Too Few Chefs Threaten to Spoil the Pension Broth

The estimated value of pension savings managed by financial institutions is currently about NIS 800 billion and they are almost all in the hands of five or six companies.

Debating legislation to address the unacceptable degree of concentration of economic power in Israel in so few hands, the Knesset Finance Committee has turned its attention to a particularly hot topic: the provision that would impose limits on holding companies having a controlling stake in both financial and non-financial businesses.

What limitations, for example, will be imposed on someone who owns sizable non-financial businesses from also having a major interest in a bank or insurance company? And will changes in the law require the holding groups that already have a controlling interest in a major bank to sell it?

And getting down to details, the issue of where the ceiling should be drawn could prompt massive pressure from leading business people who stand to lose big.
But this whole issue is actually distracting the Knesset from a far more important matter. The cross-ownership of financial and non-financial businesses is just one of two kinds of concentration of economic power in the financial sector. And the other is getting no attention in the current debate, even though it is potentially no less dangerous: the concentration of economic power within the financial sector itself, particular in the insurance business.

The estimated value of pension savings managed by financial institutions is currently about NIS 800 billion. In just seven years, by 2020, these assets will double in value to NIS 1.6 trillion, according to an estimate by the strategic planning department in the Prime Minister’s Office presented a few weeks ago to the cabinet. There are those in the capital markets who think the figure will be even higher by 2020 − as much as NIS 2 trillion.

The most frightening aspect of this is that assets of this magnitude, which would dwarf the assets held by the country’s banks, are almost all in the hands of five or six entities − the five largest insurance companies and the smaller Psagot investment group. All five of the insurance firms offer the full range of pension products: standard pensions, provident funds and managers’ insurance. They also maintain the major marketing operations to ply their pension products to the public. Each of them is therefore a giant pension conglomerate in its own right.

That means that new players don’t have the ability to threaten their hold on the pension market. As their assets grow, each of the five insurance companies can be expected to control about NIS 400 billion in pension assets. That figure is roughly half of the current credit assets of the country’s banks put together.

From a legal standpoint, the situation poses no problem. The issue of cross-ownership of financial and non-financial businesses by a single holding company is not a major problem in the pension business either. Of the six major companies involved, it’s only an issue that affects three of them: Phoenix, Clal Insurance and Psagot. Furthermore, Phoenix and Clal are expected to be sold off.

A law barring major cross-ownership of financial and non-financial firms should also not pose a problem for the controlling shareholders at three other insurance companies: Shlomo Eliahu’s Migdal Insurance, Menahem Gurevitch’s Menora and Yair Hamburger’s Harel Insurance. Their owners’ interests are almost only in insurance, so cross-ownership is not an issue for them.

And when it comes to purely financial firms, there is no apparent problem with concentration of financial control. The law has barred pension savings management firms from controlling more than 15% of the sector’s combined assets. This should require that there be a minimum of seven firms in the business − and that is precisely the case.

Despite all of this, anyone can see that there is a highly serious problem with concentration of economic power. Looking to the future, it is inconceivable for five companies to control 95% of the public’s pension savings in a NIS 2 trillion market. A major investment misstep by one or two of them could reverberate throughout the economy.

Herd mentality

We should also recall findings released in March by a Bank of Israel study that showed that institutional investors’ portfolios are highly similar to one another. Over 40% of their investments were in the country’s five largest corporate holding groups. The Bank of Israel attributed that to the limited supply of investment options in the capital markets here, but said it was also due to concentration of economic power and a kind of herd mentality. That means all of them wanted to invest as the competition did, so they themselves didn’t risk turning in a poor performance. The similarity of the investment portfolios, said the central bank, risks turning an isolated risk into a system-wide one.

The way in which the investment firms make investment decisions is further exacerbated by the fact that the management fees they earn are not linked to the performance of their portfolios and are not subject to the risks of the market. The profits − and losses − are the clients’ to bear, which in turn makes the investment firms apathetic.

The Bank of Israel looked at that, too, while trying to figure out why the institutional investors staked so much of their portfolios on the businesses in the country’s major multi-layered holding companies − like the now-troubled IDB group − even when it was clear that a particular company may not be able to meet its obligations. The central bank cited the weakness of the incentives and that the institutions have to properly gauge the risk to which their clients’ savings are exposed. In other words, the fee structure doesn’t give the companies an incentive to make wise investment decisions.

So with all due respect to the Knesset’s concern over limiting cross-ownership of financial and non-financial businesses by a single holding company, MKs should really be dealing with the concentration of economic power and investment decision-making within the financial sector itself.

Michal Fattal