The value of a company soared more than five times in six months. No, this is not the latest unicorn in start-up alley. This is Life Insurance Corporation of India, a 67-year-old public sector insurer.
LIC’s embedded value (EV) in FY21 was Rs 95,605 crore which shot up to Rs 5,39,686 crore by September 2021, the insurer’s share sale prospectus states. The reason behind this was a small step that LIC took in January of changing the way it holds and distributes its surplus, or in other words profit.
EV is the present value of all future profits that a life insurer will make through its policies and net worth put together. Since life insurance is all about upfront costs and calibrated profits over a long period of time, EV is a popular metric at which insurers are valued in the capital market.
Life insurers make money by deploying the premium they collect from policyholders into investments. In short, insurance policies generate the profits for the life insurer.
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Since any company requires some capital, there are shareholders too for a life insurer and in LIC’s case it is the government of India. Both policy holders and shareholders get a bite of the profits the insurer makes.
LIC is unique as almost the entire profits of the company and its net worth has come from policy holders than the shareholder. LIC has been distributing 95 percent of its profits to its policyholders as bonuses and the rest to the government in the form of dividends. There is another level here. Among policy holders, some participate in the profits and some don’t.
For the purpose of distribution, life insurers hold their surplus, or profit generated, in two parts—a policy holders’ fund and a shareholders’ fund. LIC had a single consolidated Life Fund wherein it held its surplus. The small step of bifurcating this fund into participatory and non-participatory funds has boosted its EV.
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LIC’s Life fund was Rs 34.33 lakh crore as of March 2021. The Finance Act, 2021, amended this provision, mandating all life insurers to hold two separate funds for surpluses generated from participatory and non-participatory policies. Further, shareholders can get 100 percent of non-participatory surplus while they continue to get up to 10 percent from the participatory fund.
“As per the Finance Act, the maximum share of distributed surplus that is payable to shareholders is 10% for participating business and 100% for non-participating (including unit-linked) business,” the prospectus said.
As of September 2021, LIC’s participatory fund was Rs 24.57 lakh crore and the non-participatory fund was Rs 11.37 lakh crore.
In the consolidated Life Fund, the value of non-participatory surplus was a small fraction as LIC had focused mostly on participatory products such as endowment policies.
However, the insurer has been pushing non-participatory policies over the past few years and the proportion of surplus from this segment has increased. With the bifurcation of the single fund, the non-participatory surplus goes entirely to shareholders.
This reflects in the EV as profits distributable to shareholders. Given that more profits would be distributable to shareholders, the value of in-force business goes up and by extension so does the EV.
The upshot is that LIC’s valuation has ballooned by simply changing the way it shares its profits with its policyholders and shareholders.
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