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Translated from the Hebrew original Migdal Insurance and Financial Holdings Ltd. and its subsidiaries Financial Statements As at December 31, 2006 Migdal Insurance and Financial Holdings Ltd. and its subsidiaries Financial Statements As at December 31, 2006 Index Page Independent Auditors’ report to the shareholders 3-2 Consolidated financial statements: Balance sheets 3-3 ; 3-4 Income statements 3-5 Statements of changes in shareholders’ equity 3-6 Life assurance business statements 3-7 General insurance business statements 3-8 Statements of cash flows 3-9 ; 3-12 Financial statements of the Company: Balance sheets 3-13 Income statements 3-14 Statements of cash flows 3-15 ; 3-16 Notes to the financial statements 3-17 ; 3-144 Appendix to the financial statements 3-145 ; 3-152 ------------ Independent Auditors' Report to the Shareholders of Migdal Insurance and Financial Holdings Ltd. We have audited the following financial statements of Migdal Insurance and Financial Holdings Ltd. (the Company) and the following consolidated financial statements of the Company and its subsidiaries: Balance sheets as at December 31, 2006 and 2005 - Consolidated and Company and Consolidated and Company statements for each of the three years in the period ended December 31, 2006: - Income statements - consolidated and Company - Statements of changes in shareholders’ equity - Consolidated life assurance business statements - Consolidated general insurance business statements - Statements of cash flows - consolidated and Company These financial statements are the responsibility of the Company’s Board of Directors and Management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audit in accordance with generally accepted auditing standards in Israel, including those prescribed by the Israeli Auditors Regulations (Auditor’s Mode of Performance), 1973. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Board of Directors and Management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audits as stated above: (a) The above financial statements of the Company present fairly, in all material respects, the financial position of the Company as at December 31, 2006 and 2005 and the results of its operations, the changes in its shareholders’ equity and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with generally accepted accounting principles. In addition, in our opinion, the above financial statements were prepared in accordance with the Securities Regulations (Preparation of Annual Financial Statements), 1993. (b) The above consolidated financial statements of the Company and its subsidiaries present fairly, in all material respects, the financial position of the Company and its subsidiaries as at December 31, 2006 and 2005, and the results of their operations and their cash flows on a consolidated basis for each of the three years in the period ended December 31, 2006, in conformity with the accounting, reporting and presentation principles prescribed by the Supervision of Financial Services (Insurance) Law, 1981 and the regulations enacted pursuant thereto. As described in Note 2, the aforementioned financial statements are in reported amounts, in conformity with the Accounting Standards of the Israel Accounting Standards Board. Without qualifying our opinion we draw attention to Note 32A to the financial statements with regard to the exposure to class actions. SOMEKH CHAIKIN A member of KPMG International KOST FORER GABBAY & KASIERER A member practice of Ernst & Young Global Joint Auditors Tel-Aviv March 6, 2007 3-2 Migdal Insurance and Financial Holdings Ltd. Consolidated Balance Sheets Note Investments Cash and cash equivalents December 31, 2006 2005 Reported NIS in thousands 1,481,140 1,432,425 Securities 3.A 41,056,770 37,997,230 Loans and deposits: Loans Bank deposits 4.A 5 2,553,434 3,779,587 1,889,727 3,712,863 6,333,021 5,602,590 12,626 25,099 1,644,212 1,297,642 50,527,769 46,354,986 199,149 222,126 255,531 186,261 421,275 441,792 241,103 1,131,048 62,533 250,303 1,508,180 69,764 1,434,684 1,828,247 323,793 223,899 399,385 221,551 547,692 620,936 1,982,376 2,449,183 1,130,121 74,977 31,021 1,148,051 79,947 16,068 1,236,119 1,244,066 600,056 339,580 1,836,175 1,583,646 54,767,595 50,829,607 Investments in investees 6 Real estate for lease 8.B Total investments Fixed assets Office premises Other fixed assets 8.A Total fixed assets Amounts receivable Insurance companies and insurance brokers: Reinsurers’ share in insurance reserves Reinsurers’ share in outstanding claims Other accounts 9 Outstanding premiums Other debtors and receivables 10 11 Total amounts receivable Deferred acquisition costs and other assets Deferred acquisition costs in life assurance Deferred acquisition costs in general insurance Deferred acquisition costs in health insurance 12 13 Other assets 14 Total deferred acquisition costs and other assets The accompanying notes are an integral part of the financial statements. March 6, 2007 Date of approval of the financial statements Aharan Fogel Chairman of the Board Izzy Cohen Member of the Board and Managing Director 3-3 Shimon Kalman Chief Finance Officer Migdal Insurance and Financial Holdings Ltd. Consolidated Balance Sheets Note December 31, 2006 2005 Reported NIS in thousands 2,848,403 41,499,838 455,151 339,415 42,294,404 585,440 3,595,023 3,817,909 4,180,463 50,180,699 46,474,867 69,842 110,460 87,557 122,727 180,302 210,284 125,968 855,845 117,777 727,843 1,162,115 1,055,904 54,767,595 Insurance reserves and outstanding claims Life assurance: Assurance reserves Reserve for extraordinary risks Outstanding claims 605,485 556,606 3,261,303 Total long-term liabilities 48,484 227,772 15,292 313,937 46,362,790 15 16 17 27.D 24,196 223,193 17,609 308,978 45,526,757 455,151 380,882 Long-term liabilities Subordinated deeds Loans from banking institutions and others Liabilities in respect of severance pay, net Deferred taxes 10,681 573,976 Minority shareholders interest 2,682,670 2,402 Shareholders’ equity 50,829,607 18 Total life assurance General insurance: Reserves for unexpired risks Outstanding claims 19 Total general insurance Total insurance reserves and outstanding claims Other liabilities Insurance companies and insurance brokers: Deposits by reinsurers Other accounts 9 Total insurance companies Credit from banking institutions and others Other creditors and payables 20 21 Total other liabilities The accompanying notes are an integral part of the financial statements. 3-4 Migdal Insurance and Financial Holdings Ltd. Consolidated Income Statement Note Year ended December 31, 2006 2005 2004 Reported NIS thousands Transferred from insurance business statements: Income from life assurance business Income from general insurance business 635,753 214,829 648,552 170,261 439,788 166,477 Total income from insurance business 850,582 818,813 606,265 65,736 18,753 121,371 19,253 184,360 20,963 46,983 102,118 163,397 14,964 24,363 15,423 20,317 20,196 7,072 26,448 2,258 6,284 101,733 149,703 198,387 952,315 968,516 804,652 23,341 3,400 19,322 23,093 18,483 15,672 925,574 926,101 770,497 - - 24,066 925,574 926,101 794,563 362,640 364,138 255,308 562,934 561,963 539,255 Income not included in insurance business statements: Investment income, net Less interest expenses on long-term liabilities Income from insurance agencies, net Income from management of pension funds, net Income from other financial services, net 23 24 25 Total income, net Administrative and general expenses, not included in insurance business statements Initial differences 26 2.F.8 Reversal of impairment in value of an interested party’s quoted shares Income before income taxes Income taxes 27 Income after income taxes Company’s share in results of affiliates, net Minority’s share in net results of subsidiaries 8,685 (1,292) Net income for the year 570,327 Net earnings per share (in NIS) *: (3,216) (2,923) 555,824 (3,287) (1,520) 534,448 2.S.4 Basic earnings 0.5443 0.5342 0.5142 Diluted earnings 0.5430 0.5322 0.5120 The number of issued and paid-up shares that served as the basis for the calculation (thousands): Net earnings per share 1,047,821 1,040,420 1,039,386 Diluted earnings per share 1,050,421 1,044,389 1,043,844 * Restated – see Note 2.S.4. The accompanying notes are an integral part of the financial statements. 