The insurance sector has finally got what it was hankering after. The long- pending Insurance Laws (Amendment) Bill, 2015 was passed in the Rajya Sabha on Thursday, which has now increased the FDI limit in insurance from 26 per cent to 49 per cent. The passage of the Bill has brought banking and financial stocks in focus, as this could unlock value in their insurance subsidiaries either through a stake sale or primary market listings. There has been a lot of buzz around stocks such as Max India, Reliance Capital and Bajaj Finserv.

Insurance subsidiaries of many financial conglomerates are still undervalued, in spite of accounting for a substantial portion of their earnings. There have been two main reasons for this. One, after the insurance sector opened up in 2000, both life and general insurance have gone though a series of regulatory changes which impacted their business. Until recently only few insurance players were profitable. The second reason has been the lack of valuation benchmarks in the listed space, which has kept investor interest tepid.

But now many players, both in the life and general insurance space have now turned profitable. The much-awaited increase in FDI limit in insurance to 49 per cent is a huge trigger for listing of insurance companies. The value at which foreign investors buy stakes in these companies will provide a better benchmark to value these companies and hence kindle investor interest in the space. Smaller companies in need of capital will also be able to access it more easily to increase their penetration and develop new products.

Parent companies are hence likely to see substantial unlocking of value in their insurance subsidiaries. But the extent to which these companies will benefit will depend on the proportion of the contribution of the insurance business to the company’s overall business.

Companies such as Max India, Reliance Capital and Bajaj Finserv derive about 44 per cent to 85 per cent of their fair value (calculated on the basis of sum-of-parts value), from the insurance businesses---both life and non-life. Other companies such as Sundaram Finance, which recently acquired an additional 26 per cent stake in Royal Sundaram, draws about 11 per cent from the general insurance business. Other banking stocks such as SBI, HDFC and ICICI Bank derive a lesser share from their insurance businesses-- about 8 per cent to 14 per cent of their SOTP value.

Hence, companies with a higher contribution, to their implied value, from their insurance subsidiaries will see substantial value unlocking. For instance more than 75 per cent of Max India’s value (sum-of-the-parts) valuation comes from the life insurance business. For Bajaj Finserv, about 40 per cent of its value comes from the life insurance business and 26 per cent from the general insurance business. For Reliance Capital about a third of its value comes from the life insurance business and 13 per cent comes from the general insurance business.

Deal consideration

In recent times, deals in the life insurance space have happened at one to three times the embedded value of the life insurance business. In 2012, New York Life sold its 26 per cent stake in Max Life to Mitsui Sumitomo for about 2.8 times the embedded value (net assets plus present value of future profits). This was lower than the 3.5 times embedded value that Nippon Life had paid for the 26 per cent stake in Reliance Life in 2011. In 2013, Exide Industries had paid one time embedded value to acquire ING’s stake.

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