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MARCH 25, 2007
 Cover Story
 BT Special
 Back of the Book

Mobile Security
Today, it is all about information and how the right information is sent to the right people at the right time and right place. Uncertainty about how to secure mobile phones in the face of increasing threats is slowing individual adoption of mobile applications. There are many facets of mobile security, including network intrusion, mobile viruses, spam and mobile phishing. Analysts expect big telecom companies to develop security solutions on various security platforms.

Rough Ride
These are competitive times for the Indian aviation industry. As salaries zoom, players are scrambling to find profits. Even the state-owned Indian is now seeking young airhostesses to take on the competition. It is planning to introduce a voluntary retirement scheme for airhostesses above 40 years. On an average, they draw a salary of Rs 5 lakh a year. The salaries of pilots, too, are soaring. According to industry estimates, the country needs over 3,000 pilots over the next five years.
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Business Today,  March 11, 2007

Value Ahoy!
By 2010, the total premium collected by insurers will touch $72 billion (from $21 billion today), and life insurers will be managing assets worth $55 billion (from just $6 billion today). Want to hazard a guess as to how much these companies will be worth in three-to-five years?
"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).


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.


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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