CAPITAL MARKET, INSURANCE AND SAVINGS DIVISION

CAPITAL MARKET, INSURANCE AND SAVINGS DIVISION

Table of Contents 1. Introduction... 2. Industry analysis... A. Premiums and distribution of insurance types... B. Life Insurance Assets Portfolio... 1. General... 2. Portfolio of participating insurance plans... 3. Yields of the insurance companies... 4. Insurance policies with several investment tracks... 5. Comparison of yields - insurance and provident funds... 3. General review of the life insurance industry in Israel as of... A. Events that occurred during in the insurance areas... 1. Changes in life insurance plans... 2. Approval of new polices... 3. Life insurance for army reservists... 4. Publication and illustration in life and health insurance policies... 4. General subjects... A. Comparison of pension coefficients over the years... B. Assured yield life insurance policies... 1. Indexed life bonds... 2. Assured yield pension policies... 3. Termination of indexed life bonds issue by the state... 5. Pension saving... A. Background... B. Work disability... 6. Appendix... Appendix A: publication and illustration in life and health insurance policies... Tables: Table G-1: Gross premiums by insurance types in 1999-... 6 Table G-2: Distribution of gross premiums by insurance groups in 1999-... 8 Table G-3: Distribution of gross premiums by quarters in... 8 2

Table G-4: Distribution of total life insurance assets portfolio in 1999-... 10 Table G-5: Distribution of assets in the participating portfolio in 1999-... 11 Table G-6: Centralization index for 2000-... 14 Table G-7: Participating portfolio (individual fund) - gross and net real weighted yield and management fees in 1997-... 15 Table G-8: Gross and net yields in 1999- by insurance groups... 16 Table G-9: Direct Insurance Ltd. - gross and net yields in 1999- by investment tracks... 19 Table G-10: Clal Insurance Company - gross and net yields in 1999- by investment tracks... 20 Table G-11: Highest and lowest gross yields in 1996-... 21 Table G-12: Comparison of gross accumulated yield in 1996- between provident funds and participating life insurance plans... 25 Table G-13: Pension coefficients for each NIS 10,000 of saving accrual... 32 Table G-14: Main characteristics of indexed life bonds series... 36 Table G-15: Assets of assured yield policies... 39 Table G-16: Table G-17: Figures Contributions of the employer and employee (As per regulation 19 of the Income Tax Regulations)... 42 Main differences between new pension funds, executive insurance and provident funds... 43 Figure G-1: Gross premiums by main types of life insurance for... 7 Figure G-2: Distribution of assets portfolio in the life insurance industry in 1997-9 Figure G-3: Rate of shares out of investments in at end of quarter... 12 Figure G-4: Distribution of assets in a participating portfolio in 1999-... 13 Figure G-5: Rate of assets in a participating portfolio by groups for... 13 Figure G-6: Participating portfolio (personal fund) - net yield and management fees Figure G-7: in the insurance company in... 17 Participating portfolio (personal fund) - net average yield and average management fees for 1997-... 18 Figure G-8: Gross yield by quarters in the insurance companies in... 22 Figure G-9: Gross yield in the insurance groups in... 23 Figure G-10: Percentage of stock investment out of a participating portfolio for by quarters 21... 24 Figure G-11: Accumulated yield per insured on current depositing... 36 Figure G-12: Rates of indexed life bonds... 39 3

1. Introduction The Life Insurance Department in the Capital Market, Insurance and Savings Division regulates and applies enforcement vis-à-vis insurance companies in respect to life insurance. The department is responsible, among other things, for reviewing life insurance plans submitted to the Commissioner of Insurance for approval, regulating the life insurance industry in various respects, and handling professional inquiries from the public in the life insurance area, while increasing the transparency toward the insured in this field. The influence of long-term demographic changes on the life expectancy, amendments to the tax benefit legislation for pension saving tracks that have generated a certain preference to the pensionary track and a rise in the awareness of insured of the need for retirement insurance and the importance of the way of managing the saving money has lead during to a broad update in life insurance plans offered to the public of insured. Starting from June, new life insurance plans are marketed to the public of insured. The new plans benefit the insured. They provide them a high surrender value after a shorter period in a way that enables higher mobility of the saving accrual between various insurers, they adjust the insurance rates to changes in the life expectancy, provide more specified and clearer information to the insured and improve the competition conditions in the insurance markets. In addition, in the course of year a circular regarding the publication and illustration rules for insured and insurance agents dealing with life and health insurance policies was published. The purpose of this circular was setting disclosure requirements for insurance companies and insurance agents in order to protect the interests of the insured. Moreover, the trend of new life insurance plans that enable the insured flexibility in choosing the mix of investment has continued. Nevertheless, the scope of assets accumulated in these plans is still relatively small. In addition, a group life insurance plan was approved for army reservists. In the insurance companies reached an average gross yield on investments on assets of a life insurance participating portfolio of 6.67%. 4

