MIGDAL INSURANCE AND FINANCIAL HOLDINGS LTD. - BOARD OF DIRECTORS' REPORT AS OF JUNE 30 TH, 2004

Transcription

1 MIGDAL INSURANCE AND FINANCIAL HOLDINGS LTD. - BOARD OF DIRECTORS' REPORT AS OF JUNE 30 TH, 2004 The Board of Directors' Report for June 30 th, 2004 reviews the main changes in the activities of the Company in January-June 2004 (the report period ). The report makes the assumption that the reader also has the Directors' Report and the full Financial Statements for A. DESCRIPTION OF THE COMPANY 1. Organizational structure and areas of activity Migdal Insurance and Financial Holdings Ltd. ( Migdal Holdings or the Company ) is a holding company that holds full control of the shares of Migdal Insurance Company Ltd. ( Migdal Insurance ) and Migdal Investments Management 2001 Ltd. ("Migdal Investments Management ). The principal shareholders of Migdal Holdings are Assicurazioni Generali S.p.A. ( Generali ), which, together with its subsidiaries, hold approximately 64% of the Company's shares, and Bank Leumi le-israel Ltd. ( Bank Leumi ) and its subsidiary which hold approximately 20% of the Company's shares. The shares of Migdal Holdings are listed for trading on the Tel Aviv Stock Exchange. The main areas of activity of the Migdal Holdings Group are the various kinds of life assurance, provident funds management, pension funds management, all branches of general insurance and health insurance. Along with these activities, the Group is also active in the management of various investments, including entry into the financial services and financial assets management sector for customers. The Group is the largest in the life assurance line in Israel, and fourth in general insurance. As per data published by the Israeli Insurance Association, in 2003, the Group's life assurance premium constituted approx. 32.5% of total premium in life assurance line, and the Group's general insurance premium constituted approx. 10% of total premium in general insurance. Migdal Insurance Group consists of insurance companies - Migdal Insurance Co. Ltd. ("Migdal"), and The Magen Insurance Co. Ltd. ("The Magen"), managed jointly on the operational level, with the exclusion of various limitations and restrictions; Yozma Pension Fund for Self-employed (old fund), Migdal Pension Funds Management Ltd., which manages the pension funds New Yozma and Tnufa ; as well as provident funds management companies that manage an educational fund, a provident fund for retirement benefits and severance pay, and an employer fund for severance pay. In order to deepen its involvement in the pension sector, the Group signed an agreement for the purchase of Te utza Yield and Service Ltd. which manages Te'utza pension fund (see article 5a hereinafter). Migdal Insurance Group also includes insurance agencies, whose holdings are concentrated in the consolidated company Migdal Holdings and Management of Insurance Agencies Ltd. ("Migdal Agencies"). The Group includes companies active in investments, finance and credit, which are held by the consolidated company Migdal Eshkol Finansim B.M. ( Eshkol Finansim ). Migdal Investments Management, which concentrates the Group s financial, non-insurance activity, includes Migdal Capital Markets (1965) Ltd. ( Migdal Capital Markets ), which deals with management of investment portfolios and Stock Exchange services for customers, consulting, escorting and underwriting in issuances, as well as management of mutual funds and provident funds. Migdal Holdings has an investment recorded as "permanent investment" in negotiable securities of an interested party, Bank Leumi, see Financial Condition, article 3 hereinafter.

2 2. Composition of revenues and insurance reserves Aggregate premium, including fees, from life assurance and general insurance amounted to approximately NIS 3.3 billion, unchanged compared to the same period in Insurance premiums from life assurance constituted approximately 68% of all premiums, and general insurance premiums accounted for approximately 32% of total premiums (unchanged compared to same period in 2003). The Group's insurance reserves (including outstanding claims) before deduction of re-insurance as of June 30 th, 2004 amount to NIS 38.6 billion, of which, life assurance reserves are approximately NIS 35.3 billion (of which about NIS 19.4 billion profit participating life assurance policy reserves) and general insurance reserves are approximately NIS 3.3 billion. The Group's insurance reserves (including outstanding claims) before deduction of re-insurance as of June 30 th, 2003 were approximately NIS 35.5 billion, of which, life assurance reserves amounted to approximately NIS 32.4 billion (out of which NIS 16.1 billion profit participating life assurance policy reserves) and general insurance reserves were approximately NIS 3.1 billion. The reserves are invested mainly in "Hetz" designated government bonds, in negotiable and nonnegotiable securities, in loans, deposits and other investments. 2

3 The composition of revenues in the report period is as per the following details: Premium composition in life assurance: Reported premium in business report 1-6/ /2003 NIS m. % NIS m % Current 2, , Single premium Total premium 2, , Premium composition including fees in general insurance: Property motorcar Compulsory motorcar bodily injury Liabilities Loss of property Health Other Total 1, , Premium composition including fees in general insurance net of re-insurance: Property motorcar Compulsory motorcar bodily injury Liabilities Loss of property Health Other Total

