Insurers' own portfolios could destabilize them

The largest proprietary trading portfolios in the Israeli capital market are maintained by insurance companies.

While the typical proprietary portfolio, through which a company manages investments for its own profit rather than that of its clients, generally ranges in value from tens of millions to hundreds of millions of shekels, Israeli insurance companies have proprietary accounts worth billions of shekels each.

The source of the funds that make up the insurance companies' proprietary holdings is substantially different from that at the investment houses.

While investment firms' proprietary portfolios are funded by the firms themselves without any direct connection to their customers' assets, insurance company proprietary trading is financed by reserves that the companies are required to set aside to assure that they can pay out claims made by their customers. This difference also influences how the proprietary assets are managed.

Insurance companies are obliged by law to have a special proprietary investment committee that operates subject to specific laws and regulations. It is required to operate entirely separately from any of an insurance company's other investment committees that manage policyholders' funds.

An insurance firm's proprietary assets are drawn from three sources: its capital, funds from property and casualty insurance and funds from life insurance policies issued prior to 1991. (Life insurance policies issued from 1991 onward are structured to participate in the firm's profits and are managed outside of the company's proprietary portfolio.)

Because these proprietary assets affect the financial strength of the insurance company and are meant to be available to meet policyholders' claims, they are under the permanent regulatory supervision of the Finance Ministry's commissioner of capital markets, savings and insurance.

The special proprietary investment committees, on which several of the company's directors sit, convene on a regular basis, generally once a month, and shape the investment policy for the proprietary portfolio. Investment managers therefore do not have free rein to invest as they would wish.

Most proprietary assets are invested in illiquid debt, meaning obligations not listed for trading on a stock exchange and are therefore not readily sold. Only a small portion of assets are invested in stocks. The portfolio generally includes funds backing long-term life and disability insurance policies on which long-term investments are made, including real estate and illiquid credit transactions. In contrast, premiums from property and casualty policies are directed to shorter term investments of up to three years.

Insurance companies also pride themselves on the sophisticated supervision and risk management mechanisms they have in place. At Migdal Insurance, for example, supervisory control consists of preventative measures, remedial measures and reporting mechanisms through which reports are constantly provided to management on the state of investments. At Harel Insurance there is a risk management unit that analyzes risks in the firm's proprietary portfolio and provides immediate notice of any changes. The unit does not report to the investment portfolio managers, so it provides an independent, objective view.

Although insurance companies' proprietary investment committees are separate from those managing policyholders' funds, at some insurance companies TheMarker found that in some cases the people who manage the proprietary portfolios also manage policyholders' assets.

Although Migdal Insurance and Phoenix Insurance each maintain distinct and physically separate staffs for the two functions, at Harel the chief investment officer, Amir Hessel, is also responsible for the firm's proprietary assets.

The 40 employees in Hessel's investment division handle both policyholder assets and the firm's proprietary holdings. The investment accounts are maintained separately, it should be noted, but from a physical perspective and with respect to staffing of the operations, there is no separation.

Harel has a slogan that "What is good for us [for our proprietary account] is also good for our policyholders."

A similar situation prevails at Menorah Insurance, where Yoni Tal is in charge of investment for pensions, managers' insurance, provident funds and proprietary assets. Menorah staffers said that when dealing with debt instruments, it is the same for all kinds of investments.

At Clal Insurance, however, staff said there was a clear separation between proprietary asset management and that of policyholders' assets. The Clal group's Canaf investment division is divided into two for this purpose, and although the two departments work on the same floor of offices they are physically totally separate. Sources at Clal said the company was the first insurance company to institute such a separation, a decade ago. The separation covers staff, trading rooms, investment committees and decision-making. Clal maintains a joint real estate division, however, which manages both proprietary portfolios and policyholder assets.

The salary and other compensation that most insurance company's proprietary asset managers receive are generally not tied to the specific yields on the assets they manage. Sources at Menorah, for example, said there are bonuses but they are not directly calculated from the performance of the proprietary portfolio.

The situation is similar at Harel, Clal and Phoenix, but sources at Migdal said their proprietary managers' compensation is affected by both the performance of their portfolios and the performance of the company in general.