2. Industry analysis This section analyzes the life insurance industry while considering the following aspects: premium distribution, types of marketed insurances, assets portfolio in general and a participating portfolio in particular and the yields achieved by the insurance companies in. A. Premiums and distribution of insurance types Life insurance plans are offered to the insured in the following marketing frameworks: 1. Individual plans (for individual insured). 2. Executive plans (by means of employer) for salaried employees, indexed to the Consumer Price Index or to wage; 3. Group plans (employers, corporations and service providers). Table G-1: Gross premiums by insurance types in 1999- (NIS million, December prices) Insurance type 1999 2000 Rate of change between 1999 and 2000 (%) Rate of change between 2000 and (%) Increase in premiums between 1999- Personal endowment 1,920 1,989 1,996 3.6% 0.3% 76 Personal "Adif" 1,212 1,260 1,122 4.0% -10.9% -89 Executive endowment 944 982 915 4.0% -6.8% -29 Executive "Adif" 5,681 6,527 7,760 14.9% 18.9% 2,079 Group insurance 894 874 898-2.1% 2.8% 5 Subtotal 10,649 11,632 12,691 2,042 Work disability 962 1,023 1,182 6.3% 15.6% 221 Other (*) 270 355 291 31.5% -18.0% 21 Total 11,881 13,010 14,165 2,283.2 Source: annual reports of the insurance companies, processing of the Market Capital, Insurance and Savings Division (*) Note: Other includes health insurance and nursing-care insurance. Premium revenues in were about NIS 14 billion. Less the work disability insurances, health insurances and care-insurance (which in some companies are classified differently) the premium revenues were about NIS 12.7 billion. The premium rate of increase was about 9% in the years 2000- and it characterizes the trend in life insurances over the last years. As table G-1 shows, the premium revenues (less work disability premiums and other) climbed 5

between the years 1999- in a real increase of NIS 2 billion whereas the rate of increase was about 19%. In, life insurance plans of the Adif type were about 70% of all gross premiums (less work disability premiums and other), insurances of the endowment type were about 23% and group insurance were about 7%, see figure G-1. In plans of the Adif type, one can see on the one hand the continued uptrend in the executive insurance segment (an increase of about 19% from 2000 to ) and on the other hand a decline of about 11% in the personal insurance segment of this type from 2000 to (about NIS 138 million). The reasons for the increase in the segment of the executive Adif type are related to the relatively high insurance flexibility of this plan compared with other alternatives and the higher return they give to the insured. In addition, starting from June the insurance companies have no marketing permit for executive endowment insurance plans. Regarding the personal Adif policies, it is required to review in the next years whether or not the decline in this segment of insurance continues. Figure G-1 Gross premiums by main types of insurance for Percent Group insurance 7.1% Personal endowment type 15.7% Persnal Adif type 8.8% Executive Adif type 61.1% Executive endowment type 7.2% Source: annual report data of the insurance companies, processing of the Capital Market, Insurance and Savings Division. 6

Table G-2: Distribution of gross premiums by Insurance groups in 1999- (Percent) Group name 1999 2000 Migdal 33.0 32.8 33.5 Clal 23.1 23.1 22.5 Phoenix 16.8 17.0 16.1 Harel 13.8 13.7 13.7 Menorah 9.0 8.9 9.5 Other (*) 4.3 4.5 4.7 Total 100.0 100.0 100.0 Source: annual reports of the insurance company, processing of the Capital Market, Insurance and Savings Division (*) The section Other includes the insurance companies: Ayalon, Eliahu, ILDC, AIG, Direct Insurance IDI According to the data of Table G-2 one can see that there were no significant changes in the market structure. In the share of the Migdal group increased and the share of the Clal and Phoenix groups declined, unlike in previous years. Table G-3: Distribution of gross premiums by quarters in (Percent) Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total sum 24.9% 24.8% 24.5% 25.8% 100% Source: annual reports of the insurance company, processing of the Capital Market, Insurance and Savings Division Table G-3 shows that the distribution of premiums by quarters is approximately equally divided, about NIS 3.5 billion in a quarter. The increase in premiums in the 4th quarter results from the fact that in part of the provident funds (self-employed, severance pay) the contributions are high in relation to contributions in previous quarters due to seasonal factors, like the contributions of self-employed and employers at end of year in order to enjoy tax benefits. B. Life insurance assets portfolio 1. General The total of public assets at the end of was NIS 1,187 billion. The balance of assets in life insurance plans at the end of aggregated some NIS 78 billion (6.5% of the total of public assets). 7

In comparison, the balance of assets in pension funds is 10.1% of the total of public assets and in provident funds and advanced training funds the balance of assets is 14.4% (in provident funds only about 10.4%). Figure G-2: Distribution of life insurance assets portfolio in 1997- (NIS million) Percent 90 80 70 60 50 40 30 20 10 0 Other assets Prticipating in profits 1997 1998 1999 2000 Between 1997- the portfolio grew in real terms from about NIS 57 billion in 1997 to about NIS 78.6 billion in, a real growth rate of 37%. In 2000- the assets portfolio grew in real terms grew in about NIS 4.34 billion (an increase of 5.8%) compared with the years 1999-2000 where the portfolio rose in real terms in NIS 5.7 billion (increase of 8.6%). The moderation in the rate of increase in the assets portfolio that persisted for two years in a row, was the result, among other things, of the gap in gross yields achieved by the companies in 1999 (13.06% on average) compared with the years 2000 (4.31% on average) and (6.67% on average). This shows the importance of the way the assets portfolio is run by the companies. Over the years there has been an uptrend in the rate of the participating portfolio out of total assets portfolio, in light of the fact that starting from 1991 the plans marketed to the public are participating plans only. In, the rate of participating portfolios out of total assets was about 46%, approximately half of the total assets that year. 8