4 3. Dependence on clients or marketing factors Migdal operates through agents, and most of them work with other companies as well. The Group has one agency (a consolidated company) whose rate of sales out of total Group sales in life assurance, in the reported period, exceeds 10% (16%). In the Group there is no agent whose rate of sales out of Group sales in general insurance exceeds 10%. 4. Changes and developments in re-insurance Re-insurance conditions for 2004 are quite similar to those of During , there was a decrease in the scope of re-insurance, due to the collapse of re-insurers or a significant downgrade of their credit rating, and due to a significant hike of tariffs and a decline in covers. Further to this trend, the number of re-insurers with whom Migdal Insurance and The Magen work has decreased significantly, so the relative share of each of them in the companies' reinsurance portfolio increased. There are three re-insurers, including Generali, the Company's controlling shareholder, whose share in general insurance re-insurance premium in the reported period exceeds 10%. 5. Special issues a. On June 30 th, 2004, Migdal purchased all Te'utza's subscribed and issued share capital from its shareholders for approx. NIS 16.5 million. Teu'tza is a company managing Te'utza Pension Fund (a new comprehensive pension fund) and a general pension fund being established. In 2003, Te'utza's contributions amounted to NIS 161 million and the scope of assets in respect of liabilities as of December 31 st, 2003 totaled NIS 847 million. The number of members in the fund as of December 31 st, 2003 is approx. NIS 21 million. b. Data Car, a company held by Migdal and The Phoenix Insurance Company Ltd., provides adjustment services to the Company. The tying arrangement approval which was granted to the Company in the past expired. On June 14th, 2004 the anti-trust court authorized the request by Data Car, The Phoenix and Migdal to approve (for the third time) the continued activity of Data Car as a tying agreement. This approval was granted for two years since the ruling, and it is subject to the conditions stated in the previous procedure for approval of the agreement. In its ruling, the court examined thoroughly whether the conditions stipulated by the Court the previous procedure for the approval were met, and its conclusion was that Data Car breached the court's conditions stated in the previous procedure for the approval of a tying agreement. The Court instructs that Data Car should amend the breach within 3 months after the ruling. As to Migdal, the Court did not state that it breached its conditions in the past. In addition, the Court instructed the applicants to sign a commitment to pay NIS 1 million, each, in case there is a judiciary peremptory ruling stating that it breached the conditions stipulated in this approval. Furthermore, the Court instructed Data Car and the applicants to sign a letter of undertaking for the payment, jointly and severally (with Data Car and The Phoenix) of the amount of NIS 1 million, in case there is a judiciary peremptory ruling stating that Data Car breached the conditions imposed on it by the Court. c. On October 8 th, 2003, Migdal Agencies signed an agreement with a shareholder in Amit Insurance Agencies Ltd. (hereinafter "Amit"). According to this agreement, Migdal Agencies will buy 40% of Amit shares for approx. $ 630 thousand. The completion of the agreement is subject to complying with prerequisites, which include, among other things, receiving the approval of the Anti-Trust Director General and the Commissioner of Insurance. Furthermore, the transaction is subject to the completion of another agreement within which a significant part of the activity of Ihud is transferred to Amit against the allocation of Amit shares to Ihud. Another agreement was signed on December 30 th, 2003 between Ihud, Migdal Agencies and Amit. According to this agreement, Ihud will transfer to Amit part of Ihud activity against the allocation of Amit shares to Ihud. The completion of the transaction is subject to several suspending conditions, which include, among other things, receiving the approval of the Commissioner of Insurance, the Income Tax Commission, the completion of other agreements between the parties and completing the above mentioned agreement. After completing both transactions as mentioned above, the Company will hold, directly and indirectly, 70% of Amit's share capital. 4

5 Until the completion of the transaction, it was agreed between Ihud and Amit to cooperate regarding any activity related with insurances offer for LeumiCard customers, so that Ihud's share in the above activity is 70%and Amit's share is 30%. d. On April 25 th, 2004, the acquisition of approx. 16% of Sagi Yogev Insurance Agencies (1988) Ltd. was completed, and as a result, Migdal Agencies holds 100% of the agency's share equity. e. On June 30 th, 2004, 6.24% of Peltours Insurance Agencies Ltd. (Pettours) shares were allocated to Migdal Agencies for the amount of NIS 3,178 thousand. After the above allocation, Migdal Agencies holds 73.27% of Peltours shares. f. On July 8 th, 2004, the Company received the draft of an audit report prepared by Barlev & Co., CPAs, in the Company, as per a letter of appointment by the Commissioner from July 2 nd, 1998, regarding insurance policies entitled to designated Hetz bonds. The above audit report examined whether Migdal complies with the provisions of the agreements. According to the draft of the report which was submitted to the Company for comments, it seems that according to certain assumptions included in the report, the deviations caused a damage to the Treasury, which amounts to approx. NIS 41 million. The Company is examining the findings and is clarifying them with the above auditors. As per the results of this examination, the Company is of the opinion that the assumptions are not founded. B. THE COMPANY'S BUSINESS ENVIRONMENT General DEVELOPMENTS IN THE SECTOR During 1H04, recovery in the economic activity on the market, continued. In 1H04, GDP increased by an annual rate of 4.1% (a 2.5% increase in GDP per capita), following a 1.7% increase in 2H03 and a 1.2% increase in 1H03. GDP of the business sector increased by an annual rate of 6%. The expansion in the economic activity in 1H04 stemmed mainly from the sharp 14.9% increase in export, followed by a 12.8% in 2H03, in light of the recovery in global economy, and mainly the higher growth rates in Western countries. There was a 2.9% increase in investments in permanent assets, after a continued decrease which began in 2Q01. Improved growth rates have not affected unemployment rates, and in January-May the number of employees was similar to the same period in During 1H04, unemployment rate continued to be high, and reached 10.9% in May vs. 10.9% by the end of 2003 and 10.5% by the end of However, during January-May average salary in real terms (trend data) increased by approx. 4% vs. the same period last year. Unemployment rates impact mainly on insurance companies' life assurance businesses. INSURANCE SECTOR Most of the Israeli insurance sector is concentrated in five main groups. In 2003, life assurance premiums of these groups constituted approx. 95% of total premium in life assurance, and general insurance premium constituted approx. 73% of total premium in the general insurance line. Insurance companies sell similar products, therefore there is severe competition in general insurance as well as in life assurance and health insurance. In life assurance there is also competition from other entities which offer long term savings, such as pension and provident funds and banks selling savings plans. DEVELOPMENTS IN LEGISLATIVE ARRANGEMENTS TAXATION 1. Insurance companies and Tax authorities signed a taxation agreement extending the 2002 agreement for Such an agreement for 2004 has not been signed yet. 2. On June 29 th, 2004, the Knesset approved an amendment to the Income Tax Ordinance (No. 140 and temporary order) 2004, which decreases gradually, as of January 1 st, 2004, tax rates imposed on companies from 35% (44.52% for financial institutions) in 2004 to 30% (40.17% for financial institutions) as of 2007 and afterwards. In 2Q04, the above amendment caused a one-time NIS 31.4 million decrease in expenses on income tax in respect of deferred taxes, and an addition of 5

