HDFC Standard Life Insurance IPO: Good, but an expensive franchisee

Market positioning, a more profitable business and the HDFC brand lend support

After fuelling the valuations game in the life insurance space about a year back, HDFC Standard Life Insurance Company (HDFC Life) is all geared to go public on Tuesday. 

At the upper end of the price band of Rs 275 –290 apiece, the firm’s equity valuation (market capitalisation) is pegged at Rs 55,248 –58,261 crore. Considering that the private sector market leader ICICI Prudential Life (I-Pru Life) commands an equity valuation of Rs 55,700 crore, HDFC Life’s seem to be on the higher side. But, there are a few strong aspects, particularly with respect to its product profile, new business premium growth and profitability, which support the price. 

While growing competition in the life insurance space is squeezing out excess premium enjoyed by listed entities, the recent underperformance of I-Pru Life and SBI Life being testimony to the same, only long-term investors may consider the initial public offer (IPO).

Operations

As with most players, HDFC Life’s product segments are in sync with the industry practices (see chart). The good thing, though, is that the share of unit-linked insurance policies (Ulip) is kept at 52 per cent, and the share of participating products is relatively higher. Ulips are typically less profitable products for an insurance company, compared to participating or protection (pure term) policies. This gives some comfort to the insurer’s quality and scalability of growth. Helped by a strong in-house banking partner --- HDFC Bank, bancassurance (51 per cent of total distribution channel) is the principle support for HDFC Life. The share of direct selling is also high at 40 per cent.

HDFC Life scores high on some key parameters. In terms of total premium and new business premium earned in FY17, it takes the second spot to I-Pru Life and SBI Life, respectively. However, in terms of value of new business (VNB) margins, it tops the chart with 21.6 per cent margins in FY17. SBI Life and I-Pru Life trailed with 15.4 per cent and 10.1 per cent, respectively. However, there is room for persistency ratio (an indicator of stickiness of the policyholder) to improve. HDFC Life’s 13 months and 61 months persistency ratios in FY17 were 80.9 per cent and 56.8 per cent, respectively, slightly lower than I-Pru Life (87.5 per cent and 56.2 per cent) and SBI Life (81.1 per cent and 67.2 per cent). 

Financials

Led by strong growth in the group new business premium, total premiums expanded 14.5 per cent CAGR (compounded annual growth rate) in FY15-17. Nonetheless, as HDFC Life’s total cost ratio is higher compared to peers, net profit grew 6.3 per cent CAGR during this period. Total costs ratio was 16.7 per cent in FY17 versus 14.1 per cent and 11.7 per cent for I-Pru Life and SBI Life, respectively. There is scope for these ratios and overall return profile to improve, as HDFC Life is gaining traction in terms of new business premium, and benefits from significant investments in agency and digital channels start kicking in. For now, HDFC Life’s return in equity averaged at 29.4 per cent in FY15-17 trails that of I-Pru Life’s 31.2 per cent but is higher than SBI Life’s 20.1 per cent.

Valuations

With an embedded value (EV) of Rs 14,010 crore in FY17, the issue is priced at 4.7x FY17 EV at the higher end of the price band. The top two players trade at 3.5x – 4x their FY17 EVs. Evidently, HDFC Life’s asking rate is higher. Also, unlike its sister companies - HDFC Bank and HDFC Ltd, lack of clear leadership in its domain could prompt investors to ask if HDFC Life’s premium valuations are justified.

Risks

HDFC Bank accounts for 54.3 per cent HDFC Life’s annualised premium equivalent as of September 30. From April 1, 2016, banks can act as non-executive corporate agents for up to three life insurers, three general insurers and three health insurers. Therefore, the agreement between HDFC Life and HDFC Bank is not an exclusive arrangement and this is a risk given the high dependence on one banking partner. Similarly, while HDFC Life has been prudent about its exposure to Ulip products, plans to higher contribution from this avenue could increase the volatility in the insurers’ financials.