Table G-4: Distribution of the Total Assets Portfolio (Percent) Type of asset 1999 2000 Indexed life insurance bonds 48.1 41.2 36.9 Other governmental bonds 17.4 18.3 17.8 Other debt certificates and other 2.6 3.0 5.4 Shares 4.9 6.1 7.2 Bank loans and deposits (excl. demand deposits) 18.1 20.6 20.4 Cash and demand deposits with banks 2.9 4.0 5.0 Rental real estate 1.1 1.4 1.3 Investment in subsidiaries and insurance brokers 1.3 1.3 0.7 Premium due and insurance agents balances 0.6 0.7 0.8 Accounts receivable and credit balance 0.3 0.3 0.3 Deferred acquisition costs 2.8 3.2 3.0 Investments abroad 1.1 Fixed assets 0.2 Total assets and credit balances(nis billion) 65,812 71,486 78,639 Source: annual reports of insurance companies, processing of the Capital Market, Insurance and Savings Division The composition of the assets portfolio indicates the changes that have happened in the way of investment of insurance companies. One can see that there was a decline of 22% in the investment in the component of indexed life bonds in 1999- where at the same time there was an increase in stock and cash investments. The new Methods of Investment regulations 1 starting from removed the investment limitations therefore in additional channels of investment were added such as investments abroad. It is required to continue examining in the coming years how is the composition of assets portfolio influenced by the removal of limitations as stated. 1 Insurers Regulations for Methods of Investment and Commitment Management - 2. Life insurance participating Portfolio Plans that participate in profits are characterized by the fact that all the investment profits or investment losses, less management fees, are credited or debited to the insured. The investment in assets is done according to the instructions of the Insurance Business Supervision regulations (Insurers Regulations for Methods of Funds and Capital Investment and Commitment Management -, hereinafter: Methods of Investment regulations ) and by the rules set by the Commissioner of Insurance. This section will review the distribution of assets in the participating portfolio, and various channels of investments. 9

Table G-5: Distribution of assets in a participating portfolio in 1999- (NIS million) Type of asset 1999 Share in total for 1999 (%) 2000 Share in total assets for 2000 (%) Share in total assets for (%) Indexed life government bonds 637.9 2.6 644.3 2.2 638.5 1.7 Other governmental bonds 10,750.8 43.6 12,213.2 40.9 12,836.4 35.0 Other debt certificates and other 1,275.9 5.2 1,671.3 5.6 3,188.1 8.7 Shares 3,222.3 13.1 4,371.2 14.7 5,456.9 14.9 Bank loans and deposits (excl. demand deposits) 4,999.9 20.3 5,817.6 19.5 7,422.2 20.3 Cash and demand deposits with banks 1,227.3 5.0 1,747.6 5.9 2,852.3 7.8 Rental real estate 190.5 0.8 430.4 1.4 486.8 1.3 Investment in subsidiaries and insurance brokers Premium due and agents balances Accounts receivable and credit balances Deferred acquisition costs 504.6 2.0 517.2 1.7 253.9 0.7 320.5 1.3 362.6 1.2 557.8 1.5 112.9 0.5 133.7 0.4 152.5 0.4 1,393.9 5.6 1,927.3 6.5 2,019.4 5.5 Investments abroad 800.8 2.2 Total assets and credit balance 24,636.5 29,836.6 36,665.6 Source: annual reports of insurance companies, processing of the Capital Market, Insurance and Savings Division In there was an increase in the total of assets in the participating portfolio at the rate of about 23%, compared with an increase of about 21% in 2000. Governmental bonds are the largest components in the participating portfolio (about 35%). Then comes the component of bank loans and deposits (about 20%) and shares (15%). The rate of increase in stock investment between 2000- is lower than the rate of increase in stock investment between 1999-2000. This may be explained in light of the lower yields in the share index in most of, except for the last quarter (See detailing below). 10

In the section "other debt certificates and other" there was an increase of 55% in the rate of investment out of the total of assets in the participating portfolio compared with 2000 (from 5.6% to 8.7%). The increase may be credited to the increase in the rate of investment in nongovernmental negotiable and non-negotiable bonds due to the new Methods of Investment regulations (). Up to the insurance companies were limited regarding the investment in securities issued abroad. In consequence of the new Methods of Investment regulations coming into force, in about NIS 800 million were invested in this investment channel. Figure G-3: Rate of shares out of the investments in at end of quarter (Percent) 16 14 Percent 12 10 8 6 4 2 0 31/12/00 31/3/01 30/6/01 30/9/01 31/12/01 Source: annual reports of the insurance companies, processing of the Capital Market, Insurance and Savings Division. Figure G-3 shows that there was a decline in the value of stock investment during the 1st and 3rd quarters of. On the other hand, in the 2nd and 4th quarters there was an increase in investment and in the annual calculation there was almost no change in the rate of stock investment. The changes in the stock investments during the quarters may be explained by the trends in the general stock index in the course of the year (see the section that deals with the yields of insurance companies, Figure G-8). 11

Figure G-4: Distribution of assets in a participating portfolio in 1999- (Percent) Percent 50 45 40 35 30 25 20 15 10 5 0 indexed life bonds other gov. bonds other debt certificates and other Shares bank loand and deposits (excl. depstis on demand) cash and demand deposits with banks rental real estate investment in subsidiaries and insurance brokers premiums due and agents balances accounts receivable and credit balances 1999 2000 deferred acqui. costs investments abroad Source: annual reports of the insurance companies, processing of the Capital Market, Insurance and Savings Division. Figure G-5: Rate of assets in a participating portfolio by groups for (Percent) Phoenix 17% Other 4% Clal 22% Menorah 9% Migdal 35% Harel 13% Source: annual reports of the insurance companies, processing of the Capital Market, Insurance and Savings Division. A review of the division of assets between the various insurers in a participating portfolio shows that the structural division has not changed since the total portfolio analysis. When dividing by insurance groups, it is evident that as of the Migdal insurance company had the largest market share (about NIS 12.6 billion which are 34.6% of the market). Then come the Clal, Phoenix, Harel and Menorah groups. Moreover it shows that the three largest insurance groups in the industry (Migdal, Clal and Phoenix) account for about 74% of the market share. 12