3-5 Migdal Insurance and Financial Holdings Ltd. Statements of Changes in Shareholders’ Equity Share capital and premiums Note 110,476 305,117 1,874,768 125,000 2,415,361 17 - - - 17 - 1,036 - 110,493 306,153 1,859,216 300,000 2,575,862 9 - - - 9 2.O.6 - 120 - - 120 27.A 33.F 33.F - 855 - 110,502 307,128 1,915,040 350,000 2,682,670 - 13,626 - - 13,626 25 - - - 25 2.O.6 - 1,647 - - 1,647 27.A 33.F 33.F - 108 - 110,527 322,509 Balance as at January 1, 2004 Realization of employee options to shares Decrease in tax on revaluation increment Dividend Dividend announced Net income for the year 27.A 33.F 33.F Balance as at December 31, 2004 Realization of employee options to shares Tax benefit on employee stock options Decrease in tax on revaluation increment Dividend Dividend announced Net income for the year Balance as at December 31, 2005 Capital reserve in respect of options issued to employees Realization of employee options to shares Tax benefit on employee stock options Decrease in tax on revaluation increment Dividend Dividend announced Net income for the year Balance as at December 31, 2006 Total Capital Dividend shareholders’ reserves Surplus announced (1) equity Reported NIS in thousands 2.O.6 (1) Dividend announced after the balance sheet date The accompanying notes are an integral part of the financial statements. 3-6 (250,000) (300,000) 534,448 (150,000) (350,000) 555,824 (70,000) (330,000) 570,327 2,085,367 (125,000) 300,000 - (300,000) 350,000 - (350,000) 330,000 330,000 1,036 (375,000) 534,448 855 (450,000) 555,824 108 (420,000) 570,327 2,848,403 Migdal Insurance and Financial Holdings Ltd. Consolidated Life Assurance Business Statements Note Year ended December 31, 2006 2005 2004 Reported NIS in thousands 8,986,335 7,032,244 704,804 66,215 676,069 63,837 628,784 Claims - paid and outstanding: Death, disability and others Less reinsurance 4,491,221 *) 2,627,029 *) 706,954 78,170 Total revenues for the year 4,495,114 7,838,347 Premiums on retention 4,614,894 *) 4,515,022 *) 119,780 109,807 3,065,329 28.A 4,897,980 124,962 4,773,018 Premiums Less reinsurance 638,589 612,232 4,405,215 Surrenders of policies Maturity of policies Participation in profits by group life assurance Annuities 1,309,144 356,590 15,556 50,634 1,199,870 *) 1,328,702 *) 308,830 318,778 20,430 13,145 41,460 *) 33,962 *) Total claims and other payments for the year 2,360,708 2,209,179 Increase in assurance reserves less reinsurance Less management fees for policies participating in profits 4,452,148 5,799,258 *) 3,732,019 *) 28.F 471,338 498,666 2,306,819 321,746 Increase in assurance reserves, net Decrease in reserves for extraordinary risks 3,980,810 - 5,300,592 *) 3,410,273 *) (2,677) (3,287) Total increase in reserves, net 3,980,810 5,297,915 3,406,986 Excess of revenues over claims for the year net of increase in reserves 1,496,829 1,479,241 1,318,439 485,082 367,446 475,443 341,083 499,425 322,281 852,528 816,526 821,706 Decrease in deferred acquisition costs Reinsurance commissions 17,931 (33,557) 21,753 (32,295) 66,765 (38,405) Total expenses for the year, net 836,902 805,984 850,066 24,174 24,705 28,585 635,753 648,552 439,788 Commissions Administrative and general expenses 26 Amortization of life assurance portfolio acquisition expenses Life assurance business income for the year transferred to the income statements *) 28.B.4 Reclassification of investment contracts in accordance with the Supervisor’s Circular – (see Note 2.I.8). The accompanying notes are an integral part of the financial statements. 3-7 Migdal Insurance and Financial Holdings Ltd. Consolidated General Insurance Business Statements Note Year ended December 31, 2006 2005 2004 Reported NIS in thousands Premiums Registration and other fees 1,426,810 240,720 1,459,762 234,662 1,494,123 245,984 Total insurance fees 1,667,530 1,694,424 1,740,107 497,179 509,981 494,664 1,170,351 1,184,443 1,245,443 17,919 1,471 3,108 Insurance fees earned Investment income 1,188,270 139,271 1,185,914 156,752 1,248,551 143,433 Total revenues for the year 1,327,541 1,342,666 1,391,984 Claims - paid and outstanding Less reinsurance 830,565 92,587 1,830,590 1,011,663 1,313,455 462,445 Total claims for the year 737,978 818,927 851,010 Excess of revenues over claims for the year 589,563 523,739 540,974 Commissions Less reinsurance commissions 234,105 67,262 235,602 73,602 246,359 61,453 166,843 162,000 184,906 217,873 209,450 190,897 384,716 371,450 375,803 Less reinsurance Insurance fees on retention Decrease (increase) in reserves for unexpired risks, net of reinsurance Administrative and general expenses 26 Increase in deferred acquisition costs 2.J.2 Total expenses for the year, net (9,982) (17,972) (1,306) 374,734 General insurance business income for the year - transferred to the income statements 29 The accompanying notes are an integral part of the financial statements. 3-8 353,478 374,497 214,829 170,261 166,477 Migdal Insurance and Financial Holdings Ltd. Consolidated Statements of Cash Flows Note Year ended December 31, 2006 2005 2004 Reported NIS in thousands Cash flows from current activities: 585,591 251,817 (379,952) 692,342 168,162 (186,710) 457,456 673,794 128,380 10,384 430,073 (45,614) 138,764 384,459 (934,665) (286,948) Net cash provided by current activities 703,275 219,861 (165,816) 757,320 (A) (B) (C) In life assurance business In general insurance business In other current operations (28,473) (11,209) (3,997) (14,629) (2,531) (100,457) Cash flows from investment activities: Charges in investments earmarked to shareholders’ equity and non- insurance liabilities: Securities Loans and deposits Investments in investees, in mutual fund management activities and in insurance portfolios Realization of investments in previously consolidated subsidiaries Investment in companies consolidated for the first time Transition from full consolidation to proportionate consolidation Proceeds from realization of quoted shares of an interested party Proceeds from realization of investments in affiliates Acquisition of fixed assets and real estate for lease Proceeds from realization of fixed assets Change in shareholders’ loans to affiliates, net (D) (E) (F) - 21,782 (1,016,393) 81,728 - 8,675 (110,109) 7,142 2,928 (95,115) 8,424 (3,033) 936,876 100 (56,021) 13,495 (3,729) Net cash provided by (used in) investment activities (243,545) 273,415 (158,141) Cash flows from financing activities: Receipt of long term loans Repayment of long term loans Redemption of quoted securities Change in short-term credit from banking institutions, net Dividend paid Dividend paid to external shareholders by subsidiary Realization of employee stock options into shares (62,883) 17,798 (420,000) 25 149,892 (84,756) 54,375 (700,000) (1,337) 9 309 (97,760) (78,422) (187,629) (125,000) (330) 17 Net cash used in financing activities (465,060) (581,817) (488,815) 48,715 149,054 26,838 Balance of cash and cash equivalents at the beginning of the year 1,432,425 1,283,371 1,256,533 Balance of cash and cash equivalents at the end of the year 1,481,140 1,432,425 1,283,371 Change in cash and cash equivalents The accompanying notes are an integral part of the financial statements. 