The effect of the risk-free interest rate is obvious in the financial statements that the insurance companies will soon publish for the third quarter of 2019. The largest company in the Israeli insurance market, Harel Insurance Investments and Financial Services Ltd. (TASE: HARL), is revealing that it will be important, and will cause the company a NIS 250 million loss in the third quarter.
Harel, managed by CEO Michel Siboni, published a profit warning today, saying that it had made an enormous NIS 900 million pre-tax provision in the third quarter, with the nursing care branch accounting for two thirds of this amount.
This state of affairs is projected to affect most of the large insurance groups in Israel. The provision results from changes in the risk-free interest rate curve. Like most of its competitors, Harel recently stopped marking individual nursing insurance policies for new customers because of these interest rate effects, the abandonment of the branch by reinsurers, and demographic changes affecting the branch. Among other things, the possibility of the insurance companies resuming marketing of new individual nursing insurance policies by marketing policies that do not guarantee a return is under consideration. Policies with a guaranteed return are now causing Harel's huge expense for increasing insurance reserves.
The risk-free interest rate is relevant mainly to calculations of reserves and profits in three long-term insurance branches: nursing insurance, life insurance polices with a guaranteed return, and liability insurance in general insurance branches. Harel warned today that the group's results were strongly affected by the steep fall in this interest rate, forcing the company to publish its unusual profit warning.
The Capital Market, Insurance, and Savings commissioner instructed the insurance companies to calculate their reserves according to the linked interest rate plus 2.5%. The insurance companies must calculate their ability to provide a return according to the risk-free interest rate curve. Regardless of the returns of these concerns so far this year, the returns for portfolios that depend on the capital markets and do not guarantee a return are 9%.
In practice, the risk-free interest rate is the basis for calculating the insurance companies' liabilities. When the rate falls, as happened in the third quarter, the companies have to increase their reserves, which lowers their pre-tax profit. This increased the reserves by NIS 900 million in the third quarter, including NIS 600 million just in the nursing insurance branch.
Without the decrease of over 0.5% in the risk-free interest rate, Harel would have had a profit of NIS 400 million in the third quarter and over NIS 1 billion in the first nine months of the year, which would have been record results for the company. Now, however, Harel is warning that it will post a NIS 200-260 million loss in the third quarter, thereby reducing its profit in January-September 2019 to NIS 450 million, as a result of the huge provision.
Siboni commented, "The fact that despite a huge provision of over NIS 900 million, we will still finish the first nine months of the year with a total net profit of NIS 450 million highlights Harel's financial strength and soundness. From a business standpoint, excluding the effect of the interest rate, this is Harel's best year since it was founded."
Siboni added, "Our NIS 900 million provision will secure payment of claims to policyholders for decades in the future. Obviously, if the interest rate rises in the future, all or part of this amount will be added to the company's profit line, depending on how much the rate rises." Harel's market cap is NIS 6 billion.
Published by Globes, Israel business news - en.globes.co.il - on November 6, 2019
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