LIC offering is attractively priced

Significant growth potential, underestimated embedded value among positive

Life Insurance Corporation of India’s (LIC’S) IPO, the country’s biggestever initial offering, comes at a difficult time for many investors. The stock market’s bull run has been halted by the Ukraine war and lockdowns in China. Amid the uncertainty, the

IPO size has been scaled down.

Should retail investors participate? The short answer is ‘yes’.

The terms are generous and they will be even better for individual policyholders. The key valuation ratio for life insurers is the price-to-embedded value per share (P/EVPE).

Embedded value is the sum of the present value of expected future profits and an adjusted net asset value. For LIC, this was calculated to be around ~5.4 trillion as of December 2021. This is an underestimate because it controls an enormous amount of prime real estate. Also, the PSU has changed its policy on the percentage of transfer of surplus, which will benefit shareholders.

Adjustments aside, the P/EVPE at the top end of the IPO price band (~949) is 1.1x. This is well below the valuations of other listed life insurers — most trade at ratios of 3x or higher. If the individual is a policyholder, the discount of ~60 per share makes the valuation relatively attractive. Another point for consideration is that IPOS launched during phases when the secondary market is relatively weak give better long-term returns; the Nifty is down 8-9 per cent from its peak levels, so this is a factor.

LIC has many strengths in its excellent all-india footprint, brand recognition, and dominant market share. Its assets under management are three times that of rivals combined. The improved distribution of surplus ratio pleases the government, which retains a 96.5 per cent stake but it benefits all shareholders. The sector is expected to grow comfortably in double-digit percentages since India is still underpenetrated by insurance. India is 87 per cent “underprotected” — that is, life insurance covers only around 13 per cent of the assets it should protect.

But, aggressive private insurers have eaten into LIC’S market share. Its market share (based on premium) in group business declined from 81 per cent in 2015-16 to 74 per cent by December 2021 while in individual business, its market share has declined from 56 per cent to 43 per cent. This trend may continue.

LIC also has lower margins on its policies due to the high share (99 per cent) of policies not linked to the equity markets. Within this nonlinked segment, participating schemes with the distribution of bonus are around 61 per cent, further reducing profitability. Hence, LIC has a margin of around 10 per cent (2020-21), while most players have a 20 per cent margin or better.

LIC also has the lower short-term persistency ratio for policies (only 77 per cent go beyond 13th month). However, the long-term persistency ratio (over five years’ tenure for 62 per cent of policies) is better than competitors. It is pushing to improve the equity linkage ratio.

Insurers’ profit depends on what they do with their float — the premium collected which is not required to service expenses or claims. This is cheap long-term money. The LIC portfolio has 25 per cent equity exposure. The returns could be higher if LIC was not used as a piggy bank by the government.

In analogy to the banking sector where private banks trade at higher valuations, it is apparent why LIC receives a lower valuation. Investors must also reckon with follow-on issues since the government will probably try to divest more stake. However, taking all this into consideration, the IPO seems worth a subscription due to its low valuation.