3-9 Migdal Insurance and Financial Holdings Ltd. Consolidated Statements of Cash Flows Year ended December 31, 2006 2005 2004 Reported NIS in thousands (A) Cash flows from current life assurance business operations: Income from life assurance business 635,753 648,552 439,788 4,025,203 41,395 49,094 68,787 24,174 5,309,838 66,801 161,578 60,060 24,705 3,482,793 19,279 171,399 60,662 28,585 (3,239,854) (634,522) (41,125) (307,538) (5,326,611) (334,685) 36,171 (109,089) (2,580,818) (323,688) 43,715 (175,429) Items not involving cash flows: Change in assurance reserves net of reinsurance Change in outstanding claims net of reinsurance Change in deferred acquisition costs Depreciation and amortization Amortization of assurance portfolios acquisition expenses Realization of investments (investments), net: Securities Loans Deposits with banks Real estate for lease and office premises Change in other balance sheet items , net: Short-term credit from banking institutions Insurance companies Outstanding premiums Other debtors and receivables and other creditors and payables 10,661 18,914 18,696 (287,837) (11,429) 14,099 (188,777) 703,275 585,591 692,342 214,829 170,261 166,477 (17,919) 43,484 4,970 17,493 (1,471) 210,555 (1,904) 18,324 (3,108) 231,613 (1,306) 16,131 61,254 (24,605) (40,560) (8,163) (198,512) 19,175 65,883 (3) (279,761) (32,221) 1,190 101 Insurance companies Outstanding premiums Other debtors and receivables and other creditors and payables (20,166) 27,166 (37,922) (49,051) 10,689 7,871 (2,997) 57,920 14,123 Cash flows provided by current general insurance business operations 219,861 251,817 Cash flows provided by current life assurance business operations (2,585) 48,426 36,067 (B) Cash flows from current general insurance business operations: Income from general insurance business Items not involving cash flows: Change in insurance reserves net of reinsurance Change in outstanding claims net of reinsurance Change in deferred acquisition costs Depreciation and amortization Realization of (investments) investments, net: Securities Loans Deposits with banks Real estate for lease and office buildings Changes in other balance sheet items, net: The accompanying notes are an integral part of the financial statements. 3-10 168,162 Migdal Insurance and Financial Holdings Ltd. Consolidated Statements of Cash Flows 2006 Year ended December 31, 2005 2004 Reported NIS in thousands (C) Cash flow from other current operations: Net income for the year Income from insurance business 570,327 (850,582) 555,824 (818,813) 534,448 (606,265) (46,115) (155,893) (104,634) (14,466) 11,977 8,101 1,177 23,709 18,737 31,816 (6,892) - 22,336 - 16,393 217 (59,261) 11,806 3,984 1,546 1,292 10,316 (459) 4,162 2,923 (24,066) 7,793 (680) 2,708 1,520 130,291 (36,034) 18,279 (165,816) (379,952) (186,710) Items not involving cash flows: Changes in deferred acquisition costs in life assurance and in health insurance Changes in deferred taxes relating to income from ordinary operations Company’s share in net results of affiliates, less dividend received and write-off of initial difference Amortization of acquisition costs of insurance portfolio held by insurance agencies, pension portfolios and rights to manage provident and mutual funds Loss (profit) from realization of affiliates Income from realization of quoted securities of an interested party Reversal of impairment in value of investment in long-term quoted securities Depreciation and amortization Loss (profit) from sale of fixed assets Interest and erosion of loans External shareholders’ share in net earnings of subsidiaries Change in other debtors and receivables and other creditors and payables, net Cash flows used in other current operations (D) Realization of investment in previously consolidated subsidiaries Working capital (excluding cash and cash equivalents) Life assurance reserves Loan from parent company - - 684,862 (679,290) (8,103) Net cash outflows - - (2,531) The accompanying notes are an integral part of the financial statements. 3-11 Migdal Insurance and Financial Holdings Ltd. Consolidated Statements of Cash Flows 2006 Year ended December 31, 2005 2004 Reported NIS in thousands (E) Investment in companies consolidated for the first time Working capital (excluding cash and cash equivalents) Investment in an affiliate Fixed assets Other assets Initial difference External shareholders’ interest Liability for severance pay Other long term liabilities 658 (229) (4,502) 76 - 7,681 10,147 (14,899) (690) (30,708) 695 13,145 2,254 (2,970) (5,107) (1,352) (103,943) 7,648 3,013 - Net cash outflow (3,997) (14,629) (100,457) (F) Transition from full consolidation to proportionate consolidation Working capital (excluding cash and cash equivalents) Fixed assets Other assets Initial difference Liabilities for severance pay - 6,138 3,613 2,454 10,669 (1,092) - Net cash inflow - 21,782 - (G) Significant activities not involving cash flows For the year ended December 31, 2006 Acquisition of fixed assets and real estate for lease against creditors in the amount of NIS 17,191 thousand. Acquisition of mutual fund management activities against long term liability in the amount of NIS 28,418 thousand. For the year ended December 31, 2005 Acquisition of fixed assets and real estate for lease against creditors in the amount of NIS 8,856 thousand. For the year ended December 31, 2004 Dividend proposed for payment in the amount of NIS 250,000 thousand. Acquisition of fixed assets and real estate for lease against creditors in the amount of NIS 10,347 thousand. Sale of investment in an affiliate against debtors in the amount of NIS 600 thousand. The accompanying notes are an integral part of the financial statements. 3-12 Migdal Insurance and Financial Holdings Ltd. Company’s Balance Sheets Note December 31, 2006 2005 Reported NIS in thousands Investments Subsidiaries 2,516,074 2,032,598 306,779 6,226 21,315 593,927 220 84,824 334,320 678,971 2,850,394 2,711,569 2,848,403 2,682,670 1,991 28,899 2,850,394 7 2,711,569 Current assets Securities Other debtors and receivables Cash and cash equivalents 3.A 11 Shareholders’ equity Current Liabilities Other creditors and payables 21 The accompanying notes are an integral part of the financial statements. Date of approval of the financial statements: March 6, 2007. Aharan Fogel Chairman of the Board Izzy Cohen Member of the Board and Managing Director 3-13 Shimon Kalman Chief Finance Officer Migdal Insurance and Financial Holdings Ltd. Company’s Income Statements Note Year ended December 31, 2006 2005 2004 Reported NIS in thousands Income Company’s share in results of subsidiaries, net Dividend and realization of investment in quoted shares of an interested party 556,721 The accompanying notes are an integral part of the financial statements. 3-14 1,873 497,239 472,840 77,534 47,662 574,773 520,502 - 24,066 574,773 544,568 5,339 18,949 10,120 570,327 Net income for the year 2,195 575,666 27 2,688 - Income taxes 474,713 575,666 Income before income taxes 499,434 21,633 Reversal of impairment in value of long term investment in quoted shares of an interested party 88,028 554,033 Financing income, net - 556,721 26.B 386,685 - Administrative and general expenses 499,434 555,824 534,448 Migdal Insurance and Financial Holdings Ltd. Company’s Statements of Cash Flows Year ended December 31, 2006 2005 2004 Reported NIS in thousands Cash flows from current activities: Net income for the year Adjustments required to present cash flows from current activities (A) 570,327 534,448 (395,629) (317,893) (229,224) 174,698 Net cash provided by current activities 555,824 237,931 305,224 Cash flows from investment activities: Investment in investees Granting of shareholders' loans and capital notes to investees Proceeds from repayment of shareholders loans and capital notes to investees Proceeds from realization of quoted securities of an interested party Proceeds from sale (acquisition) of quoted securities, net (130,000) (45,000) - 50,000 - 306,768 531,044 936,876 (943,334) 181,768 531,044 (31,772) Settlement of long term loans Realization of quoted securities, net Settlement of short term credit from banking institutions, net Dividend paid Realization of employee options into shares (420,000) 25 (6,374) (700,000) 9 (24,370) (78,422) (24,095) (125,000) 17 Net cash used in financing activities (419,975) (706,365) (251,870) (63,509) 62,610 21,582 Balance of cash and cash equivalents at the beginning of the year 84,824 22,214 632 Balance of cash and cash equivalents at the end of the year 21,315 84,824 22,214 Net cash provided by (used in) investment activities (314) (25,000) - Cash flows from financing activities: Change in cash and cash equivalents The accompanying notes are an integral part of the financial statements. 