Similar methods are applied to value an insurance company. However, what differs is the nature and computation of underlying cash flows (income approach) or metrics to arrive at multiples (market approach), which are industry-specific. In this article, we discuss commonly used multiples that can be used to value the Indian insurance behemoth. We will also discuss various factors that should be considered to adjust those multiples to account for differences in size, profitability, risk profile and growth.
Understanding the multiples in practice
We can look at the market capitalisation to embedded value ratio (MCap/EV) for the three biggest listed players in India — HDFC Life, ICICI Prudential Life
and SBI Life.
The multiples range from 3x to 6x, which appear significantly higher than their Asian insurance counterparts, valued at under 2x. Such rich valuations underline the growth opportunity in the underpenetrated Indian market and the confidence of the market in the sector.
Similarly, another approach that can be considered includes a ratio derived from the assets under management (AUM) of the insurance provider. For the above three companies, the MCap/AUM ratio ranges from 40 per cent to 90 per cent. As of September 2019, the total AUM of LIC is more than Rs 30 trillion.
The raw multiples arrived at using the above approaches should be further adjusted as discussed in the next section.
Analysis of the multiples
Once the comparable companies’ multiples are derived, the next step should be to adjust the multiples based on characteristics of the subject company (LIC). Simply applying the peer group multiple will lead to an erroneous conclusion, since LIC is starkly different from its comparable peers in terms of size, profitability, ownership and growth profile. The valuation should account for the following factors:
There is great divergence between life insurance products sold by LIC and private insurers.
While LIC’s product mix contains largely traditional products (of which participating products are significant), private players have moved away from participating products and are selling unit-linked, non-participating savings, protection and annuity products. Protection policies have higher profitability than savings products. The accompanying chart illustrates the indicative VNB margin ranges of a range of life insurance products.
Listed players like HDFC Life
and SBI Life
are shifting their product mix towards higher-margin products like term life, credit life, group life and non-participating guaranteed products, resulting in higher multiples.
Persistency: This is important as it is a key driver of profitability for an insurer. A persistent book — where customers pay renewal premiums every year — also helps insurers reduce costs through economies of scale. The insurance regulator reports persistency ratios of all companies by the number of policies. It’s very important to compare persistency of policies of LIC with its listed peers.
Commissions paid by listed private insurers
have come under 5 per cent of total premiums paid. Considering that LIC is an agent-driven business, it incurs substantially higher commission costs and, accordingly, the applied multiple would have to take this into account.
Quasi-sovereign wealth fund:
With its huge corpus, LIC functions partially as a quasi-sovereign wealth fund
through its prior subscription to the power sector’s Ujwal Discom Assurance Yojana (UDAY) bonds, investments in the National Investment and Infrastructure Fund (NIIF), capitalisation of state-run banks, and active participation in the government’s disinvestment agenda. As such, there is a risk of its investments being driven to further the social and political agenda rather than purely for business reasons. Hence, an appropriate discount should be applied.
Having said that, LIC’s valuation metrics could be at a discount to the listed private insurers
in India, the quantum of discount could be reduced if not eliminated, if the government can give an assurance to investors that the management would be given a free hand in taking investment decisions, without any social and political agenda. LIC’s IPO will be a historic event in the history of capital markets due to sheer size and scale. It is expected to unlock massive value and help the government to tackle the rising fiscal deficit.
The writer is managing partner, D and P India Advisory LLP, and external advisor, Duff & Phelps India