In order to examine the centralization index in the insurance market we have used two indexes: 1. The Herfindahl-Hirshman Index (HHI) that is calculated by a formula of the squares of the insurance companies market shares in total assets in the participating portfolio. 2. The CR3 index which adds the market shares of the three largest insurance groups in total assets in the participating portfolio. These are the results of the centralization indexes: Table G-6: Centralization indexes for 2000 and Index 2000 Herfindahl-Hirshman 0.22 0.22 CR3 74 74 Source: Capital Market, Insurance and Savings Division The table shows that the Herfindahl - Hirshman index is 0.22. This result indicates centralization in the life insurance industry that is similar to the centralization in the banking system in Israel, a system that is considered highly centralized. For comparison sake, in the UK the index is about 0.028 and in the USA it is 0.026. 3) Yields of the insurance companies Life insurance premiums usually consist of the risk premium, the saving premium and the components of expenses out of the current premium. In most cases the component of expenses out of the current premium is attributed to the risk premium. In part of the new life insurance plans the component of expenses is also attributed to the saving premium or displayed in an independent manner. Moreover, it is important to bear in mind that additional components of expenses are charged to the saving accumulation. The management fees that are included in the component of expenses divide into fixed management fees which account for 0.6% of the accumulated balance of the allocated money and variable management fees which are 15% of the real profit on the annual yield (according to the management fees regulations). Starting from 1992 the saving premium is invested in the capital market and influenced by the composition of the assets portfolio and their yields (personal fund). There is a difference between the gross yield that is influenced, among other things, by the investment policy and its way of implementation in the relevant period and the net yield credited to the insured according to the their policy terms after deducting the said management fees. The yield reported by the companies is based, both in the financial statements and in the annual reporting to the insured, on the investment of assets under certain assumptions1 that characterize the yield in an insurance portfolio participating in non-transactional profits. The yields analyzed in this part of the report are based on the reported yield rather than on the actual yields credited to each insured, which as stated is influenced by additional indices (for example: the timing of depositing, their size etc.). 13

Table G-7: Participating portfolio (individual fund) - Gross and Net Real Weighted Yield and Management Fees in 1997- (Percent) Year Gross weighted yield Net weighted yield Management fees (Fixed & variable) 1997 7.17 5.57 1.59 1998 0.62-0.09 0.71 1999 13.06 10.65 2.42 2000 4.31 3.14 1.17 6.67 5.15 1.52 Source: Capital Market, Insurance and Savings Division Note to the table: the weighted yield is calculated by multiplying each company s yield values by the share of its assets in the total for all companies. 1 Like monthly deposit at the beginning of each month. In higher yields than the yields of 2000 were achieved. The increase mainly stems from the high yields in index and foreign currency linked investment channels that were mainly influenced by the scope of interest reduction by the Bank of Israel at the end of the year and the sharp depreciation at that time of the shekel rate with respect to the dollar. In addition the yields were also influenced by the sharp rise in the general stock index at the end of the year, which compensated for the drop in this index up to the appreciations as stated (See figure G-8). Table G-8: Gross and net yields in 1999- by insurance groups (Percent) Group name Migdal Clal Phoenix Hare Other Company Gross yield Net yield Gross average yield Net average yield name 1999 2000 1999 2000 in last 5 years in last 5 years Migdal 13.1 5.1 7.1 10.7 3.8 5.5 6.4 4.9 Hamagen 13.2 5.1 7.1 10.8 3.8 5.5 6.4 4.9 Clal 14.4 3.5 6.7 11.6 2.5 5.2 6.7 5.2 Aryeh 14.9 3.4 6.7 11.9 2.4 5.2 6.8 5.2 Phoenix 12.8 3.8 5.4 10.4 2.7 4.1 5.7 4.3 Hadar 11 4.4 7.3 8.7 3.3 5.6 6.2 4.7 Shiloah 11.1 3.9 7.1 8.8 2.8 5.5 5.6 4.2 Sahar-Zion (1) 12 4.5 7.1 9.6 3.3 5.5 6.3 4.8 Menorah (2) 14 4.4 8.2 11.4 3.2 6.5 7.6 5.9 Ayalon 8.2 4.2 6.7 6.4 3.0 5.1 5.6 4.2 Eliahu 9.3 3.4 6.7 7.4 2.3 5.1 5.8 4.3 ILDC 11.2 5.6 7.1 8.8 4.2 5.5 5.7 4.3 14

Notes: 1) The data for the years 1999-2000 refer to Sahar only. Starting from 1.1. the Sahar and Zion groups were merged. 2) Manulife was merged with Menorah in. Source: annual reports of the insurance companies, processing of the Capital Market, Insurance and Savings Division Figure G-6: Participating portfolio - individual fund - net yield and management fees in the insurance companies in (Percent) Percent 7 6 5 4 3 2 1 0-1 -2-3 Phonex net managemnt fees Eyalon Elliahu Aryeh Clal Migdal ILDC Sahar Zion Shiloah Hamagen Hadar Menorah Insurance companies Source: annual reports of the insurance companies, processing by the Capital Market, Insurance and Savings Division. Figure G-7: Participating portfolio - individual fund - net average yield and average management fees for 1997- (Percent) Percent 7 6 5 4 3 2 1 0-1 -2-3 Eyalon average of 5 last years net average management fees of 5 last years Shiloah The Phonex Elliahu Hachsharat Hadar Sahar Zion Migdal Hamagen Aryeh Clal Menorah Hayeshuv Insurance companies Source: annual reports of the insurance companies, processing by the capital market, insurance and saving section. 15