3-15 Migdal Insurance and Financial Holdings Ltd. Company’s Statements of Cash Flows Year ended December 31, 2006 2005 2004 Reported NIS in thousands (A) Adjustments required to present cash flows from current activities: Items not involving cash flows: Income from realization of long term investment in quoted shares of an interested party Reversal of impairment in value of long-term investment in quoted securities Company’s share in net results of investees, net of dividends received Change in deferred taxes Increase in value of quoted securities, net Erosion of loans - - (59,261) - - (24,066) (356,721) (8,146) (19,620) - (273,455) 864 (61,582) - (117,192) 8,063 (38,895) 190 (384,487) (334,173) (231,161) Changes in asset and liability items: Change in other debtors and receivables Change in other creditors and payables (6,006) (5,136) 263 16,017 (483) 2,420 (11,142) 16,280 1,937 (395,629) (317,893) (B) Significant activities not involving cash flows For the year ended December 31, 2004 Dividend proposed for payment in the amount of NIS 250,000 thousand. The accompanying notes are an integral part of the financial statements. 3-16 (229,224) Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 1 - General A. The Company is a public company whose shares are listed for trade on the Tel Aviv Stock Exchange. B. As at the financial statements date, approximately 70% of the Company is held by Assicurazioni Generali S.p.A. (hereinafter: Generali) and approximately 10% is held by Bank Leumi Le-Israel Ltd. (hereinafter: Bank Leumi). The rest of the shares are held by the public. C. The Notes relate to the Company’s consolidated financial statements, except when stated otherwise. D. Definitions In these financial statements: The Company - Migdal Insurance and Financial Holdings Ltd. Interested party as defined in paragraph (1) of the definition of an “interested - party” in a company in Section 1 of the Securities Law. The Group - Migdal Insurance and Financial Holdings Ltd. and its subsidiaries Affiliates - companies or partnerships in which the Company has significant influence but are not subsidiaries and the investments in them are included on the basis of equity value Subsidiaries - companies whose financial statements are fully consolidated, directly or indirectly, with the Company’s financial statements Proportionately - companies held by a number of entities that have a contractual consolidated subsidiaries agreement for a joint control and their financial statements are proportionally consolidated with the Company’s financial statements. Investees - subsidiaries, affiliates Index - The Consumer Price Index published by the Central Bureau of Statistics (hereinafter - CPI) Financial Statement Details Regulations - Insurance Supervision Regulations (Financial Statement Details) 1998. Related parties - as defined in the Financial Statement Details Regulations. The Regulator - Regulator of Insurance Business. Insurance Supervision Law - The Supervision of Financial Services Law (Insurance), 1981. Capital Regulations - Supervision of Insurance Business Regulations (Minimum Solvency Margin Required from an Insurer), 1998, as amended. Ways of Investment Regulations - Supervision of Insurance Business Regulations (Ways of Investment of Capital and Reserves of an Insurer and Management of its Liabilities), 2001, as amended. 3-17 proportionately-consolidated subsidiaries and Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies A. Accounting principles The consolidated financial statements, which mainly report the assets, liabilities and operations of the consolidated insurance companies are prepared in accordance with the accounting, reporting and presentation principles prescribed by the Financial Services Supervision Law (Insurance), 1981 and the regulations issued thereunder, including the Financial Statement Details Regulations and in accordance with the directives of the Regulator of Insurance. The Company’s financial statements are prepared in accordance with generally accepted accounting principles and in accordance with the Securities Regulations (Preparation of Annual Financial Statements) 1993, except for the classification of items that in Management’s opinion are prepared in accordance with the type of business of the Company, which is a holding company whose major assets are not current assets, in accordance with Rule 8 of the above Securities Regulations. B. Reporting basis of the financial statements 1) In accordance with the Financial Statement Details Regulations amendment following to the issue of Accounting Standards No. 12 and 17 of the Israel Accounting Standards Board with respect to the discontinuance of adjustment of financial statements, the adjustment of financial statements for the effect of inflation was discontinued as of January 1, 2004. 2) 3) Amounts of non-monetary assets do not always reflect their realizable value or current economic value, but only the reported amounts of such assets except for assets which are held against liabilities in respect of policies participating in investment income that are reported according to fair value (also see 2 F below). 4) The term “cost” in these financial statements represents cost in reported amounts. 5) C. In the past the Company prepared its financial statements on the basis of historical cost adjusted for the changes in the CPI. The adjusted amounts included in the financial statements as at December 31, 2003 constitute the starting point for the nominal financial report as of January 1, 2004. Any additions made beginning from this date are included in their nominal values. Condensed financial data of the Company in nominal historical values for tax purposes is presented in Note 33. Details of the index and the representative exchange rate of the U.S. dollar (hereunder - the dollar) 2006 1) 2) 3) 2005 2004 Index in points (average base 1993) For December For November 184.9 184.9 185.1 185.4 180.7 180.6 Representative exchange rate of the dollar in NIS as at December 31 4.225 4.603 4.308 The annual rate of increase (decrease) in the index and in the representative exchange rate of the dollar Index for December Index for November (0.1%) (0.3%) 2.4% 2.7% 1.2% 0.9% (8.2%) 6.9% (1.6%) Representative exchange rate of the dollar compared to the shekel 3-18 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) D. Consolidation of financial statements 1) The consolidated financial statements include the audited financial statements of the Company and those of its subsidiaries. Jointly-controlled companies have been consolidated in accordance with the proportional consolidation method. 