LIC IPO: Valuing an insurer’s growth potential

The insurance industry is particularly difficult to value. Because India has only six publicly traded insurance companies in India and the understanding of the terminology and parameters are still developing.

The valuation procedure used by insurers differs greatly from that used by other sectors. "The most important difference is that valuation entails forecasting future cashflows from the existing book." "Unlike other businesses, the profit generated from a single sale is recognised over a long period of time, which might range from 1 to 100 years, depending on the type of product provided to the consumer," explains Rahul Jain, a consulting actuary in the National Capital Region.

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Here's a quick rundown of some of the crucial factors for policy holders who are setting up their first demat account to invest in the LIC IPO.

Embedded Value And Return On Embedded Value

The after-tax profit is expressed as a percentage of the embedded value in return on embedded value (RoEV). It's a measure of profitability for investors, similar to return on equity. The EV, as calculated by the actuary-in-charge, will be mentioned in the offer documents whenever a firm declares its IPO. However, EV alone will not be the deciding factor. A pricing range will emerge from the bidding process. RoEV is another significant metric for determining a company's worth. Consider how much profit a firm can generate each year from the inherent value it has locked up. As a result, it illustrates the company's efficiency while also validating the assumptions used in its Embedded Value and mathematical reserves.

VNB Multiple and Margin

The net profit margin is equivalent to the value of new business (VNB) margin. It calculates VNB (profit earned as a percentage) or annualised premium equivalent Annualized Premium Equivalent (APE) (revenue) as a percentage.

In life insurance valuations, the market price-to-VNB multiple is also important. "When we compare the market price-to-VNB multiple, HDFC Life is 41 times more expensive one year forward, while SBI Life and ICICI Prudential Life Insurance are around 32 times," explains Philip, Senior Research Analyst,  Axis Securities.

You should also keep a watch on the VNB margins as an investor. It's the profit margin at which new contracts are signed. The higher the profit margin, the better for the company and its stockholders.

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Agency Strength

When compared to other channels, the bancassurance channel – that is, selling policies through partner banks – receives a greater bill, while individual agents also help diversify the consumer profile. "Metro clients are mostly served by bancassurance channels, whereas tier-I and tier-II clients are served by individual agents," says Philip. Banks enable cross-selling of insurance products, making the process easier for partner insurers. "This route has been critical in increasing the market share of private insurers." In addition, online channels have accelerated in the previous 2 years, benefiting private players. LIC, on the other hand, is losing market share all the time," explains Philip.

Market Share

LIC is the market leader by a wide margin, with a market share of over 61% in new business premium collections, but the decline calls for prudence. For investors to benefit from investing in the LIC IPO, the massive market must continue to expand and sustain itself. It remains to be seen if it can entice millennials who prefer to buy insurance through new-age channels. Keep an eye on the APE increase. An APE is the sum of regular, annualised premiums generated from new business during a given period plus 10% of new single premiums collected during that period.

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Product Mix

Product categories have an impact on VNB margins and are thus important to consider when analysing a company's operations. VNB margins are generally greater in protection plans (mainly term policies), followed by Ulips. As a result, growth in the share of protection plans sold by a life insurance business is a good sign. People are becoming more aware of the need for protection plans as a result of the COVID-19 pandemic, which has already pushed up demand. Once COVID-19 is no longer present, this process is anticipated to continue with increased strength.

Persistency Ratio

Higher persistency ratios are considered positive statistics; typically, the 13 and 61-month persistency ratios are considered. It shows how long the insurer has kept its customers. Customers that pay their premiums regularly have a higher persistency ratio. As renewal premiums come in, insurers are able to lower their costs without having to perform any additional sales or marketing.