Taking Stock / The Naked Insurer

What will the insurance companies do when the money starts leaking out of the provident and mutual funds? Can they force the customers to stay put? Sadly for them, they can't.

After months of reading in the papers how the power is shifting from the banks to the insurance companies, the managers of the insurance companies made a serious mistake. They began to believe it.

The story seemed straightforward enough. The banks had a flock of cash cows, in the form of provident and mutual funds. The Bachar commission forced them to sell these precious assets. So the insurance companies wrote fat checks and bought them, expecting them to start laying golden eggs for them, too.

The insurers smelled tremendous power passing from the two big banks to the five big insurance companies. But if we analyze the structure of the capital market and the business models of the banks and insurance companies, we discover that the truth was, well, the opposite.

What banks really do

The sweetest business in the financial sector wasn't at the banks, but at the insurance companies in the first place, and not because they could charge higher fees.

Israel's banks raise money from the public, through deposits and capital market investments. They charge fees and extend loans. The borrower gives the bank a note saying, "I owe you money. If I have any I'll return the loan and if I don't, we can talk about it."

The insurance companies have a much better model. They take money from the public through standing orders, usually straight from the bank account, and give it a note. "One day you'll get your money back, when you retire or undergo some insurance event. Then you come with this note and we'll talk about it. Meanwhile, we have the money."

What insurance companies really do

Bank customers know perfectly well what interest rates they pay and get, and what fees they pay. Insurance customers meet the cost three times. The first time is when the agent shoves a policy at him, the second is 20 to 40 years later when he retires or something bad happens, and the third time is when he discovers the insurance company doesn't want to pay what he thinks he should be getting.

Bank customers know the deal. Insurance customers don't. They don't know what they're buying or what they're getting, if anything at all.

And the best part is that it's easier to get blood from a stone than money from an insurance company. Happy? Not happy? Mad about the fees? Tough. We have your money. Now dance.

Then along came the Bachar commission, which ruled that the banks couldn't wear two hats at the same time, advising and also managing other people's money. Also, power in the capital market had to become more diversified, it ruled. The banks had to sell their provident and mutual funds.

Along came the insurance companies, the biggest players in the financial market after banks Hapoalim and Leumi. They wrote some pretty big checks, and each provident or mutual fund company they bought cost them more and more.

Herd of wayward pigs in a poke

But what exactly are they buying?

They are buying liquid investment portfolios belonging to hundreds of thousands of bank customers. How did the customers' money get into the banks' provident and mutual funds? Through investment advisers at the banks.

You'd go into the bank with some disposable cash (or not) and Malka or David or Rina or Simon would say that the best option available now is to invest that money in the bank's own mutual fund "Treasure/ Returns/ Yield/ Basket/ Success/ Hope/ Strength Through Strawberries" or the provident fund "Power Fill in the blank."

But now the insurance companies are taking over management of these funds. They will rake in the fees.

Simple, no?

Not exactly. Within a few months or quarters the customers of the funds will be hearing new tunes at the banks, when they inquire as to the performance of their investment. What will Malka or Simon say? Will it be that in any case they're best off leaving their savings in the fund, whether or not it made money or lost it, because it's the best around?

No, they won't. Because now an insurance company owns the fund, not the bank for which Malka and Simon work. For Malka and Simon, "Super Power Plus Excellence" is just another name now.

And that is when the real party will begin. Money is going to start flowing faster and faster between the provident and mutual funds. Customers will shift their money from company to company, encouraged by the advisers at their bank branches, which is how it should be. They will follow the returns. On days when the bottom drops out of the market, and days like that happen, sit back and watch the surge of transfers.

Who's been skinny dipping?

What is the probability that the insurance companies will achieve better returns than the banks did from the funds? Not great. As we intimated, great asset management and service aren't exactly natural to them. They are better known for astronomical fees, hiding information from clients and battles in court. That is what they are good at.

What will the insurance companies do when the money starts leaking out of the provident and mutual funds? Can they force the customers to stay put? Sadly for them, they can't. These aren't life insurance policies, these are provident and mutual funds, which are entirely liquid vehicles. More importantly, insurance companies will never have the kind of relations with customers that banks have, which enabled them to hold on to 80 to 90 percent of their assets even when their performance was pitiful.

In short, provident and mutual funds in the hands of the insurance companies are a totally new business from what they were in the hands of the banks.

The insurance companies are chortling after their great takeover of the funds, but they are about to discover that the assets under their management are slippery. They will discover that their service, returns, marketing and brand name have to improve vastly to keep the money.

This is a good time to mention what the purpose of the Bachar reform had been: to broaden the capital market, bring in more players, create a market where the money flows to companies that do good things with it.

At the moment the stock market is booming and returns are high, so the insurance companies feel all they have to do is write checks and buy market shares, and sit back and profit. But the day the market reverses, then the true new structure of the capital market will become glaringly apparent.

Warren Buffet, investor extraordinaire, likes to say, "It's only when the tide goes out that you learn who's been swimming naked."

Israel's capital market is full of naked swimmers, some sitting on a great deal of money, and using it to buy more money. The day will come - it always does - when the tide goes out and they will be exposed. And then we will see who really managed to sew himself a new suit for the new structure of the capital market.