6 approx. NIS 1 million in capital fund due to a renewed real estate evaluation addition (see Note 7 to Financial Statements). EFFECTIVE PROVISIONS In May 2004, the Finance Committee of the Knesset approved amendments to the Regulations Regarding the Supervision on Insurance, whose main points are: A. As of January 1 st, 2004, financial statements will no longer be adjusted, see Note 1 c to Financial Statements. When CPI increases, this will have the following impact compared with the adjustment method: - A decrease in comparison data of the same period last year (stated in terms of 12/03 CPI) by full increase in CPI in the reported period. - In business reports there was a change in the composition of costs, with no material change in profit, mainly an increase in investment profits against increased growth in outstanding claims and insurance reserves. - The impact on net profit depends on the composition on assets and liabilities. In the reported period, impact on Company's profits is not material. B. A change in the revaluation method of bonds, loans, deposits and non-negotiable commercial certificates of debt, from a revaluation based on adjusted cost to a revaluation based on fair value. As per the new method, cashflows expected from each of the above assets will be capitalized with interest rates determined by a company which will be chosen for this purpose by the Ministry of Finance. Furthermore, the method for calculating other non-negotiable securities (non-negotiable shares, non-negotiable options and futures) was changed from a revaluation based on adjusted cost to a revaluation based on fair value. The regulation will apply as of January 1 st, 2005, mainly for assets standing mostly against profit participating policies which were purchased starting from August 1 st, It seems that this method will increase volatility in yields of profit participating policies portfolios, thus volatility in insurance companies profitability. C. - DAC in respect of life assurance and health insurance policies issued since January 1 st, 2004 are added in full to insurance companies capital requirements, vs. part of DAC which were added to capital requirements in the existing situation. Due to structural changes in the new life assurance products which are marketed as of 2004 and in remuneration of agents in respect of these products (see Life Assurance, Pension Funds and Provident Funds, Developments in the Sector hereinafter) it is difficult to estimate how material will be the impact of the expected changes on future capital requirements. - DAC in life assurance in respect of policies issued as of January 1 st, 2004 will not stand against life assurance reserves. - Loans to agents working with insurance companies will not stand against life assurance profit participating reserves. It should be noted that regarding loans to agents, the Commissioner of Insurance and insurance companies are negotiating the details of a circular regulating this issue. LEGISLATIVE ARRANGEMENTS DRAFTS 1. On May 9 th, 2004, the Commissioner of Insurance published a draft regarding granting housing loans by an insurer. Pursuant to the provisions, the provisions which apply on banks in Israel regarding housing loans will apply, as instructed by the Commissioner and with the amendments set by him. The provisions of the draft are supposed to apply on housing loans which will be granted by insurance companies as of September 1 st, Insurance companies and the Commissioner of Insurance are negotiating this issue. 2. In August, the Commissioner of insurance published a proposal for the arrangement of insurance policies sale to borrowers of mortgage banks. According to this proposal, as of January 1st, 2005, the sale of insurance policies will be through a licensed designated insurance agency, which may be owned by the bank, with extended disclosure to insureds. Insurance companies and the Commissioner will discuss this issue. 6

