The life insurance industry has been abuzz with mergers and acquisition activity in the last couple of months, and this could change the structure of the business in India.

First came the intentions of HDFC and ICICI Bank to list their respective insurance subsidiaries — HDFC Standard Life and ICICI Prudential Life. Both their boards gave an in-principle nod for listing these entities by the end of this fiscal.

But HDFC soon came out with another announcement that it was looking at an amalgamation scheme for HDFC Standard Life with Max Life Insurance and put its IPO plans on hold until the due diligence of the deal is done.

On June 21, Bank of India reduced its stake (to 30 per cent) in its life insurance JV, Star Union Dai-ichi Life Insurance Company, by selling 18 per cent of its stake to JV partner Dai-ichi Life, for about ₹540 crore.

Valuation of a life insurance company has its own set of variables to be assayed.On the insurance IPOs on the anvil, experts say there is sense in unlocking some value.

Abhishek Bhattacharya, Co-Head and Director–Financial Institutions, India Ratings and Research, said: “These businesses were built with the purpose that some of it (value) should be realised. The caveat here is some of these players have matured. 

“And when you are mature you would have put in slightly more cost/investment into people, into commissions, you would have a more steady scale model and maybe slightly more compressed margins today. Valuations are sensitive to parameters such as persistency ratios. Even a 10 percentage point change from, say, 60 to 70 could drastically change your valuation.”

“When you value an insurance company, it is based on the franchise value. Franchise value is embedded value (EV) plus structural value (SV), says Jyoti Vaswani, CIO, Future Generali Life Insurance.

“Embedded value is the value of my current book.  So, if I have ‘x’ amount of business as of today, I project my future profits from this business, discount it back and get embedded value plus my net worth sitting in the books currently (total assets minus total liabilities). It is the value of in-force business. This is what we call as embedded value.

 “When you are taking embedded value you are assuming that this book remains as it is and there is no growth in the future. So you have to have a structural value as well. You have to project what new business will come in for the next 10/20/30 years, project profits of that and discount it to arrive at a structural value. So that is called the franchise value,” Vaswani adds.

Franchise value is embedded value plus structural value, which gives the value of the firm — the life insurance company. 

Cost side According to Bhattacharya, “There are two big pieces to the cost side — one is the agent commission and second is the opex (operational expenditure), which is not much after the initial year. After the initial year, you just allocate certain percentages. 

“Also, you can estimate using market share today. The valuation of the insurance sector is pegged at anywhere between $45 billion and $80 billion. You can make a sense of how much this player can grow in terms of market share — if it’s a 2.5-3 per cent market-share player and expected to go up to 5 per cent, you ascribe some value. So that is another approach.”

Ratios On the ratios that need to be tracked, Sampath Reddy CIO Bajaj Allianz Life Insurance Company says business growth, mortality ratio and persistency ratio are important.

 “If a company has risky clients, then it would not receive a higher valuation multiple because mortality ratio determines the insurer’s underwriting profits. Similarly, higher the persistency ratio better is the insurer’s profit and better is the multiple. Expense ratio is important because expenses eat into the NBAP (new business achieved profits) margins.”

According to the Head of Research at an MNC brokerage, “The debate is what should be the NBAP margin and what should be the multiple. NBAP margins vary according to the type of products sold by the insurer. What level of disclosure would do is also yet to evolve.”

Other nuances “But there are challenges. For example, if it is a young company which has just started business, the EV will be low and SV will be high. Value of in-force business will be lower and growth potential will be higher. In a mature business, it will be the reverse.

“So typically the deals that have happened in India so far have happened at a multiple of EV, typically at 3-3.5 times the EV,” says Vaswani.

“Those who use technology are likely to do well in the long run as it is important to reduce cost of intermediation. Industry is moving towards the bancassurance model and away from the agent model. In the last five-seven years bancassurance has picked up momentum and now commands about 60 per cent of the business,” says Reddy.

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