2) Intercompany transactions and balances have been eliminated upon consolidation of the financial statements except for insurance transactions that are reported in the relevant items of the insurance business statements and in the item "income from insurance agencies” that have been consolidated in the income statement. Intercompany earnings from commissions earned by insurance agencies classified as deferred acquisition costs of the insurance companies, have been eliminated. 3) The excess of the cost of the investments over the equity value as at acquisition date of the subsidiaries, which was allocated to assets and liabilities, is included in the related balance sheet items and is allocated to the statement of income corresponding to the depreciation of assets. Regarding the initial difference, see paragraph F (8) below. The balance of excess of cost is included in other assets. 4) Investees manage pension funds, provident funds, mutual funds and investment portfolios. The management companies have no ownership rights over the assets and liabilities of these funds and bear no obligation as to their yield. Therefore, the activities, assets and liabilities of the funds are not included in the consolidated financial statements. E. Use of estimates The preparation of financial statements and, in particular, those of insurance companies, in accordance with the Insurance Business Supervision Law - 1981 and regulations issued thereunder, and in accordance with generally accepted accounting principles, requires Management to make use of estimates and valuations that affect the amounts of assets and liabilities and the disclosure of contingent liabilities as well as the reported amounts of revenues and expenses during the reported years. Actual results may differ from these estimates. The principal estimates included in the financial statements are based on actuarial estimations made by appointed actuaries in accordance with instructions of the Supervisor of Insurance in the various insurance branches (see also Notes 12.D, 18.D and 19.H below as to actuarial assumptions and estimates). F. Valuation and presentation of assets and liabilities 1) Bank deposits for which maturity date, at the time of deposit, does not exceed three months are included under cash and cash equivalents. 2) Unquoted bonds, loans and deposits (hereinafter – unquoted assets), except such assets held against profit participating policies, and liabilities which are linked to the index, are included in the balance sheet according to the latest published index prior to the balance sheet date, (November index), in accordance with their contractual terms together with interest accrued as at balance sheet date. Premium or discount in respect of investment in unquoted bonds is amortized using the effective interest method. In cases where the nominal investment in unquoted assets is guaranteed to the Company even if it is higher than the value adjusted to the index, the unquoted assets are reported at their nominal value. 3-19 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) F. Valuation and presentation of assets and liabilities (Cont.) 2) (Cont.) Unquoted assets held against the liabilities of policies participating in investment income are included in the balance sheet beginning from 2005 at their fair value using a discount cash flow model, where the interest rates used for discounting the cash flows are determined relative to the various risk ratings on the basis of quotations of a third party provider appointed by the Regulator of Insurance (Interest Rate Company Ltd.). As a result of the change in the assets valuation method in the year 2005, there was an increase in the profit from life assurance business management fees and an increase in the profit before taxes for the year 2005, in the amount of about 32 million and the net profit increased by about NIS 19 million. 3) Balances in or linked to foreign currency are included according to the representative exchange rates as at the balance sheet date. 4) Quoted bonds, shares and warrants for the acquisition of shares, including securities abroad that are traded OTC in regulated markets are included at market value as at the balance sheet date. Investment in mutual fund units are included at their redemption value as at balance sheet date. 5) Derivative financial instruments in respect of foreign currency exchange rates, index, interest rates, shares and other which are not hedge transactions are reported in the balance sheet at fair value. Changes in the fair value of these instruments are charged (or credited) to the income statement in the period during which they arise. The fair value of derivative financial instruments is determined according to their market price, or, in their absence, according to a valuation model. Derivative financial instruments, net, held by insurance companies are reported under securities, in accordance with the Financial Statements Details Regulations. Embedded derivatives are included with the base asset. 6) Investments in unquoted shares, capital funds, and quoted shares held (by non-insurance companies) as permanent investments, are included at cost. Where in Management’s opinion, a decrease in value of such assets is not of a temporary nature, a provision for impairment in value is included. When these assets are held against profit participating policies, they are included at their fair value on the basis of their financial statements and economic valuations. 7) Fixed assets and real estate for lease not held against profit participating policies are included at cost, less accumulated depreciation and less impairment in value made in accordance with Standard No. 15 of the Israel Accounting Standards Board (see H1 below). The cost of a portion of the real estate includes an addition based on a revaluation performed by certified real estate appraisers from the firm of Katzir, Friedman and Barak - Engineering and Real Estate Appraising Ltd. on December 31, 1994. Buildings used partly for rental purposes and partly as offices for the subsidiaries, are presented as real estate for lease or as fixed assets, based on the use thereof. Depreciation of fixed assets and real estate for lease is calculated using the straight-line method over the estimated useful lives of the assets. 3-20 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) F. Valuation and presentation of assets and liabilities (Cont.) 7) (Cont.) Real estate for lease held against profit participating policies are included on the basis of valuations of market value made at least once a year. The value at balance sheet date is based on the valuations made by certified real estate appraisers from the firm of Katzir, Friedman and Barak - Engineering and Real Estate Appraising Ltd. which were prepared recently in the last quarter of 2006, except for the assets that were purchased during the reported year. The increase (decrease) in the value of the real estate is imputed to investment income in the life assurance business statements. Regarding the effect of the initial adoption of Accounting Standard No. 16 - Investment Property and Accounting Standard No. 27 - Fixed Assets see paragraphs T-1 and T-3 below. 8) Other Assets a) Other assets include the excess of acquisition cost of mutual funds management activities, which was attributed, according to the estimates of financial experts, to the present value of cash flows in future management fees, net of the existing portfolio at the time of acquisition, which will be amortized over two to three years, to a brand that will be amortized over the period of five years and the balance will be allocated to goodwill, that will not be systemically amortized. The Company performs an examination of the overall impairment in the value of goodwill and the value of the existing portfolio once a year or more, in order to examine if there were events or changes in circumstances that will show that there might have been an impairment in value in accordance with Standard No. 15. Also see Note 7. A. b) The excess of cost resulting upon the acquisition of insurance subsidiaries which was mainly attributable to the value of their life assurance portfolios, as well as life assurance portfolio acquisition costs, are amortized by the straight line method over 15 years, which in the opinion of Management reflects the average lifetime of the policies. c) The excess of cost resulting from the acquisition of insurance agencies or from the combination of businesses acquired from insurance agencies, which was mainly attributable to insurance commission portfolios, is amortized over the period of ten years plus specific provisions in case there is a decrease in value. 