How LIC should be valued

The Life Insurance Corporation differs from its listed peers in a number of ways, and these should be factored into its valuation prior to its proposed initial public offering

India’s finance minister, Nirmala Sitharaman, recently made a groundbreaking announcement proposing the listing of the Life Insurance Corporation of India (LIC) through an initial public offering (IPO). LIC is the country’s largest insurer, controlling more than 70 per cent of the market share in terms of the number of policies sold and first-year premiums. Based on media reports, the stake sale is unlikely to be more than 10 per cent, which itself could be divested in multiple tranches considering the expected size.

The proposed listing could prove to be one of the largest IPOs in the Asia-Pacific region; it would be keenly followed not only in India, but also globally from an industry and investor perspective. Since LIC is an unlisted company currently with no publicly available value indication, the value of divestment is poised to attract significant attention. 

Companies, typically, are valued in two ways: First, using an income approach which is basically the present value of future cash flows expected to be generated from business operations; or second, using a market approach which provides an indication of value by relating the equity or invested capital of comparable companies to various financial metrics such as earnings, cash flow, and book value and various operating metrics. These multiples are then applied to the subject entity’s corresponding metrics. 

Similar methods are applied to value an insurance company. However, what differs is the nature and computation of underlying cash flows (income approach) or metrics to arrive at multiples (market approach), which are industry-specific. In this article, we discuss commonly used multiples that can be used to value the Indian insurance behemoth. We will also discuss various factors that should be considered to adjust those multiples to account for differences in size, profitability, risk profile and growth. 

Understanding the multiples in practice

We can look at the market capitalisation to embedded value ratio (MCap/EV) for the three biggest listed players in India — HDFC Life, ICICI Prudential Life and SBI Life. The multiples range from 3x to 6x, which appear significantly higher than their Asian insurance counterparts, valued at under 2x. Such rich valuations underline the growth opportunity in the underpenetrated Indian market and the confidence of the market in the sector. 

Similarly, another approach that can be considered includes a ratio derived from the assets under management (AUM) of the insurance provider. For the above three companies, the MCap/AUM ratio ranges from 40 per cent to 90 per cent. As of September 2019, the total AUM of LIC is more than Rs 30 trillion.

The raw multiples arrived at using the above approaches should be further adjusted as discussed in the next section.

Analysis of the multiples

Once the comparable companies’ multiples are derived, the next step should be to adjust the multiples based on characteristics of the subject company (LIC). Simply applying the peer group multiple will lead to an erroneous conclusion, since LIC is starkly different from its comparable peers in terms of size, profitability, ownership and growth profile. The valuation should account for the following factors:

Product portfolio: There is great divergence between life insurance products sold by LIC and private insurers. While LIC’s product mix contains largely traditional products (of which participating products are significant), private players have moved away from participating products and are selling unit-linked, non-participating savings, protection and annuity products. Protection policies have higher profitability than savings products. The accompanying chart illustrates the indicative VNB margin ranges of a range of life insurance products.

Listed players like HDFC Life and SBI Life are shifting their product mix towards higher-margin products like term life, credit life, group life and non-participating guaranteed products, resulting in higher multiples.

Persistency: This is important as it is a key driver of profitability for an insurer. A persistent book — where customers pay renewal premiums every year — also helps insurers reduce costs through economies of scale. The insurance regulator reports persistency ratios of all companies by the number of policies. It’s very important to compare persistency of policies of LIC with its listed peers.

Distribution model: Commissions paid by listed private insurers have come under 5 per cent of total premiums paid. Considering that LIC is an agent-driven business, it incurs substantially higher commission costs and, accordingly, the applied multiple would have to take this into account.

Quasi-sovereign wealth fund: With its huge corpus, LIC functions partially as a quasi-sovereign wealth fund through its prior subscription to the power sector’s Ujwal Discom Assurance Yojana (UDAY) bonds, investments in the National Investment and Infrastructure Fund (NIIF), capitalisation of state-run banks, and active participation in the government’s disinvestment agenda. As such, there is a risk of its investments being driven to further the social and political agenda rather than purely for business reasons. Hence, an appropriate discount should be applied.

Having said that, LIC’s valuation metrics could be at a discount to the listed private insurers in India, the quantum of discount could be reduced if not eliminated, if the government can give an assurance to investors that the management would be given a free hand in taking investment decisions, without any social and political agenda. LIC’s IPO will be a historic event in the history of capital markets due to sheer size and scale. It is expected to unlock massive value and help the government to tackle the rising fiscal deficit. 
The writer is managing partner, D and P India Advisory LLP, and external advisor, Duff & Phelps India