MC Explains : LIC’s transfer of funds to shareholders’ fund – is it a one-off event?

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. For the purpose of distribution, life insurers bifurcate their profits into two funds. One is the policyholders' fund, and one is the shareholders’ fund. While the shareholder fund explains itself as it is the pool of profits which shareholders get through dividend payments, a separate fund for policyholders is kept mainly to pay out bonuses promised with certain policies.

Note that not all life insurance policies offer a slice of the company’s profits to policyholders. Non-participatory policies do not offer a share in the profits. Since the policyholders’ fund is a single fund which contains profits, part of the profits that are marked for non-participatory funds can be distributed among shareholders. It is this part that LIC has transferred to the shareholders' fund.

How is LIC’s transfer a massive amount?

The ratio in which the profits can be distributed between policyholders and shareholders fund is mandated by the regulator with enough flexibility given to the companies. 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.

The Finance Act 2021 amended the provision for life insurers on the funds and mandated all life insurers to hold two separate funds for surpluses generated from participatory and non-participatory policies. Further, shareholders can get 100 percent of the non-participatory surplus while they continue to get up to 10 percent from the participatory fund.

LIC has been pushing non-participatory policies aggressively and increasing its share in its overall business in the past few years. Ergo, the number of profits it needs to share with its policyholders has come down as the share of non-participatory policies has increased. Therefore, shareholders will get a higher share of the profits of the insurer.

Also, LIC is unique because almost all of its net worth is from policyholders and not its shareholder which is the government. 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.

What does the transfer do?

Since the transfer means more profits are available to shareholders, it is clearly aimed at increasing investor interest. Also, LIC can use the beefed-up funds to issue bonus shares in the future, again a reward to shareholders. Considering the largest shareholder is the government, the centre benefits the most through this transfer.

Even so, public shareholders that have bought LIC shares through the IPO stand to gain too. According to Mayank Mehraa, principal partner at Craving Alpha, the transfer of funds will increase the shareholders' fund by 10 percent. “The transfer of funds is a positive development for LIC's shareholders. It will increase the amount of money that they can receive from LIC in the form of dividends or bonus shares,” he said.

Is it a one-time event?

The transfer is entirely as per the rules and not at the whim of LIC. The transfer has also been approved by the life insurer’s board. Can LIC’s board do this again?

There is a fair possibility that LIC can transfer funds yet again if the share of the non-participatory policies surges in its books. That would mean more profits available for shareholders as 100 percent of the non-participatory fund can be given to shareholders. That said, this increase would be over time and not every year. It takes time for the share of a particular segment of policy to increase. Therefore, another round of transfer, if at all, may come after some time.

Therefore, for investors, the transfer is for now a one-time event. Since it is an existing pool of profits just changing funds, there is no impact on LIC’s profitability metrics.

What else did LIC’s Q4 performance show?

LIC improved the yields on its annuity products in the recent past. This is expected to lead to strong growth in annuity sales in the future, Bolinjkar said.

According to ICICI Securities, LIC is treading well towards increasing the value of the new business (VNB) by pushing the product mix towards the non-participating segment (8.9 percent in FY23 individual annualised premium equivalent (APE) mix against 7.1 percent in FY22) and a sharp focus on improving persistency, which is the percentage of policyholders who renew their policies after the initial term.

The 13th-month persistency ratio – an indicator of policyholder loyalty – increased to 70.16 percent in the quarter ended March, from 69.24 percent a year ago. This means more policyholders are sticking with LIC beyond one year. However, the 25th-month persistency ratio fell to 63.84 percent in Q4 from 68.23 percent a year earlier.

Volume growth outperformed the industry in the nine months ended March (27 percent YoY for LIC compared with 20 percent for private insurers in terms of total weighted APE) but declined 16 percent YoY in the fourth quarter against the growth of 18 percent YoY for private insurers, the brokerage said.

“We have always believed that product mix-driven possible increase in VNB margin (management’s aim is to close in on private peer levels within 3–4 years) is achievable and is underappreciated by the market,” ICICI Securities said.

The company remains assertive in increasing its share of high-margin non-par policies. Holders of non-participating insurance plans, also called non-par products, do not receive additional benefits or bonuses as dividends.

Kotak Institutional Equities pointed out that the current disclosures suggest an increase in the share of non-par to 6 percent in FY23 from 5 percent in FY22 and group to 32 percent in FY23 from 29 percent in FY22.

The management expects to make up for the low premium from high-ticket policies through other businesses. High-ticket policies are those with a large premium amount. LIC expects to increase its business in other areas, such as individual life insurance and health insurance, to make up for the shortfall in high-ticket policy premiums.

LIC’s solvency ratio – a measure of an insurer's ability to meet long-term debt obligations – improved to 1.87 from 1.85 a year earlier.