final form. Definition and Characteristics The insurance laws do not carry a definition of mutual insurance. Conventionally, mutual insurance is treated like group insurance, in which the group insures each of its members by incorporating in order to benefit from all gains from the insurance transaction after the insurance proceeds are paid. The group members are also expected to make up any shortfall resulting from the insurance coverage after insurance proceeds are disbursed from actuarial reserves and reinsurance arrangements. Mutual-insurance agreements usually provide a level of coverage that is additional and complementary to main coverage (comprehensive pension, etc.). Mutual insurance has several characteristics: 1. It can be created by mutual-insurance funds, nonprofit associations, or a corporation of groups of insured. It is sold directly to the groups, not via an agent. 2. The insurance arrangement transfers risk from the individual to the collective so that the collective participates in covering damage caused. This insurance is mutual in that the premium is uniform for all types of insured; thus, healthy insured subsidize ill insured and the young subsidize the old. Since concern for group members is the purpose of the arrangement, mutual insurance is meant to enhance its participants well-being and not to generate a profit. The group members participate in management and control, and the purpose of decisions is to further their well-being.

3. In most cases, the insurance is created to cover events of death or total and permanent disability. The insurance benefits are usually modest and are meant to cover initial and basic expenses after the insurance event. 4. Insurance premiums and proceeds are unvarying for all insured within the group, although they may vary from one group to another in view of experience with claims. Premiums are set by an actuary and are based on annual equilibrium in premiums paid in and claims paid out. The premiums, set each year, should suffice to cover claims for insurance proceeds in the given year. If the premiums fail to cover proceeds to eligible members, all the insured may be charged higher premiums the next year; if a surplus occurs, premiums may be reduced the next year. 2. MUTUAL INSURANCE IN ISRAEL Legislation in Israel has not yet defined what mutual insurance is. However, the Ministry of Finance has authorized several mutual-insurance funds to operate under the supervision of the Commissioner of the Capital Market. Today, five mutual-insurance funds are active on the basis of approved statutes and receive annual authorizations in the category of Provident Fund for Other Purpose. By force of this authorization, the funds are subject to the Income Tax (Rules for Approval and Management of Provident Funds) Regulations, 5724 1964, and qualify for the relevant tax benefits. Additionally, several pension funds such as Mivtahim, Makefet, and Central Pension Fund have mutual-insurance mechanisms. Tax Benefits for Mutual-Insurance Plans 1. An income-tax exemption, under Paragraph 9(2) of the Income Tax Ordinance. 2. A 25 percent credit for contributions, under Paragraph 45a(a)(1) of the Income Tax Ordinance. Comparison of Mutual and Group Life Insurance The characteristics of mutual insurance resemble those of group life insurance. The two types of insurance are compared below, on the basis of the modus operandi of mutual insurance in Israel:

Table C-9 Comparison of Mutual Insurance with Group Life Insurance Criterion Mutual Insurance Group Insurance (1) Subscription eligibility All members of the group join except for those who give written notice to the contrary and obtain the company s consent thereto. Only those who confirm by signature their consent to join the group-insurance plan join. Profits The insurance is not for profit. The insurer retains earnings from the insurance. Rights of the insured Influence on decision-making Insurance agreements Policyholder All insured are covered and have equal entitlements. Insured have an influence on decision-making. Insurance statutes. For the most part, a representative labor organization that is not a legal entity. Entitlements need not necessarily be equal. The rate is differentiated by age or other criterion. Insured have no influence on decision-making. Group policy. Employer, corporation, or service provider, defined as a legal entity. Insurance agent No agents or brokers. Possibility of conducting the relationship through an agent or broker. 1. For further information on group life insurance, see Report No. 2 (1997) of the Capital Market Division.