7 LIFE ASSURANCE, PENSION AND PROVIDENT FUNDS DEVELOPMENTS IN THE SECTOR 1. In 2004, significant changes in new life assurance plans, whose main points are a lower component of premium designated for covering general and administrative expenses, commissions for agents and profits, as well as a change in collected management fees from insureds from variable to fixed, became effective. The decrease of premium component for expenses changed commission agreements with agents, whose main points are longer commission spreads and a significant decrease in commissions paid to agents in the policy's first year. At this stage, the changes in commission agreements with agents reduced new sales, especially in 1Q04, with a significant moderation in 2Q04. However, there is a significant decrease in policy cancellation rates and a decrease of premium in existing policies, due to the change in the way commissions are paid to agents, as well as due to the instructions of the Commissioner of Insurance to insurers and insurance agents regarding changing policies for insureds (see Developments in Legislative Arrangements, Effective Provisions, 1 hereinafter). 2. In 2003 a pension funds reform was introduced, aimed at financing the actuarial deficit in Trade Union pension funds in deficit. As per the settlement there were changes, among other things, in the way pension funds in deficit are managed, in members' rights, in the rate of management fees collected from members, in the determining retirement age for pension and in the way determining wages are calculated. In addition, there were changes in investment regulations of old and new funds, so that designated bonds are no longer issued for old funds as of September 2003, and for new funds as of January 2004, until the rate of designated bonds out of total funds' assets is 30%, and the rest will be diverted to investment on the capital market. Furthermore, by the end of 2003, the State took over the pension funds from the Histadrut, and now they are managed by managers licensed by the State. During June-July 2004, the Commissioner of Insurance issued instructions regarding the sale of new pension funds owned by the pension funds in the arrangement. As per these instructions, the Group's insurance companies will not be allowed to paricipate in the purchase of a controlling share in Mivtachim pension fund, but they may participate in the purchase of a controlling share in New Makefet Management of Pension and Provident Funds Ltd. (hereinafter: "Makefet"), as long as it joins an overseas company. There are no restrictions on the purchase of a controlling share in Meitavit Pension Funds Management Company Ltd. (hereinafter: "Meitavit"). Migdal joined an oberseas company in which the Company's controlling shareholder has an interest. 3. The Ministry of Finance and the Knesset are considering the implementation of a reform in the Israeli financial brokerage array through committees established for this purpose, in order to reduce centralization in the Israeli financial sector. Among other issues, the possibility that policies would be distributed by banks is also being examined. DEVELOPMENTS IN LEGISLATIVE ARRANGEMENTS EFFECTIVE PROVISIONS 1. In April 2004, the Commissioner of Insurance distributed an update of a circular, which came into effect in the beginning of the year, regulating the activities of insurers and insurance agents as far as switching or changing life assurance and health insurance policies are concerned, in order to provide insureds with comprehensive information regarding the above mentioned insurance products. 2. On February 19 th, 2004, the Commissioner distributed a circular, effective as of January 1 st, 2005, forcing insurance companies to provide comprehensive information regarding covers, premium breakdown into various components as well as management fees and expenses, in life assurance plans which include a savings component while giving an insurance proposal and while producing policies. 3. On March 24 th, 2004, the Knesset approved Amendment No. 12 to the Law of Supervision on Insurance Businesses, in the framework of which the Income Tax Ordinance was amended, and the Ministry of Finance intends to make a complementary amendment in the Income Tax Regulation (rules for the approval and 7

8 management of provident funds 1964). Further to these amendments, the following changes will be effective as of January 1st, 2005: a. The ceiling entitling for provision for capital for employees was reduced, and is NIS 7,000 per month (instead of NIS 9,900). b. The ceiling for provisions for capital and annuity in managers' insurance (in respect of all employee's employers) will be 4 times the average salary in Israel, including the capital part (in the past, the ceiling was similar to the income entitling for capital plus 4 times the average salary for annuity). c. Employer's provision to benefits may be up to 7.5% of the employee's salary (previously only up to 5%), and the provision for covering occupational disability may be included in the provision for benefits. If employers choose to make provisions for occupational disability beyond their provisions to benefits, they may increase provisions to benefits to a rate not exceeding 7.5%, together with the provision to occupational disability. d. Provisions of the employer's compensation component for annuity may be only in the same provident fund account to which he makes his provisions to annuity (in the past, the condition was employers' provisions to retirement benefits for annuity in the provident fund). e. The recognition of individual insureds' provisions to article 45a was reduced to death risk premium only (in the past, it could include the savings component in individual policies). At this stage, it is impossible to estimate the impact of changes on insurance companies. 4. On March 2004, the Commissioner of Insurance distributed instructions regarding the presentation of assets and liabilities in life assurance plans. According to these instructions, Hetz designated bonds issued in the years will be presented according to their nominal value and will not be revalued with the negative CPI accumulated since they were issued. However, insurance reserves standing against these bonds will be revalued as per the changes in the CPI as required by the policies conditions. As a result, Migdal recorded an NIS 33 million profit in the life assurance businesses report, an addition of NIS 18 million to net profit in 2003, and NIS 4 million profit in life assurance, an NIS 2 million addition to net profit in 1Q04. In 2Q04, due to CPI increase, life assurance business report recorded a loss of approx. NIS 37 million, an NIS 20 million decrease in net profit. 5. On April 2004, an amendment to the Income Tax regulations (rules for the approval and management of provident funds) 1964, was approved, as follows. a. A change in the revaluation method for non-negotiable assets held by provident and pension funds, similar to the rules applicable for insurance companies (see General, Effective Provisions, article 2 above). b. Management fees that a company managing a new comprehensive pension fund may collect should not exceed 6% of premium, as well as up to 0.5% of the fund's assets balance, instead of management fees of 8% (6% in order to cover expenses and 2% for reserves) up until now. 6. On April 2004, the Commissioner of Insurance distributed provisions determining insurers' obligation to provide an insurance continuity to insureds in collective LTS policies sold or renewed as of April 1 st, 2004, by providing the possibility to shift to an individual policy without renewed underwriting or a qualification period for insureds who were insured by the group policy for at least one year. 7. On July 2004, an amendment to the Income Tax regulations (rules for the approval and management of provident funds) 1964, was approved, as follows: a. There will be an obligation to revaluate assets on a daily basis, calculate annual yields based on daily data, along with canceling cashier interest rate. The above amendment will prevent cross subsidizing of investment profit between members. It b. A change in the rules for withdrawing money from provident funds for retirement benefits. The amendment will allow, among other things, to withdraw money from provident funds for retirement benefits when members reach retirement age, with no additional conditions. Furthermore, 8

