The insurer has growth potential, underestimated embedded value and the government sell its stake in the company again
India’s biggest IPO, for Life Insurance Corporation of India (LIC), comes at a difficult time for many investors. The Ukraine War and lockdowns in China have halted India’s stock market bull-run; and the IPO was scaled down due to global uncertainty.
Should retail investors participate still? The answer is ‘yes’. The terms are generous and they will be even better for individual policyholders. The key valuation ratio for life insurers is the Price to Embedded Value per share (P/EVPE).
Embedded value is defined as the present value of (expected future profits) and an adjusted net asset value. For LIC, this was calculated to be around Rs 5.4 trillion as of December 2021. This is an underestimate because it controls an enormous amount of prime real estate. Also, the state-owned firm has changed policy on the percentage of transfer of surplus, which will benefit shareholders.
Adjustments aside, the P/EVPE at the top end of the IPO price band (Rs 949), is at 1.1x. This is well below the valuations of other listed life insurers–most trade at ratios of 3x or higher. If the individual is a policyholder, the discount of Rs 60 per share makes the valuation very attractive. Another point for consideration is that IPOs launched during phases when the secondary market is relatively weak give better long-term returns–the Nifty is down 8-9 per cent from its peak levels so this is a factor.
LIC has many strengths in its excellent all-India footprint, brand recognition and its dominant market share. Its AUM, or assets under management, is three times that of rivals combined. The improved distribution of surplus ratio pleases the government, which retains 96.5 per cent stake but it benefits all shareholders. The sector is expected to grow comfortably in double-digit percentages since India is still very under-penetrated by insurance. India is 87 per cent “under-protected”–that is, life insurance covers only around 13 per cent of the assets it should protect.
However, aggressive private insurers have eaten into LIC’s market share. LIC’s market share (based on premium) in group business declined from 81 per cent in 2015-16 to 74 per cent by December 2021 while in individual business, its market share has declined from 56 per cent to 43 per cent. This trend may continue.
LIC also has lower margins on its policies due to the high (99 per cent) of non-linked to equity market policies. Within this non-linked segment, participating schemes with distribution of bonus are around 61 per cent, further reducing profitability. Hence, LIC has a margin of around 10 per cent (2020-21) while most players have 20 per cent margins or better.
LIC also has lower short-term persistency ratios for policies (only 77 per cent go beyond 13th month). However, the long term persistency ratio (over five years tenure for 62 per cent of policies) is better than competitors. It is pushing to improve the equity linkage ratios.
Insurers’ profits depend on what they do with their float – the premium collected which is not required to service expenses or claims. This is cheap long-term money. The LIC portfolio has 25 per cent equity exposure. The returns could be higher if LIC was not used as a piggy bank by the government.
In analogy to the banking sector where private banks trade at higher valuations, it’s apparent why LIC receives a lower valuation. Investors must also reckon with follow-on issues since the government will probably try to divest more stake going ahead. However, taking these factors into consideration, the IPO seems worth subscription due to low valuations.