Insurance IPOs can open the door for infra funding

The insurer typically has a big float of free cash, which can be deployed for projects that generate long-term returns

At Rs 6,000-odd crore, the ICICI Prudential Life Insurance initial public offering (IPO) is the largest issue since 2010, when Coal India made a Rs 15,000 crore IPO. The price band is Rs 300-334/share with 18.1 crore (181 million) shares on offer. That’s about 12.6 per cent of the post-issue capital being placed on the block.

The four institutional shareholders include ICICI Bank (which holds 68 per cent), Prudential Corporation of UK (26 per cent), Temasek (2 per cent) and Premjilnvest (4 per cent). DSP Merrill Lynch and ICICI Securities are global coordinators and book running lead managers to the issue. Others are CLSA, Deutsche, Edelweiss, HSBC, IIFL, JM Financial, SBI Capital Markets and UBS.

Most analysts are positive on the IPO. The balance sheet seems healthy. ICICI Prudential Life (ICICI Pru) has about 30 per cent return on net worth. It scores high on a key metric, the solvency ratio. The solvency ratio is generally defined as net profits plus depreciation divided by total liabilities.

Net cash plus depreciation represents the cash retained with the company and the higher the ratio, the more easily the business can meet all its obligations. ICICI Pru has a solvency ratio of over 300 per cent. This is considered a key measure for insurance companies because insurers have, by definition, high liabilities.

The insurance business is highly competitive. Successful insurers receive huge amounts of very cheap, or free cash. Premiums received for policies are essentially free money, so long as payout is not triggered. Term policies generate less premium but the insurer gets free cash. “Money-back” policies pay very low interest compared to fixed deposits.

The insurer therefore, typically has a big float of free or close to free, cash which can be deployed for projects that generate long-term returns. This is a killer app. Long-gestation projects are hard to fund for other financial institutions because other institutions have to struggle with asset-liability mismatches.

Insurers are well placed to support infra projects with timeframe extending over 10-15 years or longer. It has been one of the steadiest growth businesses for several centuries. Insurance is arguably the foundation upon which global trade is built. The great historic voyages of exploration, which connected sea routes from Europe to Asia, and Europe-America were all backed by insurers. In the modern era, shipping and aviation insurance is a must.

The world's greatest investor, Warren Buffett, built a large chunk of his wealth upon funds received from the insurance business and he controls one of the biggest general insurance and re-insurance plays in the world. He has used the free float wisely.

However, India has many restrictions on insurance. Policies don’t have flexible premiums for instance. In the life segment (where ICICI Pru is placed), there is very stiff competition. Insurers must also abide with restrictions in terms of the assets they can invest in.

There are also serious dangers. Insurers are highly leveraged by the very nature of business. Think of insurance in terms of a bet. An insurer is betting that you will not die. It accepts a very small premium and offers a pay-off of around 25:1 or better if it "loses" that bet.

In general, the insurer assumes that the death of one policy-holder will not be linked to the death of the next. That assumption may be wrong in case of an epidemic, or a natural disaster, where many policy-holders die at the same time. Those caveats must always be borne in mind when investing in an insurance company. If this IPO is successful, other insurers are very likely to tap the market as well.

The author is a technical and equity analyst