The insurance sector in India is on a structural growth path. Listed private insurers have gained a significant edge over agency-led insurers and are now witnessing accelerated growth. We are enthused by private insurers’ improving profitability metrics in general and changing business mix in particular. We see low penetration, increasing persistency ratios and growth of protection business as key growth drivers for insurance companies.
Given the promising sectoral outlook, the moot question is which life insurance companies' stock is a worthy investment consideration at this juncture? We analysed the Q1 FY19 earnings of ICICI Prudential Life Insurance and HDFC Standard Life Insurance, two of India’s leading private insures that have reported earnings so far.ICICI Prudential Life Q1: Mixed set of numbers but on the right track for profitable growth
ICICI Prudential Life reported a subdued Q1 FY19 performance, with net profit declining 31 percent year-on-year, dragged down by increasing operating expenses and lower investment income. However, operating performance was healthy.
There were two negative readings from the quarter gone by: 1) Decline in annualised premium equivalent (APE); and 2) Increase in operating expenses. Both these factors doesn’t concern us much given the encouraging details like:1. Decline in APE
The insurer reported an 18 percent YoY decline in total APE. This was on the back of savings APE declining 21 percent on a higher base. However, the highlight of the quarter gone by was the 48 percent YoY growth in protection APE, which got masked by the headline growth number. It is heartening to see improving business mix in favour of high margin protection business. The share of unit-linked insurance schemes (ULIPs) in new business APE stood at 79.8 percent, while that of the protection business improved further to 8.2 percent (4.5 percent in Q1 FY18).2. Increase in operating expenses
Total operating expenses spiked in Q1 on increase in commission expenses by 29 percent YoY as well as a 45 percent rise in advertising and other expenses. As a result, the cost to total written premium ratio deteriorated to 17.5 percent as compared to 14.2 percent last year.
Despite rising cost, new business margin expanded significantly to 17.5 percent compared to 10.5 percent a year ago. Apart from improvement in persistency ratio, product mix and increasing share of protection business drove margin expansion.
It appears that the company has increased spending on advertising and incentives to grow the protection business. It does seem the right strategy as the benefits of the same exceeds costs as is evident in the improved margin.
ICICI Prudential Life has articulated its 4P strategy for growth. While it faltered on 2Ps (premium growth and productivity), performance on other two (protection and persistency) was better, leading to decent quarterly performance.HDFC Standard Life Q1: Superior performance driven by premium growth and margin improvement
HDFC Standard Life continued to deliver strong performance, with profit rising 20 percent YoY aided by growth in underwriting profits.
Premium growth remained strong with total premium increasing 37 percent YoY as new business premium growth at 62 percent outpaced the 16 percent growth in renewal premium. The management’s continuous focus on the relatively high margin protection business was clearly visible as the share of protection in total APE further improved to 18 percent in Q1 compared to 11 percent last year.
Performance improvement continued with operating expenses-to-total premium ratio declining to 14.4 percent from 15.4 percent last year. Persistency ratio improved at the shorter end, with 13-month ratio increasing to 87 percent versus 85 percent last year. The 61-month persistency dropped to 50 percent (57 percent in Q1 FY18) due to lower persistency of business written in FY13. As this business goes off, we can expect the persistency rate to improve and increase embedded value. Thanks to product mix and superior operating performance, new business margin expanded to 24.2 percent versus 20.5 percent YoY. Return ratios were strong and steady with operating return on embedded value (RoEV) at 18.4 percent and return on equity (RoE) at 31 percent.Both insurers witnessed growth in protection business
Buoyant capital markets have helped insurance companies improve their profitability as the sector witnessed growth in ULIPs and improvement in persistency. Going forward, we see large share of growth emanating from the protection business as there exists a huge opportunity in this segment.
India continues to be a high protection deficit country. As per Swiss Re, for every $100 needed for protection, only $8 is spent by a typical Indian household, leaving a massive mortality protection gap.
It is worth noting that while the protection business grew for both players, a large part of it came from the credit protection business. This makes break-up of the credit protection business -mortgage, loans against property and microfinance - a key monitorable going forward.Prefer ICICI Prudential Life over HDFC Standard Life on the valuation front
We like HDFC Standard Life for its balanced product mix, leading position in the protection business, expanding distribution network, high technology focus, product innovation and experienced management. However, the premium valuation leaves us with cold feet.
Following the strong price performance since its listing, HDFC Standard Life is trading at 6.4 times its trailing price-to-embedded value (P/EV), a significant premium to its peers. Given the company’s best-in-class return ratios and profitability levers, the premium valuation will be sustained. While the stock is a long term compounder, the stretched valuations limit upsides in the near term.
At the other extreme, we have seen ICICI Prudential Life’s stock underperforming the Nifty in the past one year. The rally after its Q4 earnings was short lived as the stock corrected on the back of technical factors like promoter’s stake sale. Uncertainty relating to the management change at the parent bank weighed on the stock’s performance.
The stock is currently trading at 3 times trailing P/EV, a significant discount to HDFC Standard Life, despite RoEV improving from 16.5 percent in FY17 to 22.7 percent in FY18. We view the valuation discount of around 50 percent to its closest peer as unwarranted and expect the gap to narrow down in the near to medium term, offering upside to the current stock price.
We remain positive on the insurance sector and suggest investors to participate in insurance growth story through ICICI Prudential Life, which is available at a compelling valuation.
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