3-21 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) F. Valuation and presentation of assets and liabilities (Cont.) 8) Other Assets (Cont.) d) Up to December 31, 2005, the goodwill was systematically amortized according to the straight line method, over periods of up to twenty years. From January 1, 2006, following the initial implementation of Accounting Standard 20 (Revised), the Company discontinued the systematic amortization of the goodwill that was included in the balance sheet in respect of investees. See paragraph S 3 hereunder. The impairment in value of goodwill in respect of subsidiaries is examined once a year or more, to see if there are any signs of impairment in value, in accordance with Accounting Standard No. 15 (see paragraph (H) hereunder). Impairment in value of goodwill in relation to affiliates is handled in the framework of the examination of impairment in value of the entire investment (see paragraph (H) hereunder. G. Investments in investees Investments in investees are included according to the equity value method. Regarding the handling of the initial difference that was created upon the purchase of these investees – see paragraph F.8 above. H. Impairment of assets 1) Impairment in value of fixed assets and intangible assets The Group Companies apply Accounting Standard No. 15 "Impairment in value of assets" (hereunder – “the Standard”). The Standard applies to all assets appearing in the balance sheet, excluding assets derived from benefits to employees, deferred tax assets, and financial assets (not including investments in shares of an affiliate). According to the Standard, whenever there is an indication that an asset may be impaired, the Group should determine if there has been an impairment of the asset by comparing the carrying amount of the asset to its recoverable amount. The recoverable amount is the higher of an asset's net selling price or value in use, which is determined based on the present value of estimated future cash flows expected to be generated by the continuing use of an asset and by its disposal at the end of its useful life. If the carrying amount of an asset exceeds its recoverable amount, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. An impairment loss recognized should be reversed only if there have been changes in the estimates used to determine the asset's recoverable amount since the impairment loss was recognized. The Company evaluates impairment loss for each cash generating unit separately. In testing for impairment, the Company takes into consideration corporate assets that relate to other cash generating units, as well as overheads that are attributed directly, or that can be reasonably and consistently attributed to other units. 3-22 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) H. Impairment of assets (Cont.) 2) Impairment of investments in other companies The Company generally evaluates the fair value of its investments in each reporting period and whenever changes in circumstances or occurrence of other events indicate a decline in value that is other than temporary. The evaluation of the fair value takes into consideration, among others, the market value of the investments, estimates of analysts and valuations of the investments, the conditions of the industry in which the portfolio company is operating, the portfolio company's business condition, off-market transactions in the portfolio company's securities, prices of equity transactions in the portfolio company and additional information that the portfolio company presents to its board of directors (if the Company is represented on the board) or to its shareholders. Based on the results of the above evaluation, the Company, if necessary, recognizes an impairment loss that is other than temporary in the statement of income. I. Life assurance business 1) Life assurance premiums, including savings premiums, not including receipts in respect of investment contracts (see paragraph 8 below) are mainly reported as income, when due. Cancellations are recorded upon receipt of notice from the policyholder or by the Company as a result of default in payment, as permitted by law. 2) The life assurance reserves, reinsurers’ share therein and life assurance deferred acquisition costs were determined by the actuary Mr. Leibush Ulman (previous year Mr. Dov Raphael), a senior officer in subsidiary companies, who certified that their respective amounts were calculated based on the data base of the subsidiaries according to the Instructions of the Supervisor of Insurance and rules and methods detailed in Note 18 hereunder. (The statement of the actuary is attached to the financial statements). 3) The reserve for extraordinary risks is designated to serve the Group at a time of future catastrophe and is calculated as a percentage of the insured amount at risk, in accordance with principles laid down in draft regulations published in 2002, as set out below: Insurance companies shall gradually increase their reserves for extraordinary risks in life assurance until such reserves equal 0.2% of the amount on retention at risk as at December 31, 2001. Provisions required as a result of changes in the amount on retention at risk beginning from January 1, 2002, will be executed in equal parts over no more than eight reporting years. A company may release funds from the reserve if the reserve exceeds 0.25% of the amount on retention at risk. In March 2004 the International Accounting Standard Board published an International Accounting Standard regarding “Insurance Treateas” (IFRS4). The directives of this Standard prescribe that the provision for extraordinary risks does not comply with the Standard’s directives and therefore it should be eliminated. Taking this into account and in view of the necessity to classify the reserve for extraordinary risks in life assurance in the financial statements of insurance companies in Israel as shareholders’ equity, a Temporary Provision was published in the framework of the States Capital Market Regularization Law (Legislation Amendments to Achieve the Targets of the Budget and Financial Policy for the year 2007), 2007, which grants a tax exempt with respect to the classification of the reserve for extraordinary risks as shareholders’ equity, at the rate of up to 0.17% of the amount at risk that the insurer holds, and any excess amount that will be transferred to shareholders equity, as mentioned, will be liable to tax during the period of four years from the year 2007, onwards. 