LIC IPO: To be Valued Below the Private Insurer’s Valuation

The government has started the process of preparing for the initial public offering of Life Insurance Corporation of India (LIC), in which they are expecting to divest up to 5% of the stake. The first step in preparing an insurance company’s divestment is determining its embedded value. This is the sum of the present value of all its future profits. The secretary of the Department of Investment and Public Asset Management (DIPAM), agreed that the LIC DRHP had been filed on February 13.

According to the Milliman Advisors’ actuarial exercise, the EV for LIC is about Rs. 5.4 lakh crores. This figure will form a base on which the valuation of LIC depends. The valuation multiple to be assigned to embedded value must be determined. One can also look at the relative valuation multiple of the leading private life insurers to arrive at LIC’s worth and valuation multiple. As of September end, HDFC Life had a relative valuation multiple of 4.4 times.

Valuation Multiple

LIC is a leading insurance giant with assets under management of more than Rs 36 lakh crore. Unlike private insurance companies, LIC policies have a sovereign guarantee. This makes them more attractive against the private players. It is estimated that LIC will be valued at around Rs 19 lakh crore if it is priced at the average valuation of the three private life insurers which is 3.4 times. Some of the reasons why LIC’s valuation is lower than that of its private peers are due to various factors such as government interference and outdated systems and processes.

Lower Multiple Compared to Private Insurers

LIC has amended its profit-sharing arrangement with its policyholders. This benefit will now be aligned with that of private-sector peers. There are some key reasons why LIC is planning to raise funds at a discount to its private-sector peers.

Stunted VNB Margins

The profitability of a life insurance company is often measured by the value of its new business (VNB). This is the sum of the expected profits from the new business that the company will generate in the future. While LIC’s return on equity is among the highest in the industry, its VNB margins are significantly lower than those of the private players.

VNB is the value created by the company for its equity shareholders during a specific period. It is the reason why valuations are so attractive for private players like HDFC Life and ICICI Prudential Life Insurance Company. This is another reason for the lack of enthusiasm for the LIC IPO.

Low Yielding Insurance Products

The product mix of LIC is inclined towards savings products, which are typically defined as endowment plans. India’s life insurance story is all about protection business as the country has the highest protection gap in Asia-Pacific. This report shows that there is a huge opportunity for LIC in the life insurance industry.

Poor Distribution Channel

LIC’s distribution mix is very different from that of private insurers. This difference in commission rate leads to a higher premium ratio. While private insurers mainly rely on bancassurance channels, LIC mostly depends on its agents for its business. Direct channel contribution was less than 2 percent for LIC.

Since LIC operations are not likely to improve significantly, it is unlikely to get valued at over 3.4 times its embedded value. The IPO will allow retail investors and policyholders to participate in the company’s future growth.

FAQs

Why is the commission ratio of LIC higher compared with private peers?

The commission ratio of LIC is higher than the private insurance players because of the distribution model of LIC. They rely on agents and hence shell out a higher percentage of premium towards the commission to agents.

What is the VNB margin?

The VNB margin is the profitability of a life insurance company. It tells investors how much they should pay for their insurance. The VBN margin is computed by dividing the value of the new business by the annualized premium equivalent. A VBN margin of 20% shows that the insurer has underwritten a new business premium of Rs.100 on which the insurance company will earn Rs. 20. Insurers with higher VNB margins tend to focus on their protection business.

What are the recent updates on LIC IPO?

In the most recent update, the government has submitted the LIC DRHP on 13th Feb 2022 for the proposed initial public offering to finalize the disinvestment plan of the insurance giant.

Disclaimer: This blog is exclusively for educational purposes and does not provide any advice/tips on investment or recommend buying and selling any stock.