4) Insurance policies with several investment paths Until the end of this year the two insurance companies (Clal and Direct Insurance) have offered their insured insurance plans that enable investing the premium money in additional investment paths different from the general investment fund for all the insured in a portfolio participating in profits in each company. At the end of, Migdal also started to operate insurance plans as stated. With respect to this period, the main part of assets in the capital market investment path is run in investment portfolios that are common to all the insured in any insurance company. It seems that the progress in the area depends on completing the preparations of the insurance companies to supply services as stated and on proper training of the insurers marketing array. Table G-9: Direct Insurance Ltd. - gross and net yields in 1999- by investment paths (Percent) Path 1999 2000 Gross Management Management Management Net Gross Net Gross fees (*) fees (*) fees (*) Net Bonds and deposits (Solid) 11.1 0 11.1 6.8 0 6.8 12.35 1.5 11.60 Medium (up to 15% shares) 15.9 0 15.9 6.0 0 6.0 11.45 1.5 10.70 Share-oriented (up to 50% shares) 30.0 0 30.0 1.1 0 1.1 10.25 1.5 9.50 Average weighted yield 13.9 0 13.9 5.6 0 5.6 11.89 1.5 11.14 Source: annual reports of the insurance companies, processing by the Capital Market, Insurance and Savings Division. * Note: in 1999 and 2000 the company did not charge management fees. The management fees in were only charged for the 2 nd half of the year. In, Direct Insurance achieved higher yields than achieved in 2000 in all the investment paths in this plan. 16

Table G-10: Clal Insurance Company - gross and net yields in 1999- by investment paths (Percent) 1999 2000 Path Gross Management Net Gross Management Net Gross Management fees (*) fees (*) fees (*) Net Shares (at least 85% shares) 37.4 0.4 37.0 11.2 1.4 9.8 1.9 1.4 0.5 Bonds (bonds and deposits 10.0 0.2 9.8 12.1 0.8 11.3 15.8 0.8 14.9 Foreign currency (at least 75% 1.10 0.2 0.9 7.8 1.0 6.8 13.1 1.0 11.9 indexed to exchange rates) Solid/mixed 13.7 0.2 13.5 9.0 0.9 8.1 13.7 0.9 12.7 (up to 15% shares) Flexible/mixed 14.7 0.3 14.4 10.1 1.1 9.0 11.5 1.1 10.3 (15%-50% shares) Speculative/mixed 27.6 0.3 27.3 5.0 1.2 3.8 4.6 1.2 3.4 (50%-75% shares) Average weighted yield 24.9 0.3 24.6 10.0 1.0 9.0 14.2 0.9 13.2 Source: annual reports of the insurance companies. * Note: yields for 1999 pertain to the 4th quarter only. The increase in the importance of the investment management area in insurance companies over the last years has lead to increased competition between the insurers. The gap between the different companies is mainly explained by the difference in the investment policies of the companies, which is mostly expressed in the way of dividing the investments between the various assets. Table G-11: Highest and lowest gross yields in 1996- (Percent) Highest gross yield max Lowest gross yield min Standardized standard deviation 1996 4.5 2.1 0.23 1997 7.8 4.7 0.16 1998 3.8-0.9 2.66 1999 14.9 8.2 0.15 2000 5.6 3.3 0.15 8.2 4.1 0.10 Source: annual reports of the insurance companies, processing by the Capital Market, Insurance and Savings Division. The standard deviation of the yields is an indicator that enables to assess the scatter of yields for the insured. When reviewing the standard deviation on a multi-annual basis, it appears that in 1998 the standard deviation was 2.66%. This standard deviation attests to a high 17

degree of scatter in yields for the insured. The yields in this year were low, and the standard deviation is explained by the fact that there were companies that achieved a positive yield of about 3% compared with other companies that achieved a negative yield. On the other hand, in 2000 and, the standard deviation declined significantly and was 0.10% in (the lowest in the described years). Meaning, in these years there were no significant differences between the yields achieved by the insurance companies. Figure G-8: Gross yield by quarters in the insurance companies in Percent 25 20 15 10 5 0-5 -10-15 -20-25 1st quarter 2nd quarter 3rd quarter 4th quarter Insurance companies gross yields General share index Non-index linkedbonds Index linked bonds Dollar bonds Source: Capital Market, Insurance and Savings Division The year was characterized by high volatility of the stock market on the one hand and relative stability of the inflation level on the other. The insurance companies have had a weighted annual yield of 6.67% gross as seen in Table G-7. Most of the annual yield was achieved due to the last quarter where the insurance companies had a weighted yield of 6.3%. In comparison, the yields of the insurance companies in, the general bonds index was 13.2% whereas the linked bond index and the unlinked bond index were 15.4% and 10% correspondingly in that year. 18

