An insurance co is a hedge in itself, says Ashvin Parekh

Speaking about margins, he said, it depends on the product mix. ICICI Pru has a higher share of Ulips and lower margins.

He said if you are a long-term investor, you are going to see an upside by investing in ICICI Pru’s IPO.Below is the transcript of Ashvin Parekh and R Sreesankar’s interview to Latha Venkatesh and Sonia Shenoy on CNBC-TV18.Sonia: Not talking about the initial public offering (IPO) per se, but just talk a little bit about the industry. What kind of growth do you see in the insurance industry because in the past, it has not been a great wealth creator for investors?Parekh: It is. There are two parts to it. When you are looking at life insurance stock for instance worldwide, you are looking at growth in the value rather than looking at income by way of dividend. So, that is the first major distinction.Second is if you look at the multiple, that is if you look at the total capital deployed by the promoters -- and you look any life company and let us say the value in the market, that is even when they sell it to another shareholder for instance or take it to the market, the multiples are substantial, which means, you are talking about large growth in case of life companies.Two things -- one is let us say basically a life insurance contract, under the contract, the policy holder promises his cash flow for another 10-15 years, commits it to the insurance company. So, unless he surrenders his policy or there is a lapsation, the value or the cash flow to the insurance company continues growing. That is what the multiple, the value at the market is all about. It is all about encashing, taking future profits into account.So, past and future profits are considered in the embedded value calculation basically and then the multiple of valuation determines the price at the market. By and large, life company, it is a very stable stock to begin with and then the value keeps on growing over a period of time.Latha: People talk about two issues against the stock. One that they recently sold their shares to Premji Investments at a much lower price of Rs 240 thereabouts. Secondly, the margins of this business for ICICI Prudential come at 8 percent compared to comparable companies, SBI Life 14, Max Life 17. How would you answer both these charges? Where do you stand on the stock?Sreesankar: First and foremost, the previous transaction done at an earlier date, but the market conditions were different. Number two, we probably did not have also this HDFC and Max combined entity coming into picture, etc. So, the valuation obviously is a function of where the market is, how the market is taking this into considerations, etc. Now, the valuations obviously have changed. We are at a market, which is probably closer to 9,000-8,900 and the inflow continues to be strong. So, the price-earnings ratio (P/E) multiples or whichever multiple that you speak about, in insurance it is not P/E, we are looking at embedded value in the business and the valuation that is there has gone up. So, I do not think there is much to be worried about looking at -- few months back it has been sold at Rs 240 and today, it is coming at anything from Rs 300-334, the price range. So, I am pretty comfortable with that. That is number one.Number two is the issue you mentioned about margins. It depends upon the product mix, you have higher unit linked insurance plans (ULIP), you will have lower margins from that particular business. And now in ICICI Prudential’s case, it has got a higher share of ULIP and obviously, the lower margins there. If I go back to looking at the return on equities (ROE) consistently, this company has been 30 percent plus in excess of ROEs.Sonia: So, what is the recommendation then to retail investors for this particular IPO, not just for the IPO itself, but post listing, what kind of gains do you see?Sreesankar: The question is what are you looking at in this IPO. Are you going to be an investor who is going to try to flip off after listing? Post listings you get certain pop-up and try to flip it out. Or are you an investor who is going to be invested, carrying on with the gains that you will get from the persistency which keeps decreasing over a period of time. If the answer is the first, I am going to be an investor who is going to be looking at flipping immediately on listing, our view is that you may not see much of an upside out there. But if you are a long-term investor, you are going to be benefitting out of all the persistency and the continuous cash flows coming from -- as Ashvin Parekh pointed out -- the ULIP holders, etc, you are going to see a real upside over a longer-term period. You are talking about anything from three to five years. And you should be part of that financial services part and the insurance company, which is the largest in the private sector and continuing to grow. So, there you will see a bigger upside.Latha: Purely as an insurance expert, how would you rate insurance companies? Would it be on their persistency ratio, will it be on their market share, will it be on their ULIP to non-ULIP products, what will be the parameters?Parekh: All these four parameters are very critical. If we talk about the size for example, the biggest thing for a life company is when your portfolio size is very large, you find the hedge in your portfolio itself. So, if there is any spike in any claims then you are taking care of it through the portfolio, so that was one.Persistency is perhaps the most critical part because if a policy holder commits his future cash flow and thereafter he surrenders his policy or there is a lapsation for instance, then the value comes down because for the embedded value, they would have already considered, taken into account the future cash flows for a policy, which is already sold. So, that is also a very important one. All these factors do influence and the product mix, most important. So, if you have more of ULIP, then normally, the market price will be a little lower.Sonia: So, the ROEs for this business, especially for ICICI Prudential has been at 30 percent since FY12. So for the last many years. You think it could better this ROE level over the next couple of years or is this a standard by which the industry functions?Parekh: I am certainly seeing that for life companies in this country, the ROE -- as a band -- will be certainly in the region of about 25 to 30 percent. It could be even more. The reason is very simple. The penetration rates in India are so low that there is a huge potential in the market compared with the other growing economies.