3-23 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) I. Life assurance business (Cont.) 3) (Cont.) In February 2007 the Regulator published a circular whereby commencing from the first quarter of 2007, the provision for the reserve for extraordinary risks in life assurance will be eliminated in the financial statements of insurance companies. According to the aforementioned circular, the elimination of the provision will be imputed to the income statement as an extraordinary item, net of the affect of income taxes, if any. At the same time a capital requirement was defined at the rate of 0.17% of the amount on retention at risk. Nevertheless, it was determined that the minimum capital requirement in respect of the amount at risk will not be lower than the requirement on the date of transfer. As at December 31, 2006 the subsidiaries’ reserve for extraordinary risks is in the amount of about NIS 455 million, which comprise about 0.24% of the amount on retention at risk, out of which about NIS 321 million under the basic framework of 0.17% of the amount on retention at risk and about NIS 134 million above the said limits. As a result of the aforementioned Regularizations, it is expected that in the first quarter of 2007 Migdal Insurance will record a profit, net of tax, in the amount of about NIS 406 million, while at the same time an additional capital requirement will be created in the amount of about NIS 321 million. With respect to the tax implications regarding the classification of the reserve, as mentioned, see also Note 27. A. 5 hereunder. With respect to the increase in the capital requirements from insurance companies, see also Note 7.D. 5 hereunder. 4) Outstanding claims include provisions for outstanding claims made by Group experts on the basis of notices received of insurance occurrences and insured amounts. The provision for claims incurred but not yet reported (IBNR) is included in assurance reserves. 5) The provisions for annuities and for disability and long-term care claims in payment are included in assurance reserves (see also paragraph S.1 hereunder). 6) Deferred acquisition costs (the “DAC”) include direct commission expenses to agents including prizes and bonuses, and other expenses relating to acquisition and writing new policies, including medical examinations, underwriting and marketing and administrative and general expenses The DAC is amortized in equal portions over the policy period but not over more than 15 years. DAC in respect of cancelled policies are written-off at date of cancellation. This method relates to policies sold as from January 1, 1999. Deferred acquisition costs for policies produced until December 31, 1998 continue to be included on the “Zillmer deduction” method, based on rates from premium or from the sum at risk according to the various insurance programs. 7) Index-linked life assurance reserves and the investments used to cover these reserves, including deferred acquisition costs, are included in the financial statements according to the latest published index prior to the balance sheet date (the November index), including life assurance reserves in respect of policies which are linked to the index for June (semi-annual linkage). 3-24 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) I. Life assurance business (Cont.) 8) The Company implements the directives as determined in the Regulator’s circular dated January 7, 2007, regarding receipts in respect of the investment contracts and according to this circular the investment contracts were defined as insurance contracts with a legal structure which do not expose the insurer to any significant insurance risk. The investment contracts include, among others: a) 100% savings policies which are withdrawn as a capital amount without insurance riders. b) Annuity policies for a defined period. The accounting treatment of investment contracts is as follows: receipts in respect of investment contracts will not be recorded under premiums in the life assurance business statements and they will be allocated directly to the life assurance reserves. Surrenders in respect of these contracts will not be allocated to the surrenders item but rather they will be deducted directly from the life assurance reserves. Investment income is allocated directly to the reserve at the rate of yield that was guaranteed to the policyholders. The financial margin between the yield from the investment and the yield that was guaranteed to the policyholders in respect of these contracts, as well as the expenses relating to this activity, will be allocated to the statement of life assurance business. According to the aforementioned circular, only products that were issued in the framework of investment contracts and do not contain any insurance risk were defined in the financial statements of Migdal Insurance, in the year 2006, as investment contracts. According to the aforementioned circular, beginning from 2007, additional insurance products which contain an insignificant insurance risk will be defined as investment contracts. It is expected that during the year 2007, discussions will be held between the representatives of the insurance companies and the Regulator of Insurance, regarding the definition of the types of policies that will be included as investment contracts. The comparative figures were reclassified. See Note 28. A. and B. J. General insurance business 1) Insurance fees (premiums and fees) are recognized as income on the basis of monthly production reports. These fees are generally in respect of insurance policies having a duration of one year. (For fees relating to the period subsequent to balance sheet date, a provision for unexpired risks is calculated – see 4 below). A portion of the premiums in the health and foreign travel insurance branches are reported on a monthly or daily basis. Insurance fees in the motor act insurance branch are recorded upon payment of the premium since insurance coverage in contingent on payment of premium insurance fees. 3-25 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) J. General insurance business 1) (Cont.) Insurance fees in respect of policies commencing subsequent to balance sheet date or fees for periods exceeding one year are included in deferred income. Monthly production reports, primarily in the motor casco and comprehensive residential insurance include the automatic renewal of all policies whose renewal date has arrived. The revenues included in the financial statements is after deductions in respect of policy cancellation notices received from policy holders and after the deduction of provisions for cancellation and non payment of premiums subject to legal provisions. 2) Deferred acquisition costs in general insurance include commissions to agents and a portion of general and administrative expenses relating to writing new policies, relative to retained unearned insurance premiums. The deferred acquisition costs are calculated at the lower of actual costs or standard rates, set by the Insurance Regulations, calculated as a percentage of unearned premiums for each branch. In the year 2005, the Company began to compute deferred acquisition costs also relating to health insurance. Deferred acquisition costs refer to costs arising from writing new policies, that were written from the year 2005, including medical examinations, underwriting and marketing and general and administrative expenses. Deferred acquisition costs are amortized at equal rates over the policy’s term. However, in policies whose insurance period is longer than six years, the asset can be amortized over a shorter period, providing that it will not be less than six years. Deferred acquisition costs relating to cancelled policies are eliminated at the time of cancellation. As a result of the implementation of the directives, the deferred acquisition costs in the health insurance branch, as at December 31, 2006 and 2005, totaled NIS 31 million and NIS 16 million, respectively. The profit from general insurance business for the year ended as at December 31, 2006 and 2005 increased by the amount of about NIS 15 million, and about NIS 16 million, respectively. The net profit for the years 2006 and 2005 increased by the amount of about NIS 9 million in each of the years. 