Budget proposals change the narrative for private life insurers

I MAJOR IMPACT As nearly 30–40 % of premium inflow draws support from tax incentives, private insurers stare at weak earnings growth in FY21

The life insurance sector felt an unprecedented jolt when the Union Budget introduced the new optional regime for personal income tax, which while lowering rates takes away most deductions and exemptions which individuals could avail for subscribing to insurance products.

A move, which could be particularly detrimental to private life insurance, saw stocks of HDFC Life, SBI Life, I CICI Prudential Life (I-pru Life) and Max Financial Services (holding company of Max Life Insurance) plunge 6–13 per cent on Saturday. “While the business for FY20 may be secure, there is now doubt on how much growth is ahead in FY21,” says Suresh Ganapathy of Macquarie Capital. His scepticism is shared by those in the industry as well.

According to estimates, 30 –40 per cent of new business is generated owing to tax benefits that investors avail from buying insurance products. “In certain cases, tax incentives drive nearly 50– 60 per cent of products sold and it (tax advantage) is an important tool to bring the young population to the savings fold and our businesses,” explains a senior executive of a private insurance company not wanting to be identified.

While for the next financial year, investors have an option to remain in the old tax slab and avail the existing deductions/exemptions, the larger risk is that of the old regime being discontinued in the near future. “It is directionally negative and is going to be tough to predict the growth trajectory,” says Nidhesh Jain of Investec Securities. Stocks in the sector could continue, hence, to remain under pressure in the near term.

What’s also bad is the timing of the blow. Seen as a proxy to capture the financialisation theme, despite valuations expanding by 40 – 60 per cent in a year, these stocks enjoy high investor interest. Before Saturday’s stock market carnage, SBI Life, HDFC Life, I-pru Life and Max Financial traded at 2–4.8x FY21 embedded value.

Given the tax changes, experts say, the fundamental premise may itself be tested in the coming months. In other words, the Street would get an estimate of how many investors pile on to insurance products purely from a savings/protection perspective and whether the sector has a leg of its own to stand, if a key pillar of support be withdrawn. Analysts at Credit Suisse believe that the valuations may shrink by 4–5 per cent for life insurance companies as a result of the new tax regime.

Analysts at Jefferies have for long had a contrarian call on the sector for this reason. They note that tax arbitrage on insurance products versus most other forms of financial savings is one of the primary drivers.

The other risk that the analysts point is cyclical competitiveness to fixed deposits. As per Jefferies, net returns offered to policyholder is 4 - 5.5 per cent under the "return-guarantee" plan and even less (post-tax) in annuities. “Their attractiveness exists only for the period until bank deposit rates are low. With the reversal of the rate cycle, (life insurance) products may not be able to compete with term deposits,” they add. Deposit rates have bottomed out, though banks believe they may not have further room to reduce rates.

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“With revenue growth getting challenged, it casts doubts over near- to even long-term earnings momentum of life insurers and hence their appeal among investors is likely to reduce, going forward,” says Vineeta Sharma, head of research, Narnolia Financial Advisors. She says listing of Life Insurance Corporation (LIC) in FY21 would also put pressure on stocks of private life insurers as investor interest could shrink a bit.

Analysts say that with the impact of the new tax regime on life insurers businesses currently an unknown, early investors into the sector could consider booking gains. “When the regulatory changes happened for unit-linked insurance products in 2010, it shook the mutual funds industry. This (new tax regime) isn’t as much a shock, but good enough to disrupt the show,” say an analyst from a foreign brokerage.

Large brokerages say that while they may not turn completely pessimistic just yet, they would not advice clients to take fresh exposure in these stocks.

“Investors should not be trapped by valuations even if the sector soon turns attractive,” says a research head of a foreign brokerage.