Robust outlook for life insurance companies but valuations extremely pricey

Good growth in high-margin products, persistency and reach augur well; risk-averse investors could buy the dips

At a time when the economy is sagging, the robust outlook for life insurance companies has found good support of investors. The stocks of three major life insurers — SBI Life Insurance Company (SBI Life), HDFC Life Insurance Company (HDFC Life) and ICICI Prudential Life Insurance Company (ICICI Life) —have surged by 49-60 per cent in the last six months. While Max Financial Services (holding company of Max Life Insurance) underperformed its peers with around 19 per cent gains in its stock price, it was because of factors such as overhang related to distribution tie-up with Axis Bank and pledged shares. Still, all these stocks have outperformed the Nifty Financial Services index and Nifty50, which are up by 15 per cent and 7 per cent, respectively, in the same period.

With the sharp rally, these stocks are currently trading at high valuations as compared to their global peers. One reason for such high valuations is the underlying growth potential. The other reason, according to Deepak Jasani, head of retail research at HDFC Securities, is: “There is flight to quality stocks in the market which is lifting the valuations of life insurers.” However, the outlook for profitable growth remains strong, Jasani adds. The inclusion of SBI Life and ICICI Life in the Morgan Stanley Capital International (MSCI) index, recently, also highlights the sturdy growth outlook, and has added to the demand for the stocks. There are factors pointing to a strong outlook for life insurers’ profitability, which is measured in terms of value of new business (VNB) margin. This, in turn, will improve shareholders’ value. For instance, embedded value (EV) of all the four listed insurers is expected to increase at an annual growth rate of 15-20 per cent over the medium term, estimate analysts. EV is the present value of shareholders’ interest in a life insurer’s retained earnings.

Besides expectations of good premium growth, there is rising traction for high-profitable businesses, such as annuity and protection products, which should continue. Lower penetration and rising awareness about the importance of life insurance as a protection channel rather than a savings product is also benefiting insurers.

According to Edelweiss, the protection part is 10-20 per cent for the Indian life insurance business and the rest is investment/savings management and the protection component is far lower in India than peer nations. This is where the huge opportunity lies.

The April to September period or H1FY20 numbers show companies are continuously pushing protection products. While the share of protection products in the overall annual premium equivalent or APE of ICICI Life expanded by 690 basis points year-on-year in H1FY20, it was 50-150 basis points (bps) up for others. For SBI Life, the share is based on new business premium as the APE-based data is not available. For these life insurers, VNB margin, too, expanded by up to 350 bps year-on-year in H1FY20.

Strong distribution franchise with bank branches should make protection products sales easier, mainly for the top three insurers with banking parentage. According to H1FY20 data, ICICI Life, HDFC Life, and SBI Life garnered over 50 per cent of their businesses from banking channels. Improvement in persistency ratio, which indicates the stickiness of customers, is another profitability booster for insurers. “Persistency ratio should improve with rising financial literacy,” says an analyst with a domestic broking house.

Overall, life insurance stocks offer an opportunity for investors. However, risk-averse investors may want to wait for some correction before entering these counters. ICICI Life and SBI Life are among top picks of analysts in the life insurance space.