Figure G-9: Gross yield in insurance groups in (Percent, by quarters) 8 7 6 5 4 3 2 1 0-1 -2-3 Migdal Clal Phoenix Harel Menorah Other 1st quarter 2nd quarter 3rd quarter 4th quarter Source: annual reports of the insurance companies, processing of the Capital Market, Insurance and Savings Division. Before assessing the development of yield along the entire year, it should be clarified that the yields of insurance companies and their investments are supposed to be measured in the course of time and conclusions may not be drawn based on a single annual yield. By visual inspection of Figure G-9 one can see that in the 1st and 3rd quarters the large insurance companies achieved negative yield whereas the group of small companies ("Other") achieved a positive yield. This trend changed in the 2nd and 4th quarters where the group of small companies achieved lower yields than the large groups. This may be explained in light of the different exposure the insurance companies have in stock investment. The large groups are characterized by a higher rate of stock investment than the small companies (See figure G-10). Figure G-10: Percentage of stock investment in a participating portfolio for by quarters 18 16 14 12 10 8 6 4 2 0 1st quarter 2nd quarter 3rd quarter 4th quarter Migdal Clal Harel Phoenix Other Source: annual reports of the insurance companies, processing of the Capital Market, Insurance and Savings Division. 19

5. Comparison of yields - insurance and provident funds The yields achieved by the insurance companies may be compared to other alternatives in the market. Table G-12 compares between the accumulated yield (gross) in provident funds and participating life insurance plans in the years 1996-. The comparison was based on an investment of NIS 100 at the beginning of 1996 in a provident fund vs. an identical investment in a participating insurance plan. Table G-12: Comparison of gross accumulated yield in 1996- Between provident funds and participating life insurance plans (NIS, 1/1996 = NIS 100) Year Provident fund Gross Life insurance Gross 1996 102.32 103.11 1997 110.24 110.5 1998 112.54 111.19 1999 127.36 125.71 2000 131.66 131.13 140.31 139.87 Source: Capital Market, Insurance and Savings Division. The table shows that the provident funds have achieved an accumulated yield similar to the yield achieved by the insurance companies, and the differences only aggregates about 0.44%. The liberalization process of the investment rules will eventually lead to equalization of the investment rules in the various channels, and the differences in yields will be mainly a function of the management qualities. 20

3. General review of the life insurance industry in Israel in A. Events that have happened during in the life insurance industry (1) Changes in life insurance plans Background In recent years there has been many changes in the conditions of the pensionary saving market in general and in the insurance companies in particular. Since 1992 the insurance companies have started to market participating policies with no assured yield, and in 1998 the direct insurance companies entered the industry. The fact that they have joined the market has increased the competition in the pure risk area. Then the investment options were made more flexible and during 2000 the maximum permissible rate for an insurer s investment in negotiable shares against participating policies was increased from 15% to 25%. At the beginning of the investment options were extended and made more flexible and starting from April the investment limitations were totally removed except for stability limitations (see the chapter Stability). In addition, on December 31 1999, the Knesset passed the Economic Arrangements Bill into law, designated to correct distortions with respect to tax benefits regarding pension funds and provident funds when making provisions and withdrawals. Moreover, new rules regarding the pension funds were set. All of these and the increase in the life expectancy and in the insured needs have served as a basis for the improvement and adjustment of insurance plans according to the new market conditions. Mortality tables One of the most prominent changes is related to the mortality tables that are used to set the mortality probability by ages. In the old plans the mortality tables have failed to reflect the increase in life expectancy that has happened over the recent years and the change in the risk insurance companies are taking upon themselves. Due to the increase in life expectancy the mortality probability has declined therefore the mortality risk tariffs are supposed to be cheaper (see detailing in the annual report of the Division for 2000). On the other hand, in pension type policies (where the insured gets monthly payments at the end of the insurance period until their death) the period of pension payments is longer and the risk taken by the insurance companies is higher. In the new plans the mortality tables were changed in a way that reduces the death risk premium and enables routing more money to saving. In the new plans of the pension type the price of pension was raised (by reducing the pension 21

advances) and due to the increase in life expectancy the monthly pension an insured gets at the age of retirement will be smaller. Nevertheless, there has been a reduction in the death risk premium in plans where a component of death risk is purchased until starting to get the pension, thus more money may be directed to saving and a higher accrual may be achieved. In addition the minimal fundamental term of payment assurance (default) for pension payments, in case an insured dies after starting to receive the pension, was extended from 120 monthly payments to 180 and 240 payments (according to the terms of plans in the various companies). Moreover, the matter of assuring or not assuring pension advances in pension policy has risen. In the old plans the pension coefficients are assured so that an insured knows in advance how is the rate of pension he will get is set (their rate changes due to the influences of yields in the capital market after starting the pension payment), unlike the new pensions where the rate of pension coefficients might change and be updated in the course of years before starting getting the pension payments. In the new plans the insurance companies can choose between a track of pension coefficient assurance and a track where at the time of buying the insurance, the insured does not know for sure what are the coefficients to be used to set his pension (like in pension funds). This track where the insured doesn t know for sure what are the pension coefficients for setting his pension, clear rules were set due to its complexity, especially in the matter of proper disclosure to the insured (for example, the way of publishing the update of coefficients, the option of fixing the coefficients by the insured etc. See detailing in the Commissioners report for 2000). It should be noted that the changes in legislation have changed the tax arrangements. They have set, inter alia, that money that was earmarked, at the time of depositing, for pension and that will be paid in a way other than as a pension, will be considered an unlawful payment and tax at the rate of 35% shall apply to them or according to the insured s marginal tax rate, the higher of the two. These changes have increased the probability of pension payments, therefore have brought up the need of the companies to update the pension plans. Mobility of saving money Surrender values At the time of selling the insurance policies, the insurance companies incur selling and marketing expenses. An insured who cancels the policy before the end of the insurance term is required to return part of these expenses by setting a surrender value lower than the full amount of saving accrual for that term. The surrender values in traditional plans are very low in a way that the impact on the insured s capability to mobilize the saving component has damaged the competition in this market. In the new plans, the surrender values were considerably raised in the first years, and the term that credits full surrender was shortened to five years instead of ten to thirty. This update enables higher mobility of savings between the insurers, and enables withdrawing 22