9 the proposed amendment cancels the possibility to withdraw funds belonging to a salaried member from provident funds for retirement benefits before retirement age, unless there is a severe economic or health problem. c. A change in the reporting method to members in pension funds and an expansion of reports to members in new pension funds. d. Setting arrangements for transfer of money between provident funds. e. Setting arrangements regarding investment tracks in provident funds. f. Additional changes in arrangements determined in regulations regarding related parties. The amendment's general implementation was set to 30 days after the publication of the amendments, except for a few material amendments (mainly clause a. above) whose implementation was postponed to January 2 nd, LEGISLATIVE ARRANGEMENTS DRAFTS 1. Insurance companies and the Commissioner of Insurance are negotiating the possible separation in the financial reporting between the savings component and the risk component in life assurance policies, and the savings component in insurance policies shall be recorded in balance sheets only, and only the balance shall be recorded as an income in the business report, similar to the rules stated in the new international accounting standard regarding insurance contracts. 2. After the Commissioner of Insurance appointed a think tank in order to set general rules regarding management fees paid by the profit participating policies and provident funds for investment funds, mutual funds and similar financial instruments, the Commissioner issued a decision according to which management fees in respect of investment funds will be considered as commissions (therefore from the insured's/member's account), while management fees in respect of mutual funds in Israel and abroad will be considered as management fees (therefore will be from the management fees collected by the insurer/managing company). As per the above decision, all management fees paid to related parties will be considered as management fees and not as commissions. Procedures (changes of regulations) in order to implement the above decision have not been prepared yet and insurance companies are discussing this matter with the Commissioner of Insurance. GENERAL INSURANCE DEVELOPMENTS IN THE SECTOR 1. According to data of the Israel Insurance Association, premium volumes remained unchanged in 1Q04 compared with the same period last year (a 0.6% decrease). 2. According to the data of the Israeli Police, the number of car thefts in 1H04 increased to 77, vs. a daily average of 68 car thefts in 1H03, and a daily average of 69 in the entire According to data published by the Central Bureau of Statistics, the number of house and commercial burglaries in 1H04 increased by approx. 4% compared with the same period in Health Ministry informed insurance companies that it intends to significantly increase maximum hospitalization tariffs. This increase would somewhat increase the cost of claim in CMBI line. Until the publication date of this report, hospitalization tariffs were not increased. DEVELOPMENTS IN LEGISLATIVE ARRANGEMENTS EFFECTIVE PROVISIONS 1. On March 3 rd, 2004, the Commissioner of Insurance issued instructions regarding recording expenses stemming from issuing new policies in the disease and hospitalization line in general insurance as DAC, similar to the rules common in life assurance policies. The instructions apply to policies issued as of January 1 st, 2004, starting from the date in which insurers' liability in disease and hospitalization line is presented in financial statements as per an actuarial evaluation. 9

10 Insurance companies and the Commissioner of Insurance are discussing the implementation of actuarial evaluations in disease and hospitalization insurance. 2. On March 15 th, 2004, the Supreme Court ruled regarding the estate of Michael Ettinger (Ettinger affair) which overruled a rule which was effective for years (Gavriel ruling). The old ruling stated that an injured person's estate is not compensated for the loss of ability to earn money in the years his life expectancy was shortened ("the lost years"). In Ettinger affair, the Supreme Court states that in the case of an injured person who is alive, and whose life expectancy was shortened, as well as his estate, are entitled for a compensation for his loss of ability to earn money in respect of the lost years as well, in the amount of the difference between the lost income and the expenses which were saved. The Supreme Court returned the case to the District Court for continued discussions regarding compensation. At this point, the implications of the ruling on the cost of claims in CMBI and liabilities lines may not be assessed (Ettinger affair). 3. In May 2004, the amendment to the Regulations of the Supervision on Insurance Businesses (conditions of contracts regarding private vehicles) (amendment) 2003, regarding changes in standard motorcar policies, whose aim is, among other things, having more flexible policies, came into effect. 4. The Commissioner of Insurance set principles for the approval of homeowners insurance tariffs for borrowers in mortgage banks, as of 2004, so that a minimal rate of damages (rate of claims out of premium) was determined. The implementation of these principles will be gradual till THE CAPITAL MARKET General Positive trends characterizing financial markets in 2003 and 1Q04 subsided and most investment channels recorded low real yields or even negative ones. Interest rate cuts by the BoI stopped, and in the three months of 2Q04, it remained unchanged at 4.1%. Inflation in April, May and June was -0.1%, 1.1% and 0.4%, respectively. By the end of 2Q04, CPI increased by 1.4% (known index). Inflation since the beginning of the year totaled 1.2% (known index). Bonds Non-linked bonds By the end of the first quarter, yield to maturity on short term bonds was approx. 4.5% and on long term bonds it was approx. 7.5%. In April yields to maturity were the highest in the last six months approx. 7.7% (for 8-9 years). These increases in yield to maturity are one of the reasons why BoI stopped cutting interest rates and left it unchanged. In May there was high volatility in long term non-linked bonds, mainly because of the long term non-linked bonds market in the USA, which has become a very important factor in the domestic market. In Israel and the USA yields increased by the beginning of May and declined by the end of that month. In June, yields to maturity of non-linked bonds continued to decline, mainly the short and medium term ones. By the end of June, yields for 3 years were approx. 6.1%, yield on one year short term loans was 4.8%, while in long term bonds (8-10), yield was approx. 7.5% by the end of the quarter. In 2Q04, non-linked bonds recorded real average yield of -0.3%, and since the beginning of the year real yield of -0.1%. CPI-linked bonds By the end of 1Q04, yields to maturity on short and medium term bonds were approx. 3.7% and in long term approx. 4.4%. In April, real yield to maturity on medium term CPI-linked bonds decreased to approx. 3.5% on average. In long term bonds, yield to maturity was 4.4%. In June there was a decline by approx. 0.1% in long term bonds, to approx. 4.3%. In medium term bonds there was no change in yield to maturity towards the end of the quarter, and it remained at approx. 3.5%. By the end of the quarter, the fixed income channel yielded approx. -0.1% in real terms on average, and 1% real yield since the beginning of

