New regulations to keep life insurance growth muted
19 Feb, 2014 01:01 PM
Private players’ opex ratios have fallen from 26% in FY09 to 19% in FY13.

The recent regulatory strictures from the Irda on traditional products may keep growth muted for the life insurance industry in the near term but the reduction in new business strain coupled with efforts on productivity and some help from surrender profits over the past three years have helped companies turn profitable, brokerage Edelweiss Securities said in a report.

In 2010, a deadly combo of regulatory upheavals along with challenging macro conditions spooked the hitherto dream-run enjoyed by insurance companies, with headline sales- premium of private players shrinking to 88% of FY11 (NBP shrinking to 78%). After gaining ground in the first eight-nine years post liberalisation, private players ceded ground to the incumbent, Life Insurance Corporation (LIC), leading to drop in the former’s market share from 57% in FY09 to 38% in FY13.

Another challenge private players had to brace was to realign their product portfolios in favour of traditional products from a ULIP heavy set up. Net-net, the domestic insurance industry, once touted as promising given the low penetration level of 4%, became more attractive with penetration further dropping to 3% .

Efforts were launched to realign business models to the new reality anchored by underlying theme of cutting flab (branches + agents) with unrelenting focus on improving productivity. As a result, private players’ opex ratios fell from 26% in FY09 to 19% in FY13.

The good news is the important vector of persistency received serious attention, leading to improvement in 13-month persistency for five out of seven private players. A reduction in new business strain coupled with efforts on productivity and some help from surrender profits over the past three years have helped companies turn profitable. This is resulting in wiping out of accumulated losses of most players, further bolstering solvency ratios. Also, the regulatory overhaul has ensured that products offer a much better value proposition—a long-term value driver, the brokerage said.

“Another positive emerging from the challenging phase has been reduced competitive intensity among players despite 24 companies vying for a minuscule pie given the capital burn. Top seven private players along with LIC continue to dominate 90% business,” it pointed out.

“We believe, a large part of regulatory actions, specifically on product-side are behind us; this, coupled with macro support factors: (1) interest rates have peaked and are gradually moving South; and (2) physical assets are already losing ground (gold, real estate), along with long-term structural factors still remaining intact—demographics, under penetration—imply that the industry will move towards steady state growth, which will inch up in the medium term to a more sustainable 12-15% on new business,” the brokerage said.

Accounting profits are likely to taper off in the interim, but return on embedded value will still remain robust given unwinding of in-force book coupled with declining cost overruns and operating variances. As stability returns, though at a lower but respectable level and RoE of high teens, the market will start ascribing higher valuation as large value is captured from stable EV (70%) against structural value which is susceptible to vagaries of new business growth.

“We value private sector players using appraisal value—a combination of EV and structural value (assigning multiple to new business value). EV forms a large part of the value, ensuring stability to valuation, especially in an environment which is moving towards stability in business growth. Assigning new business multiple varying between 10x and 14x, higher for players with strong bancassurance tieup, specifically HDFC Life, which warrants a higher multiple given its best-in-class operating metrics, we arrive at an appraisal value which translates into derived multiples of 1.3-1.7 times on EVs, a fair value for steady state ROEV of 12-15 per cent,” it said.

The brokerage said it has initiated coverage on Max India and Bajaj Finserv, which are the closest proxy to play the reviving fortunes of the domestic insurance industry.

"Max India is a play on underpenetrated segments—insurance, hospitals and health insurance. With strong business partners coupled with stabilisation phase setting in for all for the three key businesses, the company offers a valuable proposition. “We initiate coverage with ‘buy/sector putperformer’ recommendation/rating and target price of Rs 261 valued on a SOTP basis,” it said.

On Bajaj Finserv, the brokerage said the company offers an attractive investment opportunity for investors seeking exposure to the insurance sector and a rapidly growing lending business. Its key strengths are: (i) diversified play; (ii) focus on profitable growth; and (iii) strong parentage. “We value Bajaj Finserv at INR856 using SOTP. Additionally, we believe the company has a strong chance of getting a banking licence, which provides an upside risk to our estimates. We initiate coverage with ‘buy/sector outperformer’ recommendation/rating,” it added.
Source : Money Guru India

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