The LIC IPO is the biggest ever in India. The nation’s biggest life insurer plans to raise about Rs 21,000 crore by offering 3.5% of the Government’s equity at a price of between Rs 902 to Rs 949 per share. In the offer that will be open for subscription from May 4th to May 9th, policyholders will be offered a discount of Rs 60 per share, while employees and retail investors will get a discount of Rs 45 per share.

The indicated offer price pegs the market capitalization value of LIC at Rs 600,000 crore, which is a significant climb down from the earlier expected valuation of about twice that much.

The big question is: Should you subscribe? The answer is a tricky one. There are some pros and some cons, and it is best to weigh them before you decide. We lay out the key ones for you here.

SIZE AND SCALE

One area that LIC is unrivalled on is its sheer size and scale of operations. Its assets under management (AUM) are three times that of all private life insurers put together. If we compare this to the next biggest player, SBI Life Insurance, the multiple is 16.6 times. What’s more, its AUM is also 1.2 times that of the entire mutual fund industry.

Also Read | LIC IPO may be the much needed windfall for this government department

Even in terms of new business premiums in the life insurance industry, LIC commanded a share of 63.2% in the fiscal ended March 31, 2022, and remains the dominant player in the industry. Expect you get the picture.

LIFE INSURANCE POTENTIAL

The other argument that is often proffered when talking about investing in the life insurance sector is its long-term potential. The popular metrics cited are the sum assured and the premium to GDP. Let’s see how these stack up. On sum assured (the amount assured to be paid to the insured on death) to GDP, India is at just 23% compared to 251% in the US and even 127% in South Korea.

Similarly, when comparing premium to GDP to neighbouring Asian economies we find that India is way behind South Korea, though better than China. But the former metric is more relevant. Also, if we look at the protection gap (protection needed less protection provided) the potential opportunity is over $16 trillion.

Looked at another way, only 12.5% of taxpayers with incomes in excess of Rs 2.5 lakh have an insurance cover. Also, the insured population is only 6 million, compared to the mutual fund investor population of 21 million. So, there’s clearly a good runway for growth.

Also Read | Why Samir Arora thinks LIC IPO is fairly valued but Thomas Isaac doesn't

MORE SAVINGS LESS PROTECTION

Unfortunately, a lot of life insurers in the country are selling more savings products than true-life covers. The same holds true for LIC. In fact, even more so. LIC’s share of sum assured for the fiscal ended March 31, 2022 was 18.3% even as its market share of new business premium was 63.25%. Compare this to private leaders ICICI Prudential Life with 13.4% and 4.78%, and HDFC Life Insurance with 12.44% and 7.73%, respectively, and the difference appears stark.

Remember, protection as a business is not just more the need, it is also more profitable. So, when you compare LIC to any of these insurers, you aren’t exactly comparing apple-to-apple.

LARGE ASSETS, LOW VALUE OF NEW BUSINESS

We’ve already laid out how LIC trumps other insurers on the size of its assets, so let’s now consider the Value of New Business or VNB. The VNB is nothing but the value of profits expected to be earned in future from the policies sold during a period, usually a year. As you are aware, life insurance plans have long tenures running into several years.

So, once a policy is sold, premiums from it will continue to accrue many years into the future. The VNB is a sum of the future profits expected from the policies in a year, adjusted for the time value of money. This is because inflation erodes the value of one rupee received, say five years from now compared to receiving it today.

Also Read | LIC IPO: Paytm will allow investors to place bids up to Rs 5 lakh through UPI

Before proceeding to the VNB numbers, let’s also demystify Embedded Value. This is nothing but the networth of the insurer plus the value of profits expected to accrue from all policies sold till the date. So, in effect, it is the VNB of all policies sold not just in a year, but all previous years plus the networth.

Now to the VNB comparison. While LIC scores on size and scale in assets, its score on VNB is less flattering. After accounting for 100% of the surplus from its non-participating business and 10% from its participating business, the VNB for the fiscal-ended March 31, 2021 works out to Rs 5,199 crore. This implies a VNB margin (read profit margin) of 12.3%.

This is far lower than the margins of leading private insurers at about 25%. And though LIC has stated its aim to get to a near 20% margin in about 5 years in recent interactions, even that may not change a key equation, the VNB to EV ratio.

In fact, even if we assume a 20% margin for FY2021, the VNB improves only to Rs 8,454 crore. This implies a VNB to EV of 1.57%, compared to over 8% for HDFC Life, over 10% for Max Life and about 5.6% for ICICI Prudential Life, for the same fiscal. So, the VNB added each year will be much lower than private insurers, and that justifies a lower discount multiple on valuations.

DRIVEN BY ASSETS NOT NEW BUSINESS

The Embedded Value (EV), the key valuation metric for life insurers, in the case of LIC is more dependent on returns on its large assets than the new business it generates each year. To give you a sense, this factor contributed near 52% to LIC’s EV increase in fiscal 2021, compared to a VNB contribution of 8.5%. For HDFC Life, the VNB contribution to EV increase in FY22 was almost 65%.

What this indicates that LIC’s future profits will be driven more by earnings on assets than by profits from new business. The colour of money is green, so here it is more a matter of investor choice, comfort and preference.

SHOULD YOU INVEST?

The revised valuation of LIC makes it far more attractive at a little over one-time EV. As EV is the present value of business already contracted, it does not account for gains from any future business. To that extent, there is scope for upside and downside comfort. Will it grow at the same pace as smaller insurers? Unlikely, but then also take note of its size.

There are a few triggers for possible gains, like inroads it may make in the non-participating business, where it has been a relative laggard and where the 100% surplus goes to shareholders. So, the answer is a tricky one. Do you want to be invested in smaller, faster-growing businesses or in a business with a dominant share and a possible upside from exploiting potential opportunities? The choice is yours.

(Edited by : Priyanka Deshpande)

First Published:May 1, 2022 11:28 AM IST