11 Shares In Israel The domestic stock market recorded a positive trend in 2Q04, but to a lower extent compared with those in 2003 and 1Q04. Moderate increases were recorded in April, in May volatility was high but indices remained pretty unchanged, and in June it recorded steep price increases. TA-100 reached a new record, 596 points, in June, and Maof index was close to its previous record. The main reasons for price increases in share indices are the disengagement plan, which is seen by investors as a positive step for the economy, and the decline in yields on bonds, which increases the attractiveness of the share channel. In 2Q04 the general share index increased by approx. 4.3% in real terms, the Maof recorded an increase of approx. 5.2% in real terms, and the Yeter 7.2% in real terms. Since the beginning of the year these TASE indices recorded real yields of 14.1%, 9.3% and 31.4%, respectively. Abroad In 2Q04, foreign markets were characterized with high volatility and with mixed performance. During the first half of the quarter there were sharp price decreases, however, there were steep price increases in the second half of the quarter. Leading global indices ended 2Q04 with moderate price increases of 1%-5% in nominal terms (excluding the impact of Forex). The Dow Jones recorded Forex adjusted real yield of -1.3%, Nasdaq yielded 3.3% and Nikkei recorded 3.6%. Since the beginning of the year, these indices recorded Forex adjusted real yield of 1.3%, 4.8% and 10.5%, respectively. Foreign currency In 2Q04, the Shekel appreciated by approx. 1.28% against the currency basket. Most of the appreciation is attributed to the Dollar, whose rate decreased from NIS 4.53/$ to approx. NIS 4.5/$, a nominal appreciation of approx. 0.7% (2.1% in real terms). The Euro rate was NIS 5.53/Euro in the beginning of the quarter, and it decreased by 1.3% to 5.46/Euro. Since the beginning of the year, the Shekel depreciated by 2.7% in nominal terms against the Dollar (1.5% in real terms), while since the beginning of the year the Shekel appreciated by 1.2% in nominal terms vs. the Euro (-2.4% in real terms). 11

12 Enclosed please find real yields (known index) in investment channels in January-June vs. the same period in 2003: Investment Channel Second First half Second First half quarter quarter General bond index -0.3% 0.6% 6.0% 9.5% Forex-linked government bonds -0.9% 2.1% -6.7% -8.2% CPI-linked government bonds total -0.1% 1.0% 5.7% 8.4% CPI-linked government bonds maturity 0-2 years 0.0% 1.2% 1.4% 2.6% CPI-linked government bonds maturity 2-5 years 0.0% 2.0% 4.0% 6.0% CPI-linked government bonds maturity 5-7 years 0.2% 2.0% 6.2% 9.2% CPI-linked government bonds maturity 7-10 years 0.3% 1.4% 8.3% 12.2% CPI-linked government bonds maturity years -0.3% 0.1% 9.8% 14.0% Unlinked government bonds - total -0.3% -0.1% 7.9% 12.9% Convertible bonds 3.8% 9.8% 7.3% 12.6% Corporate bonds -0.8% 1.8% 6.0% 8.6% General share index 4.3% 14.1% 31.7% 36.7% Maof % 9.3% 33.2% 32.8% TA 75 index 1.4% 11.1% 35.7% 46.0% TA 100 index 3.9% 10.2% 33.3% 36.6% Yeter 7.2% 31.4% 29.3% 29.8% Dollar USA -2.1% 1.5% -7.5% -8.8% Euro -2.6% -2.4% -3.1% -0.7% S & P % 4.1% 4.3% 1.0% Nasdaq % 4.8% 9.1% 11.3% Insurance companies, including the Company, invest a large part of their asset portfolio in negotiable assets. These assets are recorded as per their value on the Stock Exchange on the date of the report, therefore, yields on the capital market have a material impact on insurance companies' profits. C. LEGAL PROCEDURES 1. On the matter of the claim filed against Migdal concerning mortality tables in life assurance, and a request to approve this claim as a class action, see Note 4 (a) to the Financial Statements. 2. On the matter of a claim filed against Migdal concerning commissions or participation in profits paid to mortgage banks in respect of collective life assurance, in which persons who took mortgages in mortgage banks are insured, and a request to approve this claim as a class action, see Note 4 (b) to the Financial Statements. 3. On the matter of a claim filed against Migdal concerning the collection of stamp tax, and a request to approve this claim as a class action, see Note 4 (c) to the Financial Statements. 4. On the matter of an additional claim filed against Migdal concerning mortality tables in life assurance, and a request to approve this claim as a class action, see Note 4 (d) to Financial Statements. 5. On the matter of the dismissal of a claim filed against Migdal concerning the collection of stamp tax in excess, and the request to approve this claim as a class action, see Note 4 (e) to the Financial Statements. 12