the money from the insurers to other investment channels (in lump-sum individual plans). This update is supposed to improve the capital management method used by the insurers and to increase the competition. This allows proper solution to individual insured and to the entire public of insured. Remaining under an insurance coverage when transferring saving money In addition to allowing higher mobility of the saving component, the need to consider the risk component in plans of the "Adif" type is part of the plan conditions. When transferring the saving/surrender value, the insurance plan is cancelled, consequently the insured remains with no risk coverage. This is particularly true in case that the insured s medical condition gets worse, consequently he may be unable to buy an insurance coverage with the company to which the saving was transferred or that he may be required to pay a considerable additional premium. Therefore, in order to prevent a situation where a change in the health condition may be a consideration for not transferring the savings between the companies, a new section was added to the new plans that enables the insured to continue enjoying the insurance cover (death risk) in the company after redeeming or mobilizing the money in an individual policy, without having to prove their health condition and up to a certain percentage of the amount of insurance in which they were insured for a death case (usually 70%). Termination values As stated above, an insured who elects to cancel the policy prior to the end of the insurance term is entitled to a lower surrender value than the saving accrual. In traditional plans, an insured who elects to cancel the insurance plan yet leaves the accumulated savings with the company is entitled to that surrender value even if choosing to leave the accumulated savings with the company for an additional term (cleared policy). In order to improve the insured s state, the companies were demanded to add a section that adds a rider to the accumulated savings for an insured who leaves his money with the company. Increasing the saving component In addition to reducing the risk costs as stated and improving the surrender values, that are designated, among other things, to increase the accumulated savings in insurance plans for the insured, the basic mix between risk and savings in plans of the "Adif" type was changed. In traditional plans of the "Gimla" type the percent of premium routed to savings in the basic insurance was set to 72% whereas in the new plans this percentage is 80%. It is hereby clarified that an insured may choose a different mix of risk and saving. 2) New policies that were approved Besides the update of insurance plans as stated and within the framework of the actions taken 23

to improve the insurance market and respond to the needs of the insured, the Commissioner of Insurance has approved additional policies having new features. "Adif" type policies with investment tracks for executives, self-employed and individuals Besides the approval of Unit Linked type policies for executives, self employed-and individuals, that enable the insured or policyholder to choose the investment tracks where the savings will be invested, additional policies that allow investment tracks by the pattern of the "Adif" policy for executives, self-employed and individuals were approved. Hereinafter are some of the features of the above policy for executive: 1. The policy enables the insured/policy-holder to invest the savings at their discretion and by their personal preferences. 2. The plan combines a pension track and a lump-sum track (regarding the saving) and additional insurance covers. 3. The insured is entitled to divide the contributions to benefit and severance pay that he and his employer deposit between the various plans (pension and lump-sum) and change from time to time the mix of plans with respect to future deposits. 4. When the pension payments begin, the money will be transferred to the general investment track of all the insured (individual fund). 3) Life insurance for army reservists The issue of insurance cover for army reservists during their army service has been brought up lately on the background of the need to find an insurance arrangement for paying them and their families insurance amounts in case of death or for a case of work disability due to their service. The reasons for that, among other things, are the exceptionalizations to paying the insurance amount in case of death and work disability in insurance plans in the insurance companies and pension funds if the said case happens during the reserve service. In the insurance companies there are no exceptionalization to paying the amount of insurance in case of death, if the insurance case happens during the reserve service, yet in work disability plans there are exceptionalization to paying the amount of insurance in such case. Nevertheless in the last two years, the cover for the time of reserve service was extended and there are work disability plans that under certain conditions do not exceptionalize the payment of the insurance amount in case of a work disability due to a reserve service. In the pension funds there is a division regarding the exceptionalization between the traditional funds and new funds. In the traditional funds there is an exceptionalization both for a fatality and for a work disability case and in the new funds a fatality case is not exceptionalized and the work disability case is exceptionalized. Due to the problematic nature described above and the desire to assure paying the insurance payment to an army reservist who is injured during service, an intermediate solution has been started and a group life insurance plan for army reservists to cover a fatality case for the 24

