ICICI Lombard Q1 earnings stable, big rally prices in most positives, buy on dips

While the strong growth is heartening, we are most enthused by the firm’s strategy of pursuing only profitable growth. The insurer has consciously pulled back from segments like crop insurance where profitability was under pressure. Crop insurance constituted 19 percent of the premium in FY18 and is likely to be negligible in FY20 due to cautious view on the segment.

Premium growth led by fire and motor insurance ICICI Lombard maintains a diversified portfolio. The decline in crop business was partly offset by aggressive growth of GDPI in fire segment which increased by 67.3 percent in Q1, aiding growth of property and casualty segments. The growth in the fire segment was subsequent to GIC Re revising reinsurance rates for eight sectors or occupancies under the fire segment in March. The move was aimed to correct the imbalance between the premiums charged and claims history over a number of years and has improved profitability in the segment.

ICICI Lombard benefited disproportionately from the mandated longer tenure policy in third party (TP) motor insurance by the Supreme Court as its presence in the segment is well above the industry average. As a result, share of TP motor insurance in product mix increased to 19 percent as of June-end compared to 15 percent a year ago.

The recent slump in auto sales can impact future growth. However, given that the insurer enjoys a diversified product portfolio along with a deep distribution reach, the auto slowdown can be compensated by growth in other business lines such as fire and health.

The multiple sub-segments offer ample opportunities. Accordingly, ICICI Lombard’s premium is likely to grow in mid-teens over the next few years.

Underwriting performance weakens ICICI Lombard’s combined ratio, a measure of an insurance company’s profitability, increased to 100.4 percent in Q1 compared to 98.8 percent last year, leading to underwriting loss.  The combined ratio of above 100 percent indicates that the insurer is paying out more money in claims and operating expenses than premium collection.

Combined ratio is sum of loss/claims ratio and expense ratio. While claims ratio declined by 140 bps YoY to 75.5 percent with improvement across most segments excluding motor business, expense ratio (including commissions) increased 300 bps yoy to 25 percent leading to rise in the combined ratio.

The expense ratio increased after high sourcing cost of retail business, reallocation of expenses of defocused crop segment and launch of branding campaign during Q1. This, along with provisions for cyclone Fani in Odisha, led to underwriting loss. Combined ratio was 99.7 percent in Q1 FY20, excluding the impact of the cyclone.

Investment income moderates Investment income growth moderated to 4 percent YoY as capital gains declined by 30 percent in Q1. Investment assets stood at Rs 23,711 crore as of June-end and investment leverage increased to 4.27 times as of June-end compared to 4.09 times at the end of previous quarter.

Despite the moderation, investment income more than compensated the underwriting loss, aiding the net profit growth of 7.3 percent for the insurer.

Impact of key regulatory developments In a positive regulatory development, IRDAI finally decided to revise the premium rates for TP motor insurance premium for FY20, which became effective June 16. It had initially put on hold the rate increase for FY20, which could have adversely impacted the industry as a whole. However, the premium hike announced has been lower than industry expectations. Hence, insurance companies may suffer losses in this TP motor segment as the price at which business is written may fall short of claims inflation.

In another important development, the IRDAI issued a circular wherein the insurers shall make available standalone annual own damage (OD) motor insurance, effective September 1, 2019.  This is a positive for policy holders, given the option to buy standalone OD cover from its choice of insurers.

The unbundling of motor OD is expected to create new opportunities for ICICI Lombard. The management commented that it would enhance focus on certain segments/geographies where Motor TP loss ratios are higher, but motor OD loss ratios are favourable.

ICICI Lombard has been aggressively expanding its distribution franchise - especially its agency channel in tier 3 and tier 4 cities and plans to leverage this distribution franchise to deepen its motor OD segment.  Its individual agents rose to 38,581 as on June 30, 2019, as against 25,646 as on June 30, 2018.

Competitive advantage aids premium valuations ICICI Lombard is well poised for earnings growth with an increase in insurance penetration, focus on profitable segments and improvement in operating efficiency.

While there will be losses in motor segment due to pricing pressure in OD and insufficient tariff hike in TP, the increased leverage, along with  higher float income from longer tenure motor insurance contracts, will more than offset these losses.

ICICI Lombard is up 37 percent in the past one year and has significantly outperformed the Nifty. At the current market price of Rs 1,060, it is trading at a premium valuation of 8.2 times its trailing book. The current valuation is rich even after considering high RoE (return on equity) at around 23-25 percent.

While the premium valuation will sustain, near-term upside in stock price is limited.  Nevertheless, investors with a long-term horizon and wanting to participate in the secular growth in the non-life insurance sector can consider buying the stock on dips.

Follow @nehadave01

For more research articles, visit our Moneycontrol Research page

Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here