13 D. FINANCIAL CONDITION 1. Enclosed principal data from the financial statements (in NIS millions) 30/6/04 30/6/03 31/12/03 31/12/02 Balance Sheet Data Total balance sheet 43,197 39,449 41,952 36,661 Total investments 39,162 35,340 38,027 32,676 Total shareholders' equity 2,542 2,166 2,415 1,985 Insurance Reserves and Outstanding Claims Life assurance: Insurance reserves and outstanding claims: - gross 35,278 32,350 34,099 30,020 - re-insurance Out of which, reserve for extraordinary risks General insurance: Insurance reserves gross re-insurance Outstanding claims gross 2,611 2,396 2,492 2,207 - re-insurance Data from Business Reports 1-6/ / Life assurance business Premium 2,262 2,283 4,546 4,846 Premium less re-insurance 2,207 2,218 4,417 4,740 Total profit General insurance business Premium including fees 1,046 1,055 1,748 1,769 Premium including fees net of re-insurance ,231 1,190 Total profit Profit and loss report Profit before taxes and other items Net Profit Return on capital in annual terms 20.7% 19.1% 22.2% 5.2% Total G & A expenses Equity increased from approx. NIS 2,415 million as of December 31 st, 2003, to approx. NIS 2,542 million as of June 30 th, The increase stems mainly from a net profit of approx. NIS 250 million less an NIS 125 million dividend. 3. In March 2004, the Company sold BLL shares constituting 4.2% of the Bank's issued capital and voting rights out of approx 8% of the Bank's shares held as a permanent investment (see Note 6 to Financial Statements). Net profit for the Company from selling the shares is NIS 20 million. Furthermore, in February 2004 the Company received an NIS 26 million dividend from Bank Leumi. In June 2004, the Company received another NIS 3 million dividend. 13

14 After selling the shares, the Group's holdings in BLL shares decreased to below 5%, and the Group ceased being an interested party in the Bank. The adjusted cost of BLL shares after the sale amounts to approx. NIS 474 million. The investment's value in the books amounts to NIS 450 million, after a write down of the investment was performed in 2002 (see Note 6 to Financial Statements). The value of investment on the Stock Exchange as of the date of balance sheets is approx. NIS 473 million and as of August 23 rd, 2004 approx. NIS 478 million. E. RESULTS OF OPERATIONS GENERAL The Group's net profit totaled NIS 250 million, compared with a net profit of NIS 190 million in the same period in In 2Q04 net profit totaled NIS 97 million, vs. NIS 116 million in 2Q03. Profit from life assurance businesses totaled NIS 205 million (NIS 45 million in 2Q04), vs. NIS 294 million in 1H03 (NIS 181 million in 2Q03), although in January-mid-May no variable management fees were collected due to an aggregate real loss from 2002 in the profit participating policies. Profit in general insurance amounted to NIS 77 million (NIS 50 million in 2Q04) vs. NIS 62 million in 1H03 (NIS 31 million in 2Q03). The increase in net profit in the reported period stems mainly from capital gains on the sale of part of BLL shares and from a dividend received on these shares (last year no dividend was received on BLL shares), which increased profit before tax and net profit by approx. NIS 49 million in 1Q04, and from a decrease of approx. NIS 31.4 million in 2Q04 in tax expenses in respect of deferred taxes due to lower tax rates (see Results of Operations, General, Taxation above). The decrease in net profit in 2Q04 is mostly due to the decrease in revenues from negotiable investments against insurance reserves and against capital. In light of the changes in life assurance plans, and as a result of lower commissions paid to agents, there was a decrease in new sales, along with a significant decline in the rate of policy cancellations. In general insurance, there was an improvement in underwriting profit as a result of a decline in motorcar property claims, which was significantly offset by a decline in revenues from negotiable investments against insurance reserves. LIFE ASSURANCE Premiums reported in life assurance amounted to approximately NIS 2,262 million, compared with NIS 2,283 million in 1H03, a 0.9% decrease. The scope of premium in the reported period was affected by the decline in new sales, which moderated during 2Q04, along with a significant decrease in policy cancellations (see the Company's Business Environment, Life Assurance, Pension and Provident Funds). In addition, in the reported period Yozma old fund was not consolidated in life assurance businesses, and as a result, reported premium decreased by NIS 16 million (see Note 3 to Financial Statements). Profit totaled NIS 205 million, compared with a profit of NIS 294 million in 1H03. In 2Q04, profit amounted to NIS 45 million vs. NIS 181 in 2Q03. The decrease in profit stems mainly from lower revenues from investments against guaranteed yield policies in 2Q04, partly due to losses recorded in respect of investment profits, in the amount of approx. NIS 37 million in 2003 (see also Business Environment, Life Assurance, Pension and Provident Funds, Effective Provisions, article 4 above). The decline in investment revenues was partly offset by an increase in variable management fees in respect of profit participating policies, which were not received in Januarymid-May In 2003 the Company began to receive variable management fees only as of May, when losses imputed to insureds in 2002 were fully covered. Furthermore, an increase in death and disability claims caused a decrease in profit. It should be noted that a decrease in cancellations decreased the decline in DAC, and as a result it increases profit. This phenomenon was offset by an increase in portfolio persistency commission, which are not recorded as DAC. 14

