The sheer heft of LIC is unmatched. Even after 20 years since the entry of private insurance companies, LIC still sells over 70% of the life insurance policies sold in the country and receives 65% of the total new premiums. Its assets under management are nearly 16 times that of the next largest insurer and more than the AUM of the entire mutual fund industry!
Does size matter? Can LIC compete with the more nimble-footed private insurers? Beyond the eye-popping numbers and optics lie some uncomfortable truths. Sixty years of government ownership have asked a lot from this entity—hurting its profitability and efficiency. It has taken some dressing up to turn the IPO into a viable offer that can stand up to scrutiny of large domestic and foreign investors. ET Wealth delved deep into the numbers in the draft red herring prospectus (DRHP) and sifted the good, the bad and downright ugly to get the complete picture. Here’s what we found.
Exposed to government diktat
Through the years, LIC has remained obliged to do the government’s bidding whenever called upon. Its massive cash pile is regularly used to recapitalise public sector banks, get public offers of PSUs over the line to meet disinvestment targets and more. LIC is on standby to infuse capital into IDBI Bank should its position deteriorate below the minimum capital requirements for at least five years. Such directives can adversely affect LIC’s financial condition. As the DRHP itself notes, “Our corporation may be required to take certain actions in furtherance of the GoI’s economic or policy objectives. There can be no assurance that such actions would necessarily be beneficial to our corporation.” So shareholders may be disadvantaged by any action the government may pursue. This is partly reflected in LIC’s high gross NPA ratio, which stood at 7.78% for the year 2020-21—highest among all listed insurers. Deepak Jasani, Head of Retail Research, HDFC Securities, argues, “LIC has to overcome the impression of being the rescuer in the government’s financial troubles as this may not be taken well by its minority shareholders. Such actions will now be open to greater scrutiny.”
Profits cut for policyholders
LIC has had to rejig its surplus distribution policy to make the IPO palatable to shareholders. Last September, it split the consolidated Life Fund. This is the pot that holds the profits or gains from LIC’s investments. The fund has been split into two: one for participating policyholders and the other for non-participating policyholders. A participating policyholder gets a share in the profits of the company while a non-participating policyholder does not. Earlier, 95% of the Life Fund kitty was distributed to policyholders and the rest to shareholders. Now, the entire non-participatory fund will go to shareholders. The participatory fund is initially split 95:5 and will gradually be shared in the ratio of 90:10 between policyholders and shareholders. This rejig will bring down the surplus available to LIC’s participating policyholders—who constitute bulk of the company’s product mix. It may reduce the lure of LIC among some customers and perhaps even lead to surrenders. “How policyholders respond to this revised arrangement remains to be seen,” says Vaibhav Agrawal, Founder and CIO, Teji Mandi.
Higher embedded value
The segregation of the Life Fund served another important purpose for LIC—propping up its embedded value (EV). This metric serves as the basis for valuation of any insurer. It is the sum of present value of all future profits from existing business plus net worth. The company’s valuation is usually expressed as a multiple of this embedded value. LIC’s embedded value saw a five-fold jump post the bifurcation of the Life Fund allowing bigger payouts to shareholders. It is pertinent to note that the EV itself is derived on the basis of assumptions of multiple variables such as interest rates, persistency, mortality, pricing, business growth etc. This doesn’t make for a dependable valuation metric, particularly when the company is losing market share or subject to excessive government interference. Investors must note these flaws before comparing LIC’s EV with that of its peers. Vikas Gupta, Chief Investment Strategist, OmniScience Capital, argues, “Even minor changes in a few assumptions can make a lot of difference in the embedded value of the insurer. This makes valuing based on EV a very tricky proposition.” Even so, analysts predict LIC to be given a lower EV multiple to private peers because of its public sector tag and lower profitability.
