Investors abse ‘Sar utha ke jiyenge’

Life Insurance business is highly capital-intensive one & requires a long gestation period to showcase profits. Both are huge entry barriers other than regulatory barriers.

Fun fact: HDFC life took 11 years to show profits since its inception!

Why is it so?

The majority of the costs are front-ended which are expensed out. That includes Advertising & promotional expenses, distribution establishment cost (agents, branches), regulatory reserves, etc.

If there is so much pain in the start, why would so many business houses (from ICICI to Tata to Bajaj) invest so much long-term capital into it?

High ROIs: The return on investment when it does start to show compensates for all the past losses.

The lifecycle of this biz

From capital infusion (1) to self-sufficiency (2): Investors take a back seat.

Then comes the monies:

Value generation (3)- listed players are here, & will continue to scale as India’s GDP per capita shoots up.

Dividend phase (4)- decades away

Penetration of Life Insurance is so minimal, even Covid related deaths will not have any significant claims outflow ~ ICICI Prudential Life Insurance, Q1FY21 conference call.

The growth pathway is long.

So what are the revenue sources for an insurance company?

  • Premium Income (from the policyholders)
  • Investment Income (from float: see below)
  • Miscellaneous Income (fees/ charges/ etc)

The 1st two are the majority.

Float gives an Insurance business wings

Mr Buffett explains it best in his 2002 letter

Its cheap money between the premium received & when it claimed years after (decades in life insurance)

Barring regulations, decent capital allocators can earn good returns on this.

Landing back to the ground, Here are the typical expenses:

  • Commissions to agents
  • Operating expenses
  • Payouts to policyholders (different types given the insurance one buys)

Here an Insurance business diverts from a traditional one

Revenue minus Expenses is not equal to profits as a large part of premiums are allocated for future expenses (kept in reserves)

The biggest factor that affect P&L is

Provisions for future payments (Depends on mortality & future investment return assumptions: must be conservative)

Valued by actuaries (professionals)

Provide less into reserves, profits for the current year shoot up & vice versa.

Terms to understand: (Only the imp. ones)

Gross Written Premium (GWP): Total premium collected during the fiscal year.

It comprises premium from new customers (new business premium) and existing customers (renewal premium).

Annual premium equivalent (APE): Sum of annualized first-year premiums on regular premium policies + 10% of single premium policies.

Value of new business (VNB): determines the expected profitability of the new business written during the year.

VNB margin is the ratio of VNB for the period to APE for the period. It is similar to the profit margin for any other business.

Embedded value (EV): Similar to the Book Value of companies in other sectors.

It is the sum of the Company’s Net Worth and the present value of all future profits to shareholders from ‘the existing book of the Company’ (including new business written in the year).

Getting dry, Here’s the juicy part: Valuations

Two ways to value-

Market cap/Embedded Value [similar to P/B]

(Market cap- Embedded Value)/ Value of New Business [similar to P/E]

We compared the listed players

Are these valuations sustainable? Only if the growth is.

These are some Asian peer’s valuations in terms of P/EV:

China Life: 0.88

Bangkok life: 1.06

Daiichi Life: 0.43

Samsung Life: 0.72

Matured Dividend phase, so they trade at very low valuations.

In a commodity business like Insurance, What drives valuations?

Distribution, especially having a huge banking branch network (Most important factor for success)

SBI- 28500 branches

HDFC Bank- 7100

ICICI- 5700

+ other partnerships.

Note: Insurance is a push product in India.

Another imp. factor for the valuations

Persistency (ability to retain customers)

It measures the proportion of policyholders who have continued with their policies.

Higher the persistency the better.

13-month persistency: retained after 1st yr

61M: retained after 5th yr

Mis-selling is so prevalent, that even for the top insurers, 61M persistency is 50%: Only 50% of people continue paying premiums in the 5th year.

The problem has been that these policies are bought & sold for the wrong reasons. Let’s explore further.

There are two types of products:

1. Protection Products

They are just for hedging the risk of death or critical diseases, if nothing happens, one doesn’t get any money back (the way how Insurance should be)

One can get from 700-1000 times the yearly premium payment.

What really sells? The 2nd type:

2. Savings product (small insurance + Investment)

What investors soon realize is that they get the worst of both worlds in these products & they stop paying premiums

5-6% returns with 10x annual premium insurance (facepalm)

Why do Investors Care? One should if your insurance co. is growing the Non-Par book.

Non-Par is a product where the insurance co. is selling a guaranteed return thereby taking the risk in its books.

% book in Non-Par

HDFC: 31%

SBI: 5% (growing fast)


Why are we so cautious of the non-Par book?

It was one of the prime reasons for the collapse of the Japanese Insurance market after the 1990s bubble burst & Japan found itself in a recession.

However, Underwriting remains a function of management. If one can see them go through a few storms unscathed, then one can bet.

Indian private Insurance companies are no more than 20 years old, relatively young compared to western peers, so be cautious.

Good underwriting looks like this

25/ What works for Indian Private Insurance plays?

PSU to Private Play (LIC still holds 40% market share)

Greater Financialization of the economy (will lead to more savings & larger investments in insurance)

Greater penetration (Currently, 2.7% India vs 4.5% China)

Who looks to benefit?

Building a brand is hard: Selling life insurance is like selling the ‘promise’ for paying tomorrow for an uncertain event in the life of the premium payor

Trust is the Foundation.

Ergo, Large players will continue to grow larger.

Other articles:

Everything you need to know about Health Insurance! How to build a 1 Cr cover!

Term Plan or a ULIP or an endowment plan? What are they? Which one to buy when?

HDFC Life Insurance 2020 Annual report takeaways!

All our research here. | Our complete media coverage here.


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