15 The rate of Administrative & General expenses out of premium increased by 0.4%. The rate of commissions out of premium decreased by 0.9%, mainly due to a decline in new sales, as well as a longer spread of commissions and lower commissions paid to agents in the policy's first year, which were partially offset by payment of commissions in respect of portfolio persistency. The rate of surrenders out of reserves has decreased compared with 1H03. The rate of return in real terms on profit participating policies produced by Group companies since 1992 (J Fund), are shown below (in percentages): Migdal The Magen Rate of return for January-June 2004 Before management fees After management fees Rate of return for January-June 2003 Before management fees After management fees As per the instructions of the Commissioner, in 2003 the members of the Group charged variable management fees in respect of the profit participating portfolio only after achieving a positive yield, which covers the loss imputed to insureds in Starting from mid-may 2003, when the loss imputed to insureds in 2002 was fully covered, the Group's companies charged variable management fees as well. In light of the above, management fees in the amount of approx. NIS 160 million were not collected in Enclosed please find details regarding estimates of investment profits imputed to insureds in profit participating portfolio in life assurance and management fees calculated according to instructions set by the Commissioner of Insurance based upon yields and quarterly balances of insurance reserves in the Company s business reports (in NIS millions). 1-6/ /2003 Investment profits imputed to insureds after management fees 771 1,466 Management fees GENERAL INSURANCE The total premium in general insurance, including fees, amounted to approx. NIS 1,046 million, compared with NIS 1,055 million in 1H03, a 0.8% decrease. Premium decrease was caused mainly by the property motorcar and commercial business lines. Retained premium including fees amounted to approximately NIS 736 million, compared with NIS 738 million in 1H03. Profit amounted to approx. NIS 77 million, compared with NIS 62 million in 1H03. In 2Q04, profit totaled NIS 50 million compared with NIS 31 million in 2Q03. The increase in profit was due to higher underwriting profit, mainly a significant improvement in the property motorcar line due to a decrease in claims, and an improvement in health insurance results. In the reported period, investment profits totaled NIS 71 million vs. NIS 103 million in 1H03, due to a decrease in negotiable investments against insurance reserves. In 2003, part of insurance reserves were imputed to to the surplus reserves of CMBI and liabilities lines. INCOME NOT INCLUDED IN INSURANCE BUSINESS Income from investments not included in the insurance business reports, net of interest expenses on long-term liabilities, amounted to a profit of NIS 56 million, compared with NIS 5 million in 1H03. The improvement in revenues from these investments stems mainly from a capital gains of NIS 20 million on the sale of part of BLL shares (see Financial Conditions, article 3 above) and from a dividend of NIS 29 million received in respect of these shares. Revenues from insurance agencies amounted to NIS 17 million vs. NIS 22 million in 1H03. 15

16 The Company's income from Migdal Capital Markets in respect of management of financial assets and Stock Exchange services amounted to NIS 6 million vs. NIS 3 million in 1H03. PROFIT Profit before taxes on income amounted to approx. NIS 347 million, compared with approx. NIS 368 million in 1H03. Net profit amounted to NIS 250 million, compared with NIS 190 million in 1H03. In 2Q04 profit before taxes amounted to NIS 103 million vs. NIS 220 million in 2Q03, and net profit totaled NIS 97 million vs. NIS 116 million in 2Q03. The increase in net profit in the reported period stems mainly from capital gains on the sale of part of BLL shares and from a dividend received on these shares (last year no dividend was received on BLL shares), which increased profit before tax and net profit by approx. NIS 49 million in 1Q04, and from a decrease of approx. NIS 31.4 million in 2Q04 in tax expenses in respect of deferred taxes due to lower tax rates (see Results of Operations, General, Taxation above). The decrease in net profit in 2Q04 is mostly due to the decrease in revenues from negotiable investments, less the decrease in expenses on taxes as mentioned above. F. CASH FLOW The consolidated cash flows stemming from the Group s current activity totaled NIS 934 million from life assurance businesses, NIS 54 million stemmed from activity in general insurance and NIS 50 million served for other current activity. In total, net consolidated cash flows stemming from current activity, amounted to NIS 938 million. The consolidated cash flows stemming from investment activity included, among other things, NIS 505 million which stemmed from the realization of BLL shares, NIS 542 million served for a net increase in securities, and approx. NIS 109 million stemmed from a net decline in loans and deposits and NIS 20 million which served for the net acquisition of fixed assets and real estate for rent. In total, net consolidated cash flows stemming from investment activity, amounted to NIS 40 million. The consolidated cash flows serving for financing activities included, among other things, NIS 230 million, which served for net repayment of long term loans and short term credit from banking corporations, NIS 78 million served for the realization of marketable securities and NIS 125 million which served for dividend payment. In total, net consolidated cash flows serving for financing activity amounted to NIS 434 million. The Group s cash balance increased from approx. NIS 1,257 million in the beginning of the period to approx. NIS 1,800 million, at the end of the period. G. FINANCIAL RESOURCES 1. The total scope of long term loans received less current maturities totaled NIS 212 million as of June 30 th, 2004 (NIS 223 million as of June 30 th, 2003). Total scope of short term loans received, including current maturities totaled NIS 419 million as of June 30 th, 2004 (NIS 496 million as of June 30 th, 2003). The balance of short term loans as of June 30 th, 2004 includes approx. NIS 275 million in respect of real estate assets acquired against profit participating policies reserves. 2. Migdal Insurance paid the Company a dividend in the amount of approx. NIS 160 million. 16