LIC: India’s biggest IPO. How does it fare?

LIC is India’s largest life insurer. It manages close to ₹30 lakh crore in assets out of India’s ₹40 lakh crore insurance industry. The company controls two-thirds of the market by premium on new policies. As a result, it is a brand that is immediately familiar to all sections of society. Two decades after the insurance sector was opened up to private players, LIC still sells three in every four life insurance policies in India. It is substantially bigger than the combined size of the 23 private sector Life Insurance companies. LIC’s AUM of over $511 billion is more than the size of India’s entire mutual fund industry. It is a profitable business that has continually provided value to the Indian government, its only shareholder.

The government has recognized LIC as a possible candidate for a public listing. The move is part of the government’s efforts to push through an aggressive asset monetization and disinvestment programme. The IPO is the biggest component of the government’s strategy to sell assets to raise 1.75 trillion rupees. The funds will be used to reduce India’s budget deficit, which is expected to reach 6.8% in FY2022.

The government has indicated that it plans to raise a staggering Rs 1,00,000 crore ($13.4 billion) from the offering. Even half that number would make it India’s largest-ever listing by a big margin.

Valuation of LIC?

To value the company, we will need to examine millions of policies to account for parameters including mortalities, morbidities, lapses, and surrenders. The worth of LIC’s fixed assets spread throughout its 2,000 locations is also to be considered.

Valuing any IPO-bound company is tricky and it is even more so for LIC, given the complexities of the life insurance business. One of the most important valuation metrics for the life insurance sector is embedded value (EV).  The embedded value of a life insurance company is the present value of future profits plus adjusted Net Asset Value. LIC is yet to arrive at its EV. The company can be benchmarked against large competitors like SBI Life Insurance, HDFC Life Insurance, and ICICI Life Insurance. Many have used the private sector listed companies or SBI Life as a proxy EV multiple at which LIC shares could be offered.

However, in this case, Peer-to-peer comparisons are also unreliable. LIC is governed by a distinct 1956 parliamentary act rather than the law that governs the nation’s other insurance firms. LIC enjoys a sovereign guarantee of its policies, giving it a distinct competitive advantage and allowing it to operate with a lower capital base than its competitors.

LIC’s valuation metrics might be at a discount to that of the listed private players due to its product mix and business model.  For instance, when compared to private players, LIC has a higher share of traditional savings schemes such as endowment and money-back policies than protection products like term policies, which just offer a life cover. Savings schemes are less profitable than protection policies. In addition, it distributes its surplus in the ratio of 95:5 between policyholders and shareholders across the board. Private-sector insurers, on the other hand, distribute their surplus in the ratio of 90:10 for some policies, while for the rest, all the profits go to shareholders. A lower share of the surplus puts shareholders of LIC at a disadvantage relative to those of private insurance companies. This is one reason why LIC is unable to efficiently convert its huge AUM into profits.

Learning From Past Experiences

The government has to be careful not to undervalue LIC’s IPO. It valued the Indian Railway Catering and Tourism Corporation (IRCTC) at under Rs 5,200 crore ($700 million). Amid criticism that the government had been way too conservative, IRCTC listed at more than twice that valuation. The LIC IPO will be considerably larger than IRCTC’s Rs 645 crore ($87 million issue), which means the government has to be a lot more careful not to misprice it. Any such perception might lead to accusations that the Centre is underselling another of its crown jewels.

Distribution Channel 

LIC’s distribution model is quite outdated and flawed. As of March 2020, the latest year for which this data is available, India had 2.3 million life insurance agents. More than half of them worked with LIC. These agents brought in nearly 95% of the premium paid on LIC’s new individual policies in the year ended March 2020. For its peers, agents contributed under 25%. Private players have been able to leverage the reach of banks. Banks account for more than half of the business of private insurers. For LIC, it’s under 3%.

Incidentally, LIC is a shareholder in most major banks, including State Bank of India (SBI), ICICI Bank, Punjab National Bank, and Bank of Baroda. However, they all have their life insurance ventures. It is also the largest investor in IDBI Bank and has tie-ups with Axis Bank and Union Bank of India. LIC should utilize the bank distribution channel as the agency model is expensive. It costs 25-30% more than selling through banks.

Impact of IPO on LIC

The IPO will lead to greater transparency of its business. While there may be no immediate threat to its dominance in life insurance, LIC may still have to change its ways. LIC’s corporate bond holdings are not yet disclosed which will become open to the public after the IPO.

Thanks to its balance sheet, LIC has had to help the government out in many precarious situations. If a state-owned company’s share sale is met with a poor response from the market, it is rescued by LIC. The IPOs of general insurance company New India Assurance Company in 2017 and defense company Hindustan Aeronautics Ltd in 2018, are cases where LIC came to the rescue. In 2019, LIC once again supported the government by buying into bad debt-afflicted IDBI Bank.

Investors will want to know how much the government will continue to be involved in LIC after becoming public. Government can easily use LIC to do its bidding when it owns 100% of it.  Doing the same after LIC is listed will only diminish the value of the company for an investor. Relying on LIC is a habit the government may not be able to leave anytime soon and investors may well factor this vulnerability into LIC’s valuation.

External Impact of IPO

What makes the IPO even more attractive is that there are reports that the government could sell 5-6% in the IPO and then sell another 4-5% through a follow-on public offer instead of selling 10% during the listing. It will be the biggest issue size in India as of now. It is believed that the market may not have the capacity to absorb the entire issue in one go. The offering’s size may crowd out smaller listings, reducing the secondary market interest. However, the massive amount of liquidity currently around in global financial markets could help the IPO sail through. Indian companies have raised a total of US$ 10.8 billion via IPOs in the first 10 months of the calendar year 2021.

Investment Rationale

• Life Insurance Corporation of India, the only public sector life insurer in the country is the market leader with nearly 53% of the new business market share in FY20.
• LIC achieved a record first-year premium income of Rs. 56,406 crore (US$ 7.75 billion), in FY21 under individual assurance business with a 10.11% growth over last year
• There will be a scramble to own a piece of LIC simply because a large number of middle-class families are likely to have more than one LIC policy.
• LIC’s massive investment book will certainly help its valuation. The insurer also has holdings in companies such as ITC Ltd and Larsen & Toubro.

Key Risks

• The insurer has particularly seen its market share reduce in retail products. LIC’s business growth on annualized premium equivalent basis has been in the low single digits every month except March and April 2021, which were helped by a low base
• Most private sector life insurers have reported high double-digit growth consistently. On the other hand, LIC witnessed a year-on-year (y-o-y) drop of 5% in the retail business, August 2021
• LIC relies on its large agency network to push products while nimble private insurers have been aggressive with online sales. It has lost share, as digital sales of private players have scaled, while it has struggled here
• It has a lower Persistency Ratio as compared to its peers. Around 54% of LIC policies, calculated by premium, are renewed after the fifth year, compared to 62% for SBI Life, 58% for ICICI Prudential, and 53% for HDFC Life.

This article was authored by Rupam Mukherjee for Finnick Club