Market share is shrinking
LIC is a dominant player with a 60% market share, but it has ceded space to private sector rivals over the years. LIC’s market share of individual new business premiums has dropped from 56% in 2015-16 to 44% in the first half of 2021-22. It has also lost ground in the group insurance segment—traditionally its strong point. Private insurers bring wider range of offerings catering to younger customers, better digital presence and customer servicing. The Covid-induced lockdowns precipitated LIC’s market share erosion. However, analysts expect the decline in market share to slow down as the insurer addresses its shortcomings. Parag Jariwala, Director – Investments, White Oak Capital Management, reckons, “LIC will look to increase presence in banking and online channels as well as bring a wider set of offerings to arrest the market share loss in individual business.”
Higher RoE is an illusion
LIC’s profitability as indicated by its return on equity (RoE) is also unparalleled among its peerset. The company’s DRHP puts its 3-year average RoE at a staggering 289%. However, this number is not strictly comparable with peers. Being 100% government owned, LIC has never needed traditional capital. Neither has it ever clawed back profits as reserves, until last year. All profits have been distributed either as dividends to the government or payout to policyholders. This has kept its equity share capital very low (Rs 100 crore only!) until recently, which led to a very high RoE. After shoring up its equity capital, the company’s RoE reduced from 405% in 2018-19 to 82% in 2020-21. This figure will moderate further as the company goes for more equity dilution over the years. Jyothy Roy, DVP- Equity Strategist, Angel One, points out, “The high RoE should be ignored as with surplus transfer to reserves, LIC’s net worth will go up and bring its RoE to more realistic levels reflecting its profitability.
High dependence on agents
LIC’s distribution strength comes from its 13.5 lakh strong force of individual agents. This network contributed approximately 94% of its new business premium in 2020-21. Comparatively, private insurers rely heavily on online and banking channels. Jariwala insists, “LIC’s agency force is an extremely motivated, well-oiled machine trained to sell its range of policies and deeply entwined into LIC’s ecosystem.” However, there is a flipside as well. The lockdowns severely affected the ability of agents to provide services. The number of active individual agents (who sold at least one policy in past 12 months) decreased by 17.48% from 10.86 lakh as on 31 March 2021 to 8.96 lakh as on 30 September 2021.
LIC’s high dependence on its agents leaves it vulnerable to higher attrition. It terminated services of over two lakh agents (or 16.6% of its total network) in 2020-21. LIC’s commission ratio—which is gross commission paid to gross premium—stood at 5.2% as on 30 September 2021 as compared to 4.2% for HDFC Life and 3.6% for SBI Life. The DRHP notes, “We may need to increase commission and other benefits in order to attract and retain enough agents, subject to the cap on commission payable to our agents.” Only recently has LIC tied up with insurance marketplace Policybazaar to beef up its online presence. Efforts are also on to drive more sales through its own website.
LIC also scores poorly when it comes to continuation of policies. Its 13-month persitency is 78.8%, which means every fifth policy it sells is terminated after the first year. Private sector players have better persistency at 84-85% in the 13th month. However, LIC’s persistency in the 61st month is the highest at 60.6%, compared to 45-52% for private players.
Skewed product mix
LIC retains a strong focus on traditional non-linked savings products where demand is not linked to market cycles. Nonlinked products constituted 99.7% of its portfolio in 2020-21. Amongst the peer set, HDFC Life comes closest with 71% of its premium through non-linked products. This allows for predictability in returns and thus higher comfort for policyholders. A modest protection-oriented portfolio also ensures LIC cedes lesser premium to reinsurers as it is not exposed to mortality risk. At the same time, this product mix keeps investment yields lower than what its peers earn from non-participatory products like Ulips and deferred annuities. Further, it keeps LIC’s profitability depressed as savings plans are not as profitable as others. Agrawal remarks, “LIC’s value of new business (VNB) margins are very low relative to private players owing to the product skew towards lower margin plans.”
