Gloat Away, Bankers, Fair Enough

Gloating is fun, and the banks had a lot of fun in the last couple of days. If the bankers, so spiffy in their suits and gleaming shoes, hadn't been so stuffy and distinguished, they'd have crowed to the heavens, "We told you so." We told you that if you take away the provident and mutual funds from us and let the insurance companies have them, this is what would happen.

"This" is the theft of NIS 100 million, maybe less, maybe more, that came to light entirely by coincidence at one of Israel's five biggest insurance companies, at Harel Insurance Investments (TASE: HARL). "There's no way anybody could steal NIS 100 million from one of the banks," a banker couldn't resist sniffing this week. That indicates that nobody counts Trade Bank, from which a clerk stole a quarter-billion shekels, as a "real bank", like the big ones that are properly supervised.

You might be disgusted at the arrogance of the banks and their cynical exploitation of Harel's misery to toot their own horns. But truth be told, they have a point.

The fact is that none of Israel's banks has ever suffered a major theft like happened at Harel. The fact is that the supervision and control systems at the banks are light-years ahead of those of the insurance companies, and that continues to be true even after the insurance companies bought the provident and mutual funds from the banks for hundreds of millions of shekels. De facto they doubled their assets under management almost overnight.

How many hours of internal control do they spend per million shekels?

The fact that the insurance companies lag behind the banks was stated by the person who should be most worried about it: the commissioner of insurance himself.

A year and a half ago the commissioner wrote a report that compared the internal controls at the insurance companies to that at the banks. The comparison was unflattering to the insurance companies, to put it mildly. He ruled that the best of the insurers was Migdal Insurance (TASE: MGDL), which devoted 0.5 hours of internal control per each NIS 1 million under management.

But Migdal's achievement looks pretty shabby when compared with the banks. The lowest ratio at the banks (hours spent on supervision and control per million shekels) is 0.8.

On average, the banks devote double the time that the insurance companies do to supervision and control. The Israel Phoenix Assurance Company (TASE: PHOE)  and none other than Harel Insurance Investments (TASE: HARL)  devoted the least time to supervision and control, the commissioner found.

Harel devoted 0.09 hours of internal auditing per million shekels under management, less than an eighth of the effort by the most lax bank.

Following his report of November 2005, the commissioner issued a draft directive regarding these processes at Israel's insurance companies. He wrote that the minimal ratio should be 0.7. The insurance companies disputed the need, and managed to raise so many obstacles that the draft never turned into a mandatory directive.

But something did change in that time: their assets under management. They bought the provident and mutual funds from the banks, under the Bachar reform, gaining about NIS 100 billion in assets. The nature of their operations became much more complicated, too, which somehow failed to gain expression in their internal auditing efforts.

The subsidiaries that manage provident and mutual funds, like Harel Investment, are not directly subject to the parent insurance companies: they are supposed to have internal controls of their own. But when the parent company shrugs off the need for auditing, it's hard to assume that the subsidiaries will feel differently.

In retrospect, after Harel the parent company was forced to inject NIS 125 million into Harel the woebegone investment firm to cover the embezzlement, we may assume that the insurance companies will esteem internal controls rather more highly.

Harel commented that yesterday Harel Investment hired a new internal auditor, and that one will be appointed to the parent company, to act in parallel with the external company that carried out Harel's internal auditing so far. "Since the Finance Ministry check, the group has enhanced is internal controls, and invested 6,100 hours."