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"These valuations
are reflective of the Indian life insurance industry's potential.
The high GDP growth and under-penetrated insurance market
offer tremendous growth opportunities for private sector insurers"
Gary Bennett, MD, Max New York Life Insurance |
If the
50-year-old life insurance corporation (LIC) were to be valued in
today's market, it would probably run to several lakh crore. And
the market price of each Rs 10 share would be mind-boggling (no
analyst has attempted to calculate what the figure might be, but
back of the envelope estimates suggest it could be upward of Rs
1 lakh). It's unlikely that India's largest insurance company, with
a 75 per cent market share, will float an IPO, but even if it does,
the government will have to expand its capital base from the present
level of Rs 5 crore to make the pricing attractive to investors.
What is more likely,
however, is an IPO from one or more of the over a dozen private
sector life insurance companies. And valuations are likely to
be as crazy as the notional one for LIC mentioned above. Consider
this: the top five private sector insurers will have a combined
valuation of $15 billion by 2008-09, according to a recent Merrill
Lynch report (see The Treasure Trove, Today).
These soaring valuations are drawing new entrants-both
domestic and foreign-into this nascent industry despite the losses
suffered by the existing players and the 24 per cent FDI cap.
"These valuations reflect the potential of the Indian life
insurance industry. The high GDP growth and under-penetrated insurance
market offer tremendous growth opportunities," says Gary
Bennett, Managing Director of Max New York Life Insurance Company.
Gaurang Shah, Managing Director of Kotak Old Mutual Life, agrees
with Bennett but with a rider. "Factors like surrenders,
claims and high expense ratios will affect valuations in future,"
he says. These, naturally, will vary from company to company and
those that manage these better will obviously emerge the winners
(see The Key to the Cache).
| THE KEY TO THE
CACHE |
| How life insurance
companies are valued globally. |
| New Business Achieved Profits
(NBAP): Most research analysts in India have been using the
new business-achieved profits (NBAP) model to value private
sector life insurance companies by putting various multiples
to the NBAP. The higher the multiple, the better the valuation.
NBAP is actually a discounted value of future profits arising
from new business written during the year. These profits are
arrived at by attributing assumptions for parameters like
surrenders, expense ratios, and claims experience, among others.
Insurance experts say NBAP is the best tool to value a young
insurance business that is growing rapidly. In fact, NBAP
is a very European phenomenon but now, some US companies,
too, have started using this model.
Embedded Value: Embedded value (EV) is the present value
of future profit streams of the entire book, taking into
account capital, business and other balance sheet items.
It's akin to book value method of valuing a business. Globally,
EV is used to value established businesses by taking a multiple
of EV. In India, if EV is used, the valuations of life insurers
will go down, though it's very difficult to do so because
of the lack of adequate disclosures. |
 |
"We can expect to
see more realistic valuations once companies disclose more
information"
Shikha Sharma, MD & CEO, ICICI Prudential
Life Insurance |
"It's the regular premium business, rather
than the single premium portfolio, that will create value,"
says Deepak Satwalekar, MD, HDFC Standard Life Insurance Company,
adding: "Value is created by regularity and predictability
of the premium flows." Bajaj Allianz Life Insurance (which
has the second-highest valuation), Reliance Life and SBI Life
are some private sector insurers rolling out single-premium policies.
But not everyone is comfortable with the sky-high
valuations being bandied about. Says Shikha Sharma, MD, ICICI
Prudentail Life Insurance: "We can expect to see more realistic
valuations once companies make more disclosures." Future
valuations also hinge on the sustainability of growth, the interest
rate environment and the performance of the stock market.
Over the past six years, the life insurance market
has grown by over 100 per cent in terms of first premium income.
But Sharma, who heads India's most valuable private sector insurance
company, cautions against viewing this as a trend. "The rate
of growth witnessed this year is an aberration. A 100 per cent
growth rate for a large industry like ours is not sustainable,"
she says. Max New York Life's Bennett agrees. "We expect
the market to grow at over 50 per cent over the next three years
and at 25-30 per cent thereafter," he says. Max New York
Life, incidentally, focusses mainly on the traditional endowment
products.
| BUT WHAT ABOUT THE RED
BLOTS? |
| Stringent regulation
may be the culprit.
|
| The huge losses of private
insurers (see Losses are Piling Up) are a result of Indian
accounting rules that require life insurance companies to
account for insurance expenses (which are as high as 40 per
cent of the first premium) in the first year itself; whereas
the returns from the policy are expected to flow over the
life time of the policy in force. In the US, on the other
hand, expenses are required to be evenly distributed over
the term of the policy. If Indian insurance companies are
told to follow US GAAP norms, all of them will turn profitable.
