By Narendra Solanki
With suspense over India’s largest IPO finally getting over last month with the announcement of final IPO dates and valuations by the India’s largest and oldest life insurer LIC the speculations and markets buzz around size, valuation have finally come to a close. Having said that, the LIC IPO which is priced at Rs 902 – 949 per share (excluding discount) with OFS of 3.5% by the GoI demanding the valuations of about Rs 6 lakh crore for LIC.
The valuations at which the LIC IPO has been announced is well below the earlier market expectations of about Rs 11-14 lakh crore valuing the company between 2x to 3x its embedded value. This sharp cut in valuation has surprised as well as provided some relief to the markets over the worries of liquidity squeeze which such a huge IPO could create during existing dampened market sentiments due to global crisis and impending U.S. Fed rate hike event and also attract investor demand with attractive valuations.
Having said that, let us look deeper and understand the LIC’s valuation conundrum and see where it stands. To start with we first have to understand the life insurance industry business and its key drivers and ratios. The Indian life insurance industry had only one player – LIC – during CY 1956 to CY 2000. However, post-privatisation in CY 2000, private players started entering the industry and by 2000-01, four private players had set up operations. As on March 31, 2021 there are 23 players in the Indian life insurance industry. The total premium received grew at a cagr of 10.5% from FY-07 till FY-21.
The widest used valuation multiple for valuing insurance companies is Market Capitalisation to Embedded Value ratio. The LIC IPO is valued at 1.1x its EV of ~Rs 5,400 billion while listed peers are trading with EV multiples of between 2x to 4x. Though Embedded Value is one of the most important factors but there are also some factors that are incorporated in multiples at which a company trades.
Coming to the business model, the insurance companies have primarily three product categories namely Participating products (insurer invests the premiums received in a pooled participating fund to pay for certain fixed benefits as well as to share the surplus in the form of bonus as a discretionary benefit to policyholders), Non-participating products (provide a fixed amount of benefits on contingent events covered under the product. The policyholders do not participate in profits or losses.) and Unit-Linked products (directly linked to changes in the underlying investment, so the investment risk and reward is directly attributable to the policyholder). Each life insurance company has a different mix of products in each category and each category has its own profitability. For example on an industry wide basis non-participating products have better profitability margins for shareholders than the other two.
On distribution channel front, the industry has mainly three large channels out of many namely Agents, Bancassurance and Direct. In terms of low cost of acquisition the Direct channel is least cost intensive while the Agents channel is highest cost intensive for companies. Historically LIC has about 96% of its products sourced by agents while private insurers source majority of its products through Bancassurance channel (53%) and Direct channel (~16%).
Now, coming to the financials the key matrices for the life insurance companies are New business premium (NBP), Value of New Business margin (VNB Margin), Persistency ratio, Solvency ratio & Conservation ratio. NBP signifies the growth in insurance business in terms of new policies being sold excluding renewal premium, the VNB margin signifies how much profit a company is expected to make from new business generated in future. The persistency ratio signifies the sustainability of renewal premium a company receives over time, Solvency ratio is company’s size of capital in relation with risks it has underwritten and Conservation ratio represents the total renewal premium collected in the current year, expressed as a percentage of total premium collected in the previous year. For LIC the NBP growth has been lower than private peers but has seen improvements lately while NBP margins remains lowest at 9.9% while large industry peers stood around 23%-25% largely due to higher share of non-participating policies. In terms of persistency LIC is largely in line with the industry trend with better matrix in 60 plus month matrix. In solvency terms LIC has significantly improved its solvency ratios from previous years and is at par with industry standards.
Now coming to the size, LIC is the largest company in India with ~64% market share in gross written premium, has over 55% share of the industry agent pool and has highest agent productivity in industry. LIC’s agent pool is more than twice that of the entire private insurance pool. LIC garners about 10% of total household savings in India and has higher premium flows than India’s largest Bank SBI’s deposit flows.
To sum it up, the company’s current valuation seems to have priced in some drag due to its legacy and participating heavy business and higher cost of operations which has lowered the Embedded multiples but it also has lot of factors which are turning positive for the company like increasing share of non-participating policies lately, improving VNB margins, change in distribution policy to shareholders at par with private insurers and sheer size of the company which could prove to be more beneficial than a hindrance. Hence we believe there is more left on the table as far as valuations are concerned in LIC IPO.
(Narendra Solanki – Head- Equity Research (Fundamental), Anand Rathi Shares & Stock Brokers. Views expressed are the author’s own.)