As LIC gets IPO-ready, analysts are beginning to take deep dives into its draft prospectus to tell us how it stacks up against its private rivals. But if you are foxed by all the jargon they’re throwing about, here’s a simple primer on how insurers are valued, so that you are at home with the analyst-speak.
GWP and NBP
LIC is the only insurer in the world that has a market share of 64.1 per cent based on GWP and 66.2 per cent based on NBP, boasts the draft prospectus. But it also admits that LIC’s share of individual GWP has been slipping. What does this mean?
In all insurance contracts, the insurer collects upfront money (premium) from you on a one-off or regular basis, promising you a payoff in future if an unfortunate event happens. GWP is the total premium amount that an insurer has collected in a period from all policyholders who’ve signed up for its products. In India, where most insurance plans are really investment-cum-insurance plans, the GWP includes both the premium towards life insurance and an investment component. When LIC reports that its GWP in India was Rs 4.02 lakh crore in FY21, this is the total size of instalments it has collected from all its customers.
GWP captures both first-year premiums on new products sold and renewal premiums on older products. But when assessing any business, investors would like to know the rate at which it is adding new business. The NBP or New Business Premium captures the premium that an insurer earned only from new policies sold in a year.
Analysts further dissect GWP and NBP into individual policies and group policies taken by employers for their workforce on a bulk basis. While LIC dominates the group insurance business, it has been losing market share in the individual business to private players.
All about APE
When evaluating the growth or market share trends, many analysts skip the GWP or NBP and assess APE instead. This is because the APE or Annualised Premium Equivalent smooths out the premium collections from single premium plans.
If you’ve bought products like LIC Jeevan Akshay, you know that life insurance products can be of two kinds. In a single premium product, you pay a big lumpsum to the insurer at the outset and wait for payouts after many years. In regular premium products, you commit to premium payments for many years, in return for a final payout. Single premium products deliver a bump-up to an insurer’s revenues in the first year alone, but regular ones lead to more sustainable income streams, so analysts prefer them.
To assess an insurer’s sustainable growth or market share, analysts make adjustments to its NBP to arrive at its APE. An insurer’s APE is the sum of 10 per cent of premiums collected on its single premium plans and 100 per cent of first year premiums from regular plans. As LIC sells a fairly high proportion of single premium plans, its APE for FY21 was Rs 45,587 crore even though its NBP was Rs 1,85,523 crore.
An interesting factoid from the draft prospectus is that LIC’s Embedded Value or EV, which was at Rs 95,605 crore in March 2021 shot up to Rs 5.39 lakh crore by September 2021. It is EV which will decide the pricing of LIC shares in its IPO, as Indian insurers are typically valued at 2-3 times their EV.
To arrive at the fair value of any stock in a normal line of business, we know that textbooks recommend either a Discounted Cash Flow or a Dividend Discount model. Both models project the stream of cash profits/dividend payouts that are likely to flow to shareholders over the life of the company and discount it to today’s prices using an assumed rate. For financial firms like banks, we use book value or adjusted net worth. An insurer’s EV combines both these measures.
To arrive at LIC’s EV, Milliman Advisors (the independent valuer) would’ve estimated profits likely to be left over for shareholders on LIC’s 40 crore existing polices until maturity, after deducting claim and maturity payouts from premiums. Making this projection requires many assumptions on customer persistency, claims, bonuses and so on. In LIC’s case, much of its EV of Rs 5.39 lakh crore is made up of the present value of future profits (Rs 5.31 lakh crore) and very little comes from its net worth (Rs 8203 crore). LIC’s EV has shot up sharply between March and September because it has bumped up the future profit share for shareholders, by dividing its so far single portfolio into two distinct ones for participating (where policyholders get most of the profit) and non-participating plans (where shareholders get most of the profit).
Importance of VNB
The EV captures shareholder profits from plans that are already in the insurers’ books. But what about the new policies it is adding to its kitty? The Value of New Business or VNB captures this. Given that Indian insurers enjoy high valuations mainly based on the fact that a very low proportion of the Indian population has an insurance cover, analysts often use a multiple pf VNB in addition to EV to value them.
For relative newbies, the present value of new business (PVNBP) is likely to be comparable to EV and VNB margins (VNB as a percentage of APE) likely to be high. But given its mammoth size, LIC’s case is different. For the six months ended September 30 2021, LIC reported VNB of Rs 1583 crore, VNB margins of 9.3 per cent and PVNBP of Rs 1.18 lakh crore.