ICICI Lombard's high valuation may trim upside from expected premium growth

The stock of ICICI Lombard General Insurance surged by over 25 per cent in the last three months, outpacing 8-per cent gains returned by the bellwether BSE Sensex. 

The scrip now trades at around 8x its 2019-20 (FY20) estimated book value, against a far subdued 2x book ascribed to its public sector peer — New India Assurance. Steep valuations could confine the potential upsides for ICICI Lombard stock, even as the earnings outlook remains strong. 

While underwriting profit may be affected due to lower pricing potential, higher float could make good for the same as it is likely to propel investment profits. This may improve the insurer’s return on equity (RoE). 

The new third-party (TP) motor regulation, which kicked in last year and mandates for a medium- to long-term motor risk cover, could result in increased investable funds or float available to insurers. Consequently, this could push the investment leverage up from 4.1 per cent in 2018-19 (FY19) to 4.5-5x over the next three years. The investment leverage indicates an insurer’s financial strength.

According to analysts at JPMorgan, an increase in investment leverage may be RoE-accretive, when investment yield is 9 per cent and underwriting profits are near break-even. This means that the 21.3 per cent RoE in FY19 may expand to 23 per cent in FY20. Thanks to favourable regulatory changes, ICICI Lombard’s share of motor-TP segment rose from 18 per cent last year to 21 per cent in FY19. This has helped the insurer clock 19 per cent year-on-year increase in its gross direct premium income to Rs 3,485 crore in the March quarter. 

While the premium-share of other segments (mainly fire and health) remained flat at the year-ago level, share of crop segment fell by 200 basis points to 17 per cent. 

Thus, much hinges on the motor segment for ICICI Lombard. The management, in fact, braces for a sharp fall in the crop insurance segment due to its highly competitive tender-based nature of business. Maintaining better underwriting practices, hence, become key to ICICI Lombard, which has seen its combined ratio — a measure of profitability — improve from 100.2 per cent in 2017-18 to 98.5 per cent in FY19. 

While all these auger well, lofty valuations and insipid automobile demand could weigh on the stock.

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