beneficiaries was approved. According to this plan, in case that an army reservist dies, the beneficiaries in the policy will get the amount of insurance for a fatality at the amount of NIS 282,000 (linked to the index of June ). Moreover, pension will be given to relatives: to a widow (40% of the determining income) and to the children of an army reservist (15% for the first child and 10% for any additional child) according to the conditions set in the plan. In order to offer a complete final solution both for a fatality cover and for a work disability cover, the Knesset has discussed the final stages of passing a draft bill that is supposed to handle the issue in a different manner. According to the draft bill, there will be public cover to provide answer both for the exceptionalization of a fatality and for a work disability case and for paying the insurance amount to army reservists and their relatives in case that the insurance case as stated happens. 4) Publication and illustration in life and medical insurance policies In recent years there has been many changes in life insurance plans that provide the insured flexibility and allow them, more than ever, to combine risk and saving components. In the area of pensionary savings there has been additional changes that enable numerous pensionary combinations. These changes have emphasized the need to improve the proper disclosure rules to insured in a way that the information is extended and presented in a clear manner to the insured in life and medical insurance plans, staring from the stage of entering the insurance contract up to the current reporting to the insured. Hence, in a circular of the Commissioner of Insurance was published regarding the way of publication and illustration in life and medical insurance policies. The purpose of the circular was proper disclosure by insurance companies and insurance agents in order to protect the interests of the insured. For example, as part of the process of selling life insurance plans with a saving component, insurers are required to attach an illustration of the insurance plan when issuing it to the insured. In this illustration the insurer will present to the insured and emphasize data and calculations including the saving accrual as a function of time, the expected amount of pension and the factors that may influence its size. The illustration will emphasize the discrimination between elements that the insurer assures to the insured and elements that are not assured but depend on external factors, such as the rate of return in the capital market. At the same time the insurers have given the insured the right to cancel the insurance plan within 60 days since its acceptance. This right will allow the insured to consider and analyze the insurance product that is designated for a long saving period. Moreover, rules were specified regarding the way of publishing life insurance plans, while emphasizing components that are very important in the insurance plans, like the coefficients by which the monthly pension at retirement age is calculated. In addition, uniform rules were set for the insurance plans regarding the way of performing the illustration, like the rate of return for the purpose of calculating the saving accrual (the circular is attached as appendix A). 25

4. General subjects A. Comparison of pension coefficients along the years One of the most important changes in the new plans is related to the mortality tables therefore to the pension coefficients by which the rate of monthly pension at retirement age is calculated. Here is a summary and analysis of the comparison of coefficients between life insurance plans of different periods that are different with respect to the plan terms: Table G-13: Pension coefficients for each NIS 10,000 of saving accrual For women Age of starting the pension payment For men Age of starting the pension payment 60 65 65 70 Policies of the years 1985-1991 (that assure yield) 57.47 63.90 69.35 77.82 Policies of the years 1992-6/ 47.77 54.4 60.01 68.88 New polices from 6/ 45.63 49.46 50.07 53.01 Capital Market, Insurance and Savings Division The comparison shows that there are considerable differences in the rate of the pension coefficients for each NIS 10,000 of saving accrual between the different plans. The plans of the years 1985-1991 bear an assured yield (see the next section) therefore the interest by which the pension coefficients were calculated is the highest (about 5.2%). Therefore the pension coefficients in these plans are the highest and in fact they are independent of the results of the investment portfolio. These plans assure a minimum of 120 pension payments to beneficiaries in case that the insured dies after beginning the pension payment. The plans from 1992 until 6/ participate in the investment profits, therefore the interest by which the pensions are calculated is lower (2.5%), and the coefficients are lower in the rate of 10% to 20% for men and women compared with the coefficients in plans of 1985. These plans also assure a minimum of 120 pension payments as stated. The monthly pension in these plans is index-linked and influenced by the index of the investment portfolio less the interest by which the coefficients are calculated. The management fees when retiring are usually 0.6% (fixed management fees) out of the balance of assets plus 15% of the real profit. The new plans since 6/ participate in the investment profits, and the interest by which the pension coefficients are calculated is 3.5% (according to the management fees mechanism offered by the insurers, as specified below). As stated, in these plans the mortality tables were updated, therefore the level of coefficients is lower (5%-10% for women and 15%-20% 26

for men) compared with the plans of 1992 (the gaps are larger compared with the plans of 1985). Nevertheless another parameter that should be taken into consideration is the period of assuring minimum pension payments of 240 monthly payments rather than 120 monthly payments in other plans. This fact raises the value of pension coefficients in these plans. It should be noted that in these plans there is a mechanism that reduces the value of pension coefficients for each year after 2000 or (according to the type of insured). Unlike the plans of 1992, up to a real yield of 3.5%, no management fees are collected when retiring. For a yield of 3.5%-4.1% fixed management fees at the rate of 0.6% are collected and for a yield of more than 4.1% management fees at the rate of 15% are collected. In summary, the pension coefficients in plans of 1985 are the highest based on the old mortality tables and a higher rate of assured interest. In 1992 the pension coefficients were reduced due to canceling the yield assurance, and in they were again reduced according to the changes in the mortality tables. Yet the minimum fundamental period of assured payment (default) for pension payments in case the insured dies after beginning to receive the pension was extended from 120 monthly payments to 180 and 240 payments (according to the terms of plans in the different companies) and they have a preferable management fees mechanism for the insured. Therefore it is impossible to determine in an unambiguous manner which of the plans is better to this matter - the plans of 1992 or the new plans. B. Assured yield life insurance plans Even before the establishment of the State of Israel, the significance of insurance for the age of retirement was acknowledged therefore professional unions and various organizations have established corporate provident funds. After the establishment of the State, the importance of private insurance companies in retirement arrangements was also acknowledged and this was manifested in various ways, including various aspects of recognition for tax purposes. Another aspect in the State s support of insurance for retirement was arranged at the end of the 50 s and at the beginning of the 60 s as the Israel Electric Corporation, and then the State, committed to issue special bonds for the insurance companies that will assure financing of insurance for the age of retirement, index-linked insurance plans that bears a regular annual yield. These bonds, known as Indexed-Life insurance bonds, have several unique features that will be reviewed below. The nature of indexed life insurance bonds stems from the assurance given by the State for a yield on saving for retirement with the insurance companies and linking it to the index so that the long-term saving will not loose too much of its value as a result of erosion over many years in its purchasing power. The issue of index linkage was innovative at the time and has set a problematic challenge for the insurance companies, though the reasons for protecting the real value of savings for such a long term are numerous. Due to the innovative nature and the said problems in index linkage and the desire to protect the real value of savings, the State 27