The solvency margin-similar to capital adequacy in the
case of banks-is very high at 150 per cent of the statutory
requirement. The Insurance Regulatory & Development
Authority (IRDA) is clearly playing safe by keeping a high
margin to protect the interests of policy holders. Many
life insurers feel it's an extremely expensive way to factor
in safety. If this requirement is relaxed, capital will
get freed, which can be used more efficiently.
The regulator today prohibits any other form of capital
other than expensive equity to fund capital requirements.
Globally, other forms of capital like debt, hybrid capital
and preference capital are available to those in the insurance
business. Funding a business through only equity will result
in lower profitability as the higher equity base will affect
key indicators of fundamentals like earnings per share and
price-earnings ratio going forward. |
The valuations issue, still largely notional and
of academic interest at present, will really move to the centre
stage when these companies raise funds from the market or when
regulations allow the foreign partners to raise their stakes from
the current levels. The domestic players are keeping mum on what
their joint venture agreements say about this. "In a fast
growing business like insurance, existing shareholders will dilute
their stakes only if they don't have the capacity to bring in
more funds. Given the expected growth over the next five years,
I don't think any shareholder will dilute his stake," says
the CEO of a private sector insurer.
 |
"I'm not
unduly worried about valuations, but there are factors like
persistJency, surrenders, claims or high expense ratio that
could affect the valuations in future"
Gaurang Shah, MD, Kotak Life Insurance Company
|
Another challenge going forward will lie in balancing
growth with the need to build a quality portfolio. HDFC Standard
Life's Satwalekar says: "We may not be the fastest growing
company, but the stability and the quality of our portfolio is very
high. We have a 90 per cent persistence level." Persistence
level is the measure of renewal of existing policies every year.
In insurance-speak, the higher the persistence level, the better
the quality of the portfolio.
Another question mark is the Unit-linked Life Insurance
Policy (ULIP) portfolio of life insurance companies. According
to the Merrill Lynch report, ULIPs account for 85-90 per cent
of growth for private insurers. ULIPs products are like a mutual
fund scheme and the popularity of such products has coincided
with the boom in the stock market. "The high proportion of
unit-linked plans is not unique to India. It is driven by consumers'
need for transparency and flexibility," says Sharma.
Sceptics say customers may switch over to debt
schemes or even surrender such policies if the stock market enters
a prolonged bear phase. But most players feel such fears are exaggerated.
"We closely monitor the quality and profitability of business
that we write," says Sharma of ICICI Prudential Life.
 |
"The regular premium
business will actually create value for a life insurance company
rather than a single premium. The value in a life insurance
company is created by regularity and predictability of the
premium flows"
Deepak Satwalekar, MD, HDFC Standard Life
Insurance Company |
Even if one accepts that quality growth is taking
place, the fact remains that the industry is not making any money.
Most companies had expected to earn profits within 5-6 years of
launch, i.e., by 2006-07; now, this has been extended to 2008-10
for most of the companies (see But What About the Red Blots?). SBI
Life Insurance is the only company to earn profits (starting 2005-06),
but insurers say the losses are primarily due to stringent accounting
norms. "The losses are a trade-off between growth and profitability.
You can easily be profitable by not growing at your full potential,"
says an insurance industry expert.
"One must understand that insurance
is long-gestation industry that requires 8-9 years to break even,"
says Bennett of Max New York Life. Experts say that if the government
doesn't relax the FDI limit from 24 per cent to 49 per cent, the
Insurance Regulatory and Development Authority (IRDA) will be
under pressure to relax the stringent regulations to provide relief
to private sector life insurers. "One way to free up capital
will be to reduce the solvency margin requirement, which is very
high at 150 per cent," says Shah of Kotak Life.
So, as the industry continues to gallop ahead
(only the speed is being debated, not the forward movement; and
even here, the issue is: will it grow fast, or faster?), all eyes
will remain riveted on the regulator to see if it relaxes the
FDI limits or reduces the solvency ratio. But whatever happens,
the consensus among industry leaders is that the industry will
attain critical mass very soon. And we haven't even counted LIC
here.
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