The product mix also results in lower ticket size as compared to peers. The average new business premium (NBP) per individual policy for LIC was Rs 26,892, which is significantly lower compared to its peers. Jasani remarks, “LIC’s product mix is tilted towards savings and long-term participating products. This could restrict its ability to take higher risks in investments. However, the shift to sharing 10% of surplus to shareholders (versus 5% so far) could nudge it to take higher risks going forward so that the payout to the policyholders is least impacted.” With the revised surplus distribution policy, LIC now has greater incentive to focus on higher margin non-participating products.
Weaker cash position
While LIC’s cash reserves are unrivalled, its cash position took a hit in recent years. It reported negative cash flows from operating activities in the first half of 2021-22 at Rs 11,114 crore due to high other operating expenses, after reporting positive cash flows in the previous three financial years. Cash on its balance sheet has reduced substantially from Rs 67,899.5 crore in 2018-19 to Rs 26,050 crore in the first half of 2021-22. This is mostly a result of pandemic-led disruptions in normal business activity apart from higher claim-related payouts. Private insurers also experienced stress in their balance sheet during this time.
Cost superiority
Despite its commission-heavy cost structure, LIC’s expense ratio is considerably lower than that of private players. Operating expense ratios as a percentage of total premium for 2020-21 (8.7%), and six months of 2021-22 (10.1%) are lesser than median of the top five private players’ operating expense ratios during the same period. Total cost ratio (including commission and operating expenses) are also lower than the private players. Analysts point out LIC’s cost advantage relative to more efficiently run private players is on account of it being a mature business. Agrawal asserts, “Insurance is a business of operating leverage that comes with achieving scale. LIC is simply reaping the benefits from 65 years of operations.”
Skew in investments
In 2020-21, LIC booked the highest profits from share sales in its 65 year history. Big gains from its investments lend its financials a gloss in good years. But investors must learn to distinguish its market linked profits from its business profits, avers Gupta. “The market is not likely to deliver such big capital gains repeatedly. In a bad year, the marked-to-market value of its investment portfolio can drop sharply.” Agrawal notes that a sensitivity analysis reveals the equity book of LIC is more sensitive to corrections compared to peers. Further, it is worth noting that LIC’s investments portfolio carries a distinct skew. Its AUM mix is tilted towards debt—with 80% in fixed income and 20% in equities— highest among peers. This reflected in lower yields from investments in 2020-21.
Should you invest in LIC?
LIC’s scale and reach make it a unique proposition. The LIC brand itself is a huge moat given the trust it commands among millions. At the same time, it is weighed down by several operational challenges like excessive government interference, skewed product and distribution mix, stiff competitive environment etc. Despite being in a dominant position, LIC lags behind its private rivals on several metrics. While it is now actively pursuing different strategies to improve profitability and arrest market share erosion, it is likely to prove tricky. Roy insists, “While it has several levers at its disposal to improve margins, it is likely to play out only over a long period of time given its bulk.”
Meanwhile, private insurers will keep the foot on the gas pedal. The overall quality and growth track record of private sector leaders is much superior to LIC, insists Avinash Singh, Senior Research Analyst, Emkay Global Financial Services. “Their track record over the last decade, the business model, agility and their stronghold on the affluent class sets them apart from the large behemoth LIC.”
Still, the buzz around LIC’s listing will be immense. Gupta contends investors need not feel compelled to invest now, even if the shares are offered at a discount. Even after this 5% divestment, the government will keep offloading more stake in tranches in the coming years. This supply overhang will keep stock price suppressed, contend analysts. “That kind of supply tends to put a lid on the stock price,” says Roy. He further points out that the IPO is coming in tricky market conditions and so pricing of the offer remains critical. The Ukraine crisis has only added to the uncertainty. For perspective, you just have to look at the contrasting fortunes of two other government monopolies. Coal India lost over 50% value after listing even as IRCTC went up more than 300%. Only time will tell which way the pendulum will swing for LIC.
