THE VALUATION PUZZLE

The discovery of LIC’s embedded value (EV), which must precede the IPO, is a tricky exercise. Not only is the public sector life insurance behemoth unlike other financial services companies (like banks, NBFCs or mutual funds), for the purposes of a pre-IPO valuation, it’s not quite comparable with private sector life insurers either. If even other life insurers do not quite offer a reliable benchmark, it is mainly on account of LIC’s unique product mix and profit-sharing structure. Guesstimates of likely valuation vary between Rs 2-3 lakh crore and Rs 20 lakh crore— that wide range in itself an indication that the exercise is complex. It’s possibly a good start that the valuation mandate has gone to actuarial firm Milliman Advisors, which is among the world's largest providers of actuarial services.

PRESENT VALUE OF FUTURE PROFITS

Life insurance is a long-term business where the insurer receives recurring premium from policyholders over a period of five to 25 years (in the case of LIC). The valuation of such a revenue stream involves calculating the present value of future cash flows.

LIC’s product mix has a pronounced skew towards savings products—the socalled ‘endowment’ plans— which, unlike pure-insurance ‘term’ plans, have an investment element built in. LIC has thrived on these investment-cum-insurance plans—the allure of ‘bonuses’ and ‘guaranteed additions’ and a ‘sovereign guarantee’ to top it making them very popular with the risk-averse Indian investor. A key parameter in valuing LIC will be its product mix—because the profitability of a savings product is significantly higher than a pure protection plan.

Another factor that will critically determine the valuation is how the government alters the LIC Act of 1956. Of special interest in the context of valuation are proposed amendments to the unique profit-sharing commitment LIC has vis-àvis its policyholders. In the current dispensation, 95 per cent of the surplus goes to policyholders and only 5 per cent to the government, currently the lone shareholder. “The entire structure of LIC has to be revisited to make it more investor-friendly. If a major part of surpluses goes to policyholders, investors, especially institutions, will be wary of investing," says Ajay Sharma, managing director, Valuation Services (India) at Colliers International.