Beyond size, LIC’s profitability is a mixed picture

The size of India’s life insurance market in FY21 was Rs 6.2 lakh crore on a total premium basis of which the largest life insurer Life Insurance Corporation (LIC) of India had a 64.1 percent share. The size and reach of LIC is a potent leverage on which the life insurer can ensure a stable growth rate.

The government and the book runners of LIC’s initial public offer are confident that the insurer’s heft will ensure that investors come in droves to put money. After all, it makes sense to take exposure to the largest entity in a grossly under-penetrated market to get more bang for one’s buck. But before LIC’s valuation is zeroed on, there are some metrics where the insurance behemoth is overshadowed by its smaller private sector peers.  Unfortunately for LIC, these metrics surround the most important reason for investment –profitability. There are three key metrics that investors look for in a life insurance company while determining its profitability.

Embedded value

This parameter has become slightly controversial in the case of LIC given the raft of assumptions made to arrive at embedded value (EV). The fact that LIC’s embedded value has soared five times in just six months also gives it an air of incredulity. To be sure, the reason has been simply a change of how the insurer distributes its profits. LIC’s embedded value as of March 2021 was Rs 95,605 crore which shot up to Rs 5, 39,686 crore by September 2021. The insurance behemoth’s FY21 embedded value towers over private sector rivals. For comparison, SBI Life Insurance Company Ltd embedded value was Rs 33,390 crore. The most valuable HDFC Life Insurance Company Ltd’s embedded value stacked up to Rs 26,620 crore. Even the growth in embedded value for LIC is far higher than that of private sector peers. SBI Life’s EV grew by 27 percent and that of HDFC Life showed 29 percent growth. Note that this was despite the pandemic. LIC registered 105 percent jump in EV, according to the prospectus.

Value of new business

This is yet another critical profitability parameter that investors of life insurance companies closely track. Value of new business is the present value of future earnings on all business written during the year. Simply put, if an insurer sells life insurance product, it expects regular premium inflow and a return through investing that premium. The present value of all the future earnings through the tenure of the policy is the value of new business for the given period. This can be compared loosely to adjusted profit after tax for companies. Value of new business is the operating income that boosts the embedded value. LIC’s value of new business for the six months ended September was a mere Rs 1,563 crore. This compares poorly with HDFC Life’s Rs 1,780 crore but trumps SBI Life’s Rs 1,220 crore for the same period. Does this mean that LIC doesn’t expect to sustain earnings from its policies? To some extent, it is true as the life insurer’s persistency ratios aren’t impressive. In other words, its customers don’t tend to stick with it for a long time, affecting the flow of regular premium.

Persistency ratio

LIC’s persistency ratio lags behind most of its peers. For instance, the insurer’s 13^th month persistency ratio was 79 percent in FY21 and this keeps dropping in the 25^th, 37^th, 49^th and 67^th months intervals. On the contrary, persistency ratios of private sector peers are stronger. SBI Life’s persistency ratio for 13^th month was 88 percent while HDFC Life reported 90 percent. Poor persistency ratios amid low growth in business is a combination detrimental for LIC’s earnings. Data from the insurance regulator has shown that LIC has been losing market share hand over fist to its private peers over the past decade. True, it still remains formidable in the market with a 64 percent share. But growth in new business has been lower than private sector peers.

Value of new business margin

This is the profitability margin of life insurers and a reflection of the pricing of their products as also their business growth. LIC’s VNB margin again is horribly low compared with private sector peers. According to the prospectus, LIC’s VNB margin was 9.3 percent for the six months ended September 2021. This compares with SBI Life’s 21.8 percent and HDFC Life’s 26.4 percent. This means that LIC is operating at a very thin margin or that its costs are eating into its earnings in a big way. To be sure, LIC’s cost ratios are not ugly. Among insurance policies, low-cost simple term plans or non-participatory policies are most margin-friendly. Given that LIC’s dominant product are endowment policies that entail high costs, the pressure on its margins is palpable. To be sure, LIC has been focusing on non-participatory products over the past few years. Investors will need to closely examine the likely impact on LIC’s margins in the coming quarters.

LIC’s size gives it an outsized advantage against private sector insurers in sustaining a steady earnings trajectory. That said, it also prevents the insurer to orchestrate changes in business. Investors have in the past punished even nimble-footed private sector insurers when profitability has eroded. It should not make an exception for LIC. ​