The insurance subsidiaries of ICICI Bank are key to the valuation of ICICI Holdings K.V. Kamath MD & CEO/ICICI Bank

Ten billion dollars in market value is a lot of money in any industry. It is more so in an industry such as life insurance, where the payback periods are long and the industry per se is a tough one. And insurance companies, especially life insurance companies, are incredible consumers of capital. Yet, the likely valuation for ICICI Holdings-the new holding company for ICICI Bank's 74 per cent stake each in the life and general insurance and the 51 per cent stake in asset management business-ranges from $7.5-$10 billion (Rs 30,750-41,000 crore). The deal is expected to set the valuation benchmarks in the insurance business.

There's one big reason why ICICI 's insurance business is so prized. It's not just the largest, but incredibly fast growing. Consider ICICI Prudential, the key element in ICICI Holdings' valuation. In just 2006-07, it increased the number of branches from 177 to 583, scaled up the sales force from 72,000 advisors to over 2,30,000, and the number of employees from 7,000-odd to more than 16,000.

Insurance industry watchers insist that the pressure on investors to be part of the great Indian insurance story is quite strong. Not surprisingly, then, the main trigger moving the stock of parent ICICI Bank and other companies with insurance subsidiaries has been the business generated by their insurance arms (see Proxy Play). Bajaj Auto's share suffered when it was revealed that the parent company could not capture all the upside that resides in the insurance subsidiaries. If the optimism about the insurance subsidiaries, particularly the life business, is anything to go by, then there is no dearth of capital to fund the scorching growth of insurance companies. Yet it is not so simple.

Capital Hungry

It is believed that ICICI Bank adopted "the creative solution" of placing equity in ICICI Holdings due to the fact that the regulator has apprehensions about a direct listing prior to 10 years of operations. In fact, IRDA Chairman C.S. Rao told BT (see page 130) that "there is a 10-year cooling period… though the law does not prohibit an early IPO." The rationale against an early listing seems to be that the fast growth of the industry is pushing back profitability of these companies much farther than the usual 7-8 years. And in any case, the retail investor is not likely to understand the dynamics of the insurance business, especially since it loses money hand-over-fist in the early years.

However, the absence of listed stock of insurance companies is fuelling what many industry watchers call "valuation frenzy." Companies too seem to be giving in by chasing growth and market share at the expense of profitability. In such a scenario, listing in itself would bring in a lot of discipline.

Meanwhile, it is the nature of the business that needs regular capital infusions for growth, new customer acquisition, servicing existing customers, and also for regulatory requirements. "If you start a 30-sales manager branch on April 1, then by the end of the financial year you would have sunk Rs 1.5 crore," says Gaurang Shah of Kotak Mahindra Old Mutual Life Insurance.

To top it, the insurance regulator requires insurers to maintain a 150 per cent solvency margin. Simply put, they must maintain capital 1.5 times their liabilities. That means the need for capital rises in proportion to growth. Private insurers (including general insurers) have invested more than Rs 10,000 crore as equity capital into the industry since liberalisation in 2000. And as can be expected, some promoters (especially Indian promoters who own 74 per cent of the business) are getting fatigued with this constant ploughing in of capital.

This and the desire of the foreign investors to own a larger piece of the pie has led to a high-profile clamour for relaxation of the foreign direct investment cap in insurance from 26 per cent to 49 per cent. Foreign investors, wanting a bigger part of the growing Indian pie, have been frustrated by the "sometimes on and sometimes off" approach. "The frustration stems from the fact that the relaxation was in the nature of a commitment made at the time of liberalisation," says a foreign investor.

Industry watchers agree that lifting the cap would simplify the issue, yet it seems to be a holy cow for the Left allies of the government. This despite the present regulations allowing 74 per cent foreign ownership of banks in the country. Are foreign investors going to exit India if the cap is not relaxed? Certainly not (Chubb and HDFC parted ways not because the market wasn't exciting enough). It is too important a market. The government seems to know that. Is the cap affecting growth of the players? Yes, especially of those where the Indian partner is either unwilling or unable (more likely the latter) to pump in more money.

The current growth of the industry is forcing the industry to explore other options. Officials have made presentations to the regulator for relaxation in solvency requirements. S.V. Mony of the Life Insurance Council says an option is to move towards risk-based capital requirements. "Uniformly high solvency margins for all players do not lead to the most efficient utilisation of capital, as the extra cost of capital is finally built into the pricing of insurance products," he says. Another option could be exploring the forms of capital allowed other than just plain vanilla equity. "The choice of instruments such as hybrid capital should be left to the players. Appropriate regulatory compliance could be insisted on," says HDFC Standard Life's Deepak M. Satwalekar.

However, what is clear is that something has to give way soon because, as Satwalekar says, "issues of capital constraint will begin to bother the industry and may affect growth soon".