3) The reserves for unexpired risks, outstanding claims and the reinsurers’ portion thereof and deferred acquisition costs in general insurance (except as to the illness and hospitalization branches) are calculated in accordance with the Regulations for Supervision of Insurance Businesses (Mode of Calculating Provisions for Future Claims in General Insurance), 1984, directives of the Supervisor of Insurance and actuarial evaluations made by the actuary Ms. Anat Cohen, a senior officer of the subsidiaries, who certified that the amounts were calculated based on the data base of the subsidiaries, on a basis consistent with the previous year and in accordance with the instructions of the Supervisor of Insurance and applying rules and methods described in Note 19.H (see also paragraphs 4 and 5 below). 3-26 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) J. General insurance business (cont'd) 3) (Cont.) The insurance reserves and the deferred acquisition costs in the health branches were calculated as from 2005 under new rules (see paragraph 4 below). The insurance reserves in these branches were calculated by the actuary Mr. Leibush Ulman (previous year Mr. Dov Raphael) a senior officer of the insurance subsidiaries, who has certified that the amounts were calculated based on the data base of the subsidiaries in accordance with the instructions of the Supervisor of Insurance and applying rules and methods described in Note 19. The statements of the actuaries are attached to the financial statements. 4) The reserves for unexpired risk represents the portion of the insurance premiums and fees relating to the period subsequent to balance sheet date (unearned premiums) under generally accepted accounting principles. These reserves do not represent the actual liabilities of unexpired risk and therefore are not dependent on any specific assumptions. Nevertheless, the reserves in the motor vehicle and comprehensive property branches include, where necessary, provisions for premiums which do not cover the cost of anticipated claims (hereunder – premiums deficiency), which are calculated using a model set down under Regulations for Supervision of Insurance Business (Mode of Calculating Provisions for Future Claims in General Insurance) – 1984. Furthermore, in health insurance branches provisions for premiums deficiency are based on actuarial calculations. The insurance reserves include a provision for anticipated losses in respect of group health insurance which is calculated in accordance with the instructions of the Regulator of Insurance. The amounts are insignificant. According to the Regulator’s directives, the insurance reserves in the health branch are calculated according to actuarial valuations from January 1, 2005. Up to that date the reserves were calculated on the basis of the Regulator of Insurance directives. According to the directives, the cancellation of the difference between the reserve for insurance of medical expenses, which was calculated according to the previous directives, and that of an actuarial valuation with respect to insurance of medical expenses, which is calculated according to the new instructions (hereunder – the difference) will be spread equally over the period of three years from January 1, 2005. The abovementioned difference amounted to about NIS 16 million, consolidated. As a result of the implementation of the directives, the profit from general insurance and the profit before tax, in the years ended as at December 31, 2006 and 2005 increased by about NIS 5 million. The net profit for each of those years increased by about NIS 3 million. 3-27 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) J. General insurance business (cont'd) 5) 6) Profit participation in group insurance is recorded on the basis of the agreements in effect, and are deducted from insurances fees. 7) Subrogations are taken into account in the claims data on which the actuarial calculations of outstanding claims are made. In branches where there is insufficient statistical information, the subrogations are taken into account in making the overall risk assessment of the claim on a specific basis for each claim. Salvage recovery, primarily in motor vehicle property are recorded as a reduction of the cost of claims on the basis of anticipated recovery. 8) Premiums, commissions and claims from underwriting pools and coinsurance are recorded on a proportional basis in accordance with the Company’s participation in the insurance. 9) K. Outstanding claims were mainly calculated according to actuarial valuations. In branches where the actuary determined that an actuarial model cannot be applied due to lack of statistical significance, the calculations of outstanding claims were made specifically for each claim. In addition, outstanding claims include a provision for excess revenues over expenses accumulated, in accordance with the Regulation for Supervision of Insurance Business (Mode of Calculating Provisions for Future Claims in General Insurance) - 1984 - see Note 19. With respect to the change in allocation of indirect expenses – see also paragraph s. 2. hereunder. Premiums, commission and claims from other insurance companies and underwriting agencies, is included according to accounts that are received up to the balance sheet date with the addition of provisions as required. Reinsurance 1) The reinsurers’ liabilities towards the subsidiaries do not release the subsidiaries from their liabilities towards policyholders insured under the insurance policies. A reinsurer who does not fulfill his obligations under the reinsurance treaties may cause the subsidiaries losses. 2) The subsidiaries set-up a provision for doubtful debts in respect of reinsurance receivables the collection of which is in doubt on the basis of a risk assessment of specific debts and a provision calculated on the basis of an aging of the debts. In addition, in determining the reinsurers’ share of outstanding claims and insurance reserves, the possibility of collecting from the reinsurer, among others, is also taken into consideration by the subsidiaries. When the reinsurer’s share is calculated on an actuarial basis, the share of reinsurers in difficulty is calculated as per the actuary’s recommendations, which takes into consideration the general risk factors. Furthermore, the subsidiaries take into consideration when making the provisions, inter alia, the willingness of the parties to reach cut-off agreements (the payment of the agreed amounts results in a complete and final settlement of the claims) in order to reduce exposure. 3-28 Migdal Insurance and Financial Holdings Ltd. Notes to the Financial Statements as at December 31, 2006 Note 2 - Reporting Principles and Accounting Policies (Cont.) L. Liabilities in respect of employee severance pay The Group’s liabilities in respect of employee severance pay which include liabilities determined by law, agreement, custom and Management’s expectations are fully covered by insurance policies, issued mainly by the subsidiaries, by deposits with provident funds and by provisions for severance pay. M. Provisions for doubtful debts Provisions for doubtful debts are made in respect of specific debts, the collection of which, in the Company and subsidiaries management’s opinion, is doubtful. Provisions in respect of outstanding premiums in general insurance business are made according to estimates, based inter alia, on the period of default and in respect of loans secured by mortgage on buildings and other loans at various rates of the balances in default together with a general provision, representing the subsidiaries’ estimates of the risks involved. With respect to reinsurers’ debts – see paragraph K. 2 